Shadow taxes part 1: Income Tested Benefits - What are they and why are they costing you THOUSANDS of dollars in lost tax.

One of the common discussions I have with my families who have multiple children and are on their way from a wealth and savings standpoint is the impact of certain benefits like the Canada Child Benefit. There are many others that come into play in the low to middle income bands (Ex. Ontario child benefit, Trillium benefit, etc) and often are too many to fully keep track of. This is why advisors or planners will often say “it depends”.

Canada Child Benefit quickly explained

The Canada Child Benefit is an “income tested benefit” based on the number of children you have. It get’s the term “income tested” because the amount of dollars you receive is directly related to your household income. Specifically the “adjusted net family income”.

You can find more about the Canada Child Benefit (CCB) here: https://www.canada.ca/en/revenue-agency/services/child-family-benefits/canada-child-benefit-overview/canada-child-benefit-we-calculate-your-ccb.html

The key though is that in all these cases – the CCB is reduced based on each additional dollar you earn. See this screenshot as an example:

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For all intents and purposes – this functions as an additional “tax”. Depending on the family income situation – quite a large one.

For a family with 3 children – there are scenarios where potentially this 19% + the 29.65% at say 70K of income (In Ontario) means the “effective tax rate” is AT LEAST 48.65%. With 4 kids – the clawback is higher at 23% but also with 2 kids or 1 kid it’s lower and at the higher income band – there is a different lower claw back rate. All that to say – it depends.

Notice however – that I said “at least” 48.65%. The reason is – at times there are a plethora of other different tiny income tested credits that can come into play that warp the tax rates.

There are too many to legitimately list out here but the key point is being aware of the ones that affect your main clientele is important. A lot of my clients have early in their career qualified for some amount of the Canada Child Benefit (and it’s affected me) so I keep a close eye on it.

This is important to note though because there are other benefits that sometimes will come into play for middle income households such as the RDSP. The government grants for the RDSP are tied to the amount of household income generated.

At middle to lower income there are a plethora of benefits such as Ontario Trillium Benefit, Ontario Child Benefit, GST/HST rebate, etc. I have a client where they qualify for the adoption subsidy which is as much as $1000 a month per child and it's an all or nothing benefit! (If your income is too high - all $12K is just GONE).

So why is this so important that you are talking about it during RRSP season?

Conventional rules of thumb usually discuss only the income tax brackets and the marginal tax bracket now vs the marginal tax bracket at retirement. If your marginal tax bracket is higher today - then it makes sense to contribute to an RRSP. If your Marginal tax bracket is lower today - then a TFSA may make sense instead.

For a lot of "lower" or middle income families however - the existence of these benefits which function like a tax means the "effective tax rate" is potentially a lot higher than people realize.

This means - when people choose to contribute to their TFSA instead of their RRSP (think about the 48% example for someone making 70K) - they are often choosing to take a higher tax rate than they realize. When you fast forward to retirement and realize these parents will retire at a 20% or maybe 30% bracket at most - you realize there is a sizeable spread there in lost taxes.

This is an additional tax of THOUSANDS of dollars when you think about it. It's a big assumption but based on even $5000 annually to a TFSA - over 15 years (since this is predominantly during a child's life these rates exist) - that difference of 48% to 30% means 18% in additional tax or $900 a year. Over 15 years that is $13,500 in tax lost (plus the compounding of said tax dollars over time).

Assuming this couple retires at a 20% bracket then the % tax savings is 28% or $1,400 per year. That's $21,000 over the course of 15 years and all the lost compounding associated with that.

My key takeaway?

Not understanding your effective marginal tax rate is costing you THOUSANDS of dollars in lost tax.