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Marginal Tax Rates

You’ve likely heard the term “Marginal Tax Rate” a number of times (I’ve even dropped it previously on this blog), and wondered what it meant.

By definition: your marginal tax rate is defined as “the rate of tax on your last dollar of income”.

Because in Canada, there’s no flat income tax rate across all ranges of incomes your marginal tax rate will vary depending on what your salary is, and what province you live in.

It’s a somewhat complicated calculation, but thankfully there’s many tools out there to help you.  Ernst & Young’s 2009 Personal tax calculator is a great resource (among many others on their site).

So why is knowing your marginal tax rate important?  Well, one applcation relates to my RRSP articles from last week:  If you withdraw funds from your RRSP without taking advantage of a program like the Homebuyer’s Plan, or the Lifelong Learning Plan, these funds are taxed as income at your marginal tax rate.

Now to an example!

Let’s say that I live in Quebec, earn $59,000 per year, and am considering withdrawing some money from my RRSP to buy a boat.  Before I do this, I should find out what my marginal tax rate is to see if this is really a good idea.

I visit the calculator, plug in my salary, hit Calculate and find that my marginal tax rate is a whopping 38.37%!

The boat I want to purchase costs $15,000. (It’s a nice boat)  Keeping in mind that I’ll have to pay 38.37% tax on my withdrawl, I calculate:

B = the amount I need to withdraw to buy my boat

B – 38.37% = $15,000

B – (B * 0.3837) = $15,000

0.6163 B = $15,000

B = $15,000 / 0.6163

B = $24,338.80

Note: Hopefully I didn’t lose anyone here, but I know that not everyone is mathematically inclined.  If you’d like a nice formula for doing this calculation it’s:

After Tax Cost = Price / (1 - marginal tax rate)

If I withdraw money from my RRSP to buy my $15,000 boat, it’s going to end up costing me $24,338.80!  This is likely a very bad idea, and I should probably just save the money and buy my boat next summer instead.

But now I know the implications of withdrawing funds from an RRSP!…