Marginal Tax Rate Explained

Your marginal tax rate is the tax you pay on your last dollar of income, and more importantly for tax planning, what you’ll likely pay on your next dollar earned. Since Canada operates on tax brackets, you will pay more tax when you earn more. But you can also use these rates to your advantage, by planning ahead with RRSPs and other steps to reduce your taxes. Marginal tax rate should not be confused with your average tax rate, which is simply the amount of tax you pay divided by your income.

What Is Your Marginal Tax Rate?

To show how these tax rates work, I’m using the combined federal and Alberta rates for 2010. While your province may have different tax brackets and tax rates, Alberta has a flat provincial tax of 10% and will give you an idea of how marginal tax rates work. For the tax rates in your province, you can find all marginal tax rates at TaxTips.ca. Technically the first tax bracket is $0 to $40,970, but I’ve included the effect on marginal tax rate from the federal basic personal amount of $10,382 and the Alberta basic personal amount of $16,825.

  • Up to $10,382 – tax rate of 0%
  • $10,383 to $16,825 – tax rate of 15%
  • $16,826 to $40,970 – tax rate of 25%
  • $40,971 to $81,941 – tax rate of 32%
  • $81,942 to $127,021 – tax rate of 36%
  • above $127,022 – tax rate of 39%

So if you lived in Alberta and made $40,000, your marginal tax rate would be 25%. But what if you were to get a $5,000 raise? Then you would be in the next tax bracket and paying 32% on that final $4,030. Knowing this is how you can best work towards reducing your taxes.

Investing In RRSPs Based On Marginal Tax Rate

Sticking with the example above, it might make sense to put $4,030 into an RRSP since you would get $1,290 back on your tax refund. However, putting any more into an RRSP that year may not be best since you would only get 25% back, not 32%. While getting a 25% tax deduction might sound better than nothing, you need to look at what you expect to earn in retirement.

While you would be making $45,000 in this example, and will likely make more in future years, you would likely need less money in retirement. With the house paid off, children moved out, and no longer needing to put money money away for retirement, you may be able to withdraw less than $40,970 (or its equivalent whenever your retire). This is when an RRSP works best, when you can get a a larger tax deduction from contributing and pay a lower income tax in retirement. Knowing your marginal tax rate, now and in retirement, is how you can get the most from your RRSP.

Written by Tom Drake

Tom Drake is the owner and head writer of Canadian Finance Blog. While you’re here, consider signing up for the RSS feed or email subscription. Both deliver the latest articles directly to you everyday! Have a Twitter account? Then follow me for all the latest posts or to send me any comments or questions!

3 Responses to Marginal Tax Rate Explained

  1. I am so glad you posted this. I am so tired of seeing people write articles about tax savings, and they treat the marginal rate as if it’s the effective rate. By doing this, they overstate the tax benefit of certain purchase (mortgage interest for example).

    This should clear up any confusion.

  2. Bryan@turbotax says:

    Again you have some great advice here, but I really wish I could find a blog in the USA that was as comprehensive… oh well, it wouldn’t be so bad to just move to Canada!

  3. Igor Maystrenko says:

    Marginal tax rate – Is it the tax on net income, after deductions, on the taxation form or is it tax on your total income before any deductions, on the tax form.

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