I have been writing on this blog for almost nine years. Over that time, I have learned and gained a lot of personal finance and investing-related knowledge. Whenever I gain new knowledge, I try to share it on this blog with the hope that readers can gain the same understanding as well.
As much as I love sharing new knowledge with other people, there seem to be some deep-rooted misunderstandings, myths, or misconceptions on certain topics. I really don’t understand why some people have these misconceptions and I will try my best to debunk some of the common misconceptions I have encountered, just so I don’t have to keep ripping my hair out.
#1 Don’t want a raise to avoid the next tax bracket
Our tax system is extremely complicated, so I understand there are some misunderstandings here and there. The biggest misunderstanding is that all your income is taxed at your tax marginal rate.
Due to this misunderstanding, people often make such statements like…
“I don’t want a raise just to get taxed more.”
“I am not working overtime to get bumped to the next bracket and lose my income to taxes.”
And so on…
But that’s a very very wrong understanding. Your income is taxed on a tiered bracket system. Below are the 2022 federal tax brackets.
|Taxable Income – 2022 Brackets||Tax Rate|
|$0 to $43,070||5.06%|
|$43,070.01 to $86,141||7.70%|
|$86,141.01 to $98,901||10.50%|
|$98,901.01 to $120,094||12.29%|
|$120,094.01 to $162,832||14.70%|
|$162,832.01 to $227,091||16.80%|
So if you happen to make $90,000 a year, the entire amount does not get taxed at 12.29% tax rate. The first $43,070 is taxed at 5.06%, then the next $43,070.99 is taxed at 7.7%, then the rest is taxed at 10.50%.
Essentially your $90,000 annual income is taxed like below:
|Income||Tax Rate||Tax amount|
You’d be paying a total of $5,901.00 of federal tax on your $90,000 income, or an effective average tax rate of $6.56%. The same tiered tax bracket system is applicable to provincial taxes as well, albeit with different specific percentages for each province.
So no, the $90,000 you received isn’t all taxed at 10.50%. The amount is divided up and taxed at different tax rates.
What if you had an income of $90,000 and your employer decided to give you a $35,000 raise? Should you say no because you’ll move up two tax brackets federally from 10.5% to 14.7% and get taxed way more than your $35k raise?
It’s mind-boggling that some people actually believe this is the case and therefore would say no to any raises!!! Let’s do some quick and easy math to sort this out.
I ran the numbers using Wealthsimple’s 2022 income tax calculator and set BC as the province. Here’s the summary:
|Income||Federal Tax||Provincial Tax (BC)||CPP/EI||Net|
So, an increase of $35k a year raised your total taxes by $12,744 a year. More importantly, you will be netting $22,266 more than you’d have at the lower income of $90,000 a year.
So ask yourself, would you rather pay almost $13k more in taxes while pocketing over $22k more each year? Or would you rather not get the extra money at all? I think 99.9% of the population – if not more – would want the former.
All things equal, you will always come out ahead with a raise regardless of what tax bracket you end up with.
Fortunately, people that have this misconception are a very small percentage of the population.
#2 “Invest” in RRSP
Every February I hear statements in the line of… “I’m investing in my RRSP.” But when I ask for more clarification, I learn that people are simply transferring money into their RRSPs and letting that money sit in cash. They’re moving money into RRSP simply for the RRSP income tax deduction.
I get the idea of getting the RRSP tax deduction to reduce your overall taxes. But don’t you want your money to compound and grow? Why do you have your money sit inside a tax-deferred account and earn a measly 1% interest rate when you can invest in things like ETFs and stocks?
Some people argue that GICs are way safer than other investment vehicles like mutual funds, ETFs, and stocks because GICs have a guaranteed earning rate and you can’t lose money.
If you “invest” $10,000 into your RRSP and earn 1%, you’d get $100 extra a year. But that won’t do you any good when the inflation rate is at 6%. In fact, you’re actually losing 5% of your purchasing power each year.
So don’t just transfer money into your RRSP and let it sit there. Invest in something that will actually compound and increase your purchasing power.
Take advantage of your RRSP.
#3. TFSA is for short term savings only…so gotta invest in GICs only
This misunderstanding drives me absolutely bananas. TFSA stands for Tax Free Savings Account, but just like my previous point, it doesn’t mean you should invest in GICs only. And stop thinking that TFSA is only for short term savings only, start using your TFSA as a retirement account!
To get my point across more clearly, let’s consider the following:
Imagine you just became eligible to open up a TFSA this year, so you opened up a TFSA and transferred $6,000. Let’s pretend that one of the financial institutions offers a 30-year GIC at a rate of 5%. should you lock your money in for 30 years of guaranteed return?
Or should you invest your money in a broad market passive index ETF that alternates between a 20% return one year and a -5% return the year after for 30 years?
The math turns out like this…
|Year||GIC Amount||ETF Amount|
In the GIC case, you’d end up with $25,931.65 after 30 years, or an increase of $19,931.65, whereas in the ETF scenario, you’d end up with $42,827.63, or an increase of $36,827.63.
Even though half of the time the ETF has a return of -5%, the other 15 good years, were more than enough to make it the superior investment choice., tt ends up with an average annual return of 7.5%. This is roughly about the long term historical return of the stock market. Thanks to the 7.5% average return, the ETF came out ahead of the GIC by almost $17,000.
Therefore, do consider the GIC rates in comparison to the historical stock market return average. A few more things to keep in mind. One, once you lock yourself into a GIC, if you take out the money before the time is up, you may lose all the interest entirely. Meanwhile, with ETF you can sell at any time to lock in the gains. Second, the entire interest made from a GIC is taxed at your marginal tax rate while if you sell an ETF and have a capital gain, only 50% of the gain is taxed at your marginal tax rate. In other words, capital gains from an ETF is much more tax efficient than GIC interests.
Just for fun, what if the GIC has a 30 year rate of 8% while the ETF returns 21% for the first 15 years then performs poorly at -5% for the last 15 years for an average return of 8%?
|Year||GIC Amount||ETF Amount|
In this case, the GIC comes out ahead. But I’d argue if GIC offers a rate of 8%, the stock market probably would return at a higher average percentage. Furthermore, you’d probably be paying way more in terms of overall taxes with GIC than with ETF…. but without crunching the numbers, those are just pure speculations on my part.
Summary – 3 things that make me pull my hair out
There you have it, these are three things that make me want to rip my hair out and drive me nuts. I hope I have explained the concepts well enough to straighten these misunderstandings.
What do I hope you get out of this post?
First of all, it is almost always better to earn more money and pay a little extra taxes than not earning more money. Second, you should consider how to invest your money in your tax-deferred and tax-advantaged accounts. An extra 1% in return can go a long way when compounded over decades.
Dear readers, what are some personal finance and investment related misconceptions that drive you insane? I’d love to hear yours.
18 thoughts on “3 things that make me pull my hair out”
I know a few people who have a large chunk of money in a savings account at 1% interest. They feel learning about investing is “too hard” but then refuse to pay (reasonable) fees to have a professional build a financial plan and invest their money instead. They wring their hands and complain about inflation while their money sits there month after month doing less than nothing. Even a GIC would be better if they ever got around to setting one up!
‘Invest’ in RRSP is a good one. Makes ms think of people ‘investing’ in cars, bags and other depreciating goods.
Thanks for sharing your Top 3
I love your newsletters and appreciate the fact that you take the time to write them. I am afraid federal income tax rates for 2022 are higher than what you have indicated. You may see them here, scroll down to Step 5 Federal tax. Sorry I cannot post a screenshot.
Thanks for pointing this out, I see what I did here. I quoted the BC tax rates instead of the federal tax rates. Regardless, the same logic still applies… You’re better off making more money and move up to the next bracket than paying no to more income.
For years we’ve been buying RRSPs in mutual funds. However since we’ll be retiring next year we decided to buy GICs this year. We were able to get a 5 year ladder GIC with rates between 5.25 and 4.85. I think given our situation it was the right fit. The markets in the last year took a big chunk out of our RRSPs and it’s going to take a while for them to come back.
Given you’re close to retirement, that sound like the right move.
i agree! i’m not an investing guru or anything but these simple investment rules are pretty basic – i can’t understand why people don’t get it.
Unfortunately finances can be confusing. This is where more education can help.
Hi Bob, I have a question if you have looked at covered call ETFs or closed ended ETFs. I know you are a dividend investor which I really like but you hear so much noise these days, I am curious on your take. In terms of your current article, I have heard many people saying that they don’t want to make more money because they don’t want to pay any additional money to the government.
As always, I look forward to your blog on Mondays!!
Please see here
Agree mostly for long term but for the short term over the last 9 months 80% of my cash has been going into brokerage GIC / MM like CMR for Canadian side and money market ETF like BIL on US side RRSP/ TFSA
I couldn’t resist though picking up some PRU today for US side and CM for Canadian side with the bank crisis going on.
The banks are looking interesting at the recent prices.
Can you please help us understand (pros and cons) of Auto-Callable notes as a steady stream of income for high net worth individuals. Generally speaking of auto-callable notes of Canadian banks.
It probably require a dedicated post than just a quick comment. Can’t say I’m the expert on auto callable notes though. We’ll see what I can do on a post later.
Unrelated question- I am curious on your thoughts of the First Time Home Buyers Incentive, and where one should invest the $8k (max contribution for the year) if they plan on using it in the next few months to end of the year. Something safe yet effective to see some gains. Thanks!
If you want to use the money in a few months, best to put that money in GIC or money market. Open the First time Home Buyers Incentive and put the money in a safe invest seems to make sense of you’re planning to buy a place in a few months time.
Bob, your 1st one really hit home with my husband & I, in fact I had to share with our adult kids! It wasn’t until late in our income earning years that we learned that! We used to question his overtime hours and whether it was worth it ( yes he was heavily taxed on his cheque at the time) but at tax time his income levels were taxed accordingly & yes the OT was worth it. I’m glad we set our kids straight on this at a young age, thanks to you!
A lot of people get confused with the tax brackets, unfortunately. It’s good to make more money.