Your marginal tax rate (MTR) is the amount of income tax imposed on your next dollar of earned income. In a progressive tax system, if you can lower the amount of taxable income, you may be able to lower your MTR. If you increase your taxable income, you may increase your MTR. As a result, your investment activities and accounts will both affect, and be affected by, your MTR.
Knowing your MTR is important when considering an RRSP contribution. In which tax bracket does your taxable income fall? Making a contribution into an RRSP effectively removes the same amount off your taxable income (because you get a tax refund). Therefore, you can calculate the amount your tax refund will be, or conversely, the amount you won’t get back if you don’t make the contribution.
An RRSP is not an investment. It’s an account into which you put cash and then purchase investments with the cash. You can have the same investment (that is, a stock or a mutual fund) inside or outside an RRSP. The only difference is the RRSP generates a tax refund when the initial money was contributed and there are no ongoing taxes on the investment income. At withdrawal, you’re taxed at your marginal tax rate on every dollar taken out.
Investments held outside a registered plan are referred to as non-registered or taxable investments. The income (such as interest and dividends) is taxed when received or accrued. Capital gains from these investments are taxable when an investment is liquidated but not the amount of money originally invested as it is considered “tax-paid”.
Examples of taxable investments include:
Life insurance is often represented as a tax shelter, since it is assumed the proceeds are received tax-free. However, you should take note of the following: