What are marginal and average tax rates, and how might you set up an income plan to get the best tax results? Well I’m no expert, but here is my understanding. There is a progressive system of income tax in Canada. Basically, the more you make, the more you pay. For the purpose of calculating income taxes, there are various tiers with lower and upper income thresholds. These income tiers and thresholds are commonly termed “income tax brackets” and the tax rates associated within these income thresholds are termed “marginal tax rates”. The income thresholds and marginal tax rates can change year to year to account for inflation and government needs for your tax dollars. For example, income tax was increased in 2024 by 4.7% across the board, and while the marginal tax rates were unchanged, the income thresholds were lowered to make this change. Your marginal tax rate is basically the tax rate on your last taxable dollar of income. The blended marginal tax rates are made up of federal and provincial tax. The federal income tax is consistent across every province, however provincial income tax can vary, therefore income taxation is slightly different in every province. Federal tax forms the majority of the blended tax.
For the purpose of explaining tax rates, I will use the province of British Columbia (BC) as an example, as it is the province I currently live in. The tiers and thresholds for BC’s blended income taxation are listed below.
BC 2023 blended federal and provincial tax rates
20.06% between $0 and $45,654
22.70% between $45,654 and $53,359
28.20% between $53,359 and $91,310
31.00% between $91,310 and $104,835
32.79% between $104,835 and $106,717
38.29% between $106,717 and $127,299
40.70% between $127,299 and $165,430
44.02% between $165,430 and $172,602
46.12% between $172,602 and $235,675
49.80% between $235,675 and $240,716
53.50% between $240,716 and above
Also, different income sources are taxed differently. Regular income is taxed at the marginal rates, while some other sources, like dividends and capital gains, recieve preferential treatment. As your taxable income from all sources moves into the higher thresholds, you pay marginally more tax. These margins, with their lower and upper thresholds, form the marginal tax rates.
The average income tax rate, however, is defined as the overall tax you are required to pay divided by your taxable income. Couples with the ability to split income will often calculate the average rate for the household, even though they are technically taxed individually.
As you can see above, the blended income tax rates (federal plus provincial) increases as your income meets and is between certain thresholds. To reiterate, these rates are different in every province. The tax rates apply to all sources of income. Your total income from all sources minus any personal exemptions, credits, and deductions results is your taxable income. Your taxable income vs the tax brackets is what you’ll pay in tax.
Dividend income is grossed up by a factor before the tax credit is calculated. This calculation is applied differently for eligible and non-eligible dividends, with the more beneficial tax credit being given to eligible benefits. Eligible dividends are usually those paid by large Canadian companies, and ineligible dividends are those paid by small Canadian controlled private companies benefiting from lower corporate tax rates, as well as foreign companies. If you have eligible dividends, the effect of the gross up calculation on dividend income can reduce your average tax rate on total taxable income significantly. This is the government’s way of being fair, as they do not want to double-dip the taxes that corporations have already paid against their earnings, as this is where your dividends come from.
On capital gains, you will pay the marginal rate on half the capital gains. The CRA highly favors Canadians investing in (Canada) eligible shares. You just need to be sure they are eligible if you want to collect on this added benefit. This is why Canadian retirees prefer to have a good chunk of eligible dividends in their taxable investment accounts, and as they transition out of registered accounts are willing to overweight the Canadian content in their portfolios to get the maximum tax benefits. Personally, we have 100% eligible shares in our taxable joint investment account, and all the higher tax products in our tax-deferred and tax-free accounts.
Using an online 2023 tax calculator for my province, BC, let’s take and example of $50,000 in other income (e.g. from RIFs and LIFs), $20,000 in eligible dividends from a taxable account, and $20,000 in capital gains from a taxable account, for a total gross income of $90,000 (shown below).
NOTE - if it was $60,000 in other income and $30,000 in dividends the tax effect would be close to the same.
In this regard, you can see the benefit of eligible dividends and capital gains from Canadian corporations in your taxable accounts. If this $90,000 was all subject to marginal tax rates without the benefit of any credits the average tax rate would be much higher (+$8500), also shown below.
NOTE - these are just tax estimates based on standard inputs, and do not take every credit, deduction, etc into account that you may have coming to you.
If you own Canadian REITs, they are taxed separately and differently again. REITs pay distributions. These distributions are made up of a mix of capital gains, return on capital, other income, and possibly a small amount of dividends and foreign income. Exact tax treatment of REITs usually changes year to year due to these varying factors. You’ll want to have a look at the makeup of distributions within your REIT to understand the full tax implications, as all REITs are not taxed the same. You can research the fund’s breakdown to understand this. If regular income forms the majority of the distribution, you will pay tax at your marginal rate on that income, while if the capital returns are higher, they are taxed more favorably, providing the REIT holds sovereign properties.
Canadian interest bearing investments pay the highest tax in taxable accounts, and will be taxed at your marginal rate.
It’s notable to highlight that if you hold foreign investments in taxable accounts, these may be taxed even higher, as they pay tax in their own countries, plus pay tax on income in Canada. To offset this potential “double-dipping” on tax, there is a foreign tax credit available to Canadians if covered by tax treaties, but these credits may not cover all of the tax implications.
The good news, if you hold any of these investments inside a registered account you will not pay tax on any income from those investments, at least, not until they are withdrawn. When withdrawn, for example, from an RRSP, you will pay tax on the taxable income at your marginal rates.
See a previous article I wrote called “FHSA vs TFSA vs RRSP vs RESP” to understand the tax-fighting properties of Canadian registered accounts.
As a retiree, the less you have in overall expenses, obviously the less income is required and the easier it becomes to stay in lower tax brackets. The ability to split pensions, receive pension credits, and split RRIF income between spouses can significantly help lower your overall tax, although this option is not allowed until the primary earner turns 65. There are various other tax credits and tax deductions available ie for disabilities, medical, and education expenses, and you should review your elegibility for all of them and use them if applicable.
At the end of the day, every retiree should be working towards a few goals with their retirement income plans.
1) to make your income cover your planned expenses til death,
2) to get your money out of registered accounts during your lifespan, or the surviving spouse’s lifespan,
3) to withdraw your income in the most tax-efficient way, and finally,
4) to enjoy your retirement to the fullest!!!
A lot of retirees forget to do #4, and at the expense of retirement joy, have a very hard time transitioning to the withdrawal stages of retirement. They have had so much joy from saving and investing and growing their portfolios, they cannot wrap their monkey brains around declining retirement account (ie LIFs and RRSP/RIFs) balances. Some retirees overly focus on #3, and refuse to spend more than the minimum tax thresholds, even though they can afford it and much more. They scrimp through their 60s and early 70s, only to find later in life that they’ve held on to too much cash with deferred taxes, which will be subject to forced and increasing withdrawal amounts and heavily taxed as they age. They may also find at some point they lose the benefit of income splitting because they waited too long and one spouse passes away. This is the case with LIFs and RIFs, as the amounts you have to take out are forced and as you age these amounts grow and grow, so it’s advantageous to get more money out earlier in many cases, especially if you hold a lot of value in these accounts. If you don’t, and your income gets too high in later stages of life, you may find the CRA also clawing back your CPP and OAS payments when these kick in.
The easiest way to explain the impact of dying with too much money, is if you die with $1mm dollars in tax-deferred accounts like LIFs, RRSPs, or RIFs, then in British Columbia, 53.5%, or more than half, will go towards income tax when your final tax return is filed unless you have a surviving spouse to transfer the money to. But remember, the surviving spouse may still have the same problem of getting rid of that money before they die unless longevity is in their favour. The point here is it is a lot of money that could have been taken out between 20% and 35% tax, and spent, gifted, moved somewhere else (taxable), or donated. If you take it out and put it in taxable accounts and eligible shares, it pays preferential tax and won’t be subject to the effects of the crazy high taxes associated with collapsing +$200k in RIFs and LIFs in an estate settlement. It might be subject to capital losses when disposed of in an estate settlement, but if you pick stable, blue-chip investments, it’s more likely there will be modest capital gains to deal with.
You’ll want to understand how all these different sources of income are taxed to be tax efficient with both your retirement withdrawals and any future investments.