How Taxes Affect Your Income and Investments
Part 1 of 2-Part Series
For most us, putting our heads down and working hard in our careers is how we’ve managed to put away some money in the savings account. There’s no secret formula to it, and it will likely continue to bear fruit as long as we continue to do it. It’s what we’re comfortable with and very low risk, so all in all in a great strategy. But if we really want to grow our hard-earned dollars, there comes a time to venture out into the world of investments and take a few more risks. But before you do, don’t forget that the money we earn is all taxed and it’s not a one size fit all system. So even though a certain investment may bring greater profits, it may not be more after taxes. Now it’s time to work smart, and a basic understanding of the different ways of earning income goes a long way in maximizing the growth of our money.
Employment income is what we discussed above, when we work a job and earn a salary for it. Simple enough. Interest income is based on the principle of lending and borrowing. When we lend our money, the borrower pays the interest and this amount we gain is considered income. Some common examples of this would be investing in bonds and GIC’s and while we might not have thought of it as lending money, technically that’s what you’re doing. Capital gains is most easily understood as buying an asset, selling it and making a profit off of that sale. Buying and selling real estate is most often thought of when discussing capital gains, but assets can also be stocks, works of art, memorabilia and anything else considered an investment. Dividends come into play when you are a shareholder; you own a percentage of a company, or shares. As the company makes profit, this is divided among the shareholders according to your individual percentages owned and paid out. This divided profit is considered income, hence the name dividends. There are different ways to own shares, but for the vast majority of us, it’s what we bought into by investing that money in our savings account into the aforementioned company.
Each type of income has its pros and cons, and one of the most important aspects of income to understand is how it’s taxed. Nearly all forms of income we can earn we have to pay tax to the government, but they each have different regulations and tax rates. The less tax we pay on our income, the more we keep in our pocket and who doesn’t want that?!
The first part to explore when it comes to paying taxes are what’s known as tax bracket rates or the percentage of tax you pay based on your income earned. In Canada we use a progressive or graduated tax system in which the more money we earn, the more taxes we pay. There’s both a federal and provincial tax to be taken from your income and both have tax bracket rates in which the same progressive system is used wth slightly different rates. Any money you make from any kind of work or investment is considered income and is taxable. All your different income streams are added up and this total number is what determines your tax bracket. However the different income streams may not be taxed the same way, and we will explore this in the next part of this series!