Episode #63: How Millionaires Are Paying Less Tax Than You
We’ve all heard that millionaires pay less tax than us, and we’ve also all heard the stories of the incredibly wealthy people who were caught for tax fraud, tax evasion, insider trading, and generally doing sketchy things with money. These stories, combined with the very damaging rhetoric we’ve developed of villanizing ‘the rich’, have created tan overall idea that tonnes of wealthy people pay less tax than you do because they’re managing their money illegally, but this actually could not be farther from the truth!
The truth is (even though many people don’t like to hear it), the tax code we use has been written in such a way as to benefit wealthy people BUT the same rules of this tax code are available to all of us to reduce the amount of tax we have to pay as well. The vast majority of people never do this though because they don’t understand how the tax code works, and never realize they need to take it upon themselves to learn. (I would LOVE to see a day where we’re taught this vital skill in school, but until then I’ll have to keep advocating for self education to be the next best thing.)
Is the way that the tax code is currently written fair? No. Is that a good reason not to use the code to your advantage? Also no. We all have the same rules, so let’s learn to play by them to start leveling the financial playing field. .
So, why is it that a millionaire who is earning more money than you every year, is probably paying a lower percentage of their income to taxes than you are? The very first thing to know is that traditional employment income pays more tax than almost any other form of income in Canada. This means that if you’re earning a traditional paycheck, from a traditional job, you’re paying one of the highest percentages of tax dollar for dollar, in the form of income tax.
Again, is this fair? No. How can you work with it? You need to follow the example of wealthy people, and diversify your income streams to start earning money in ways that are taxed at a lower percentage. This will have the dual effect of bringing in more income to your life, AND you’ll pay less tax on that income than you would if you just got a regular raise from your traditional job.
Some of these forms of ‘alternative income’ that pay less tax are: income earned through capital gains from your investments, dividend income earned through your investments, income earned through a corporation, and small business income. The ways that these income streams are taxed varies, but overall the idea is that if you can start earning income through these streams in addition to your paycheck, you’ll be paying less tax dollar for dollar. When you make it to the point where you’re able to completely replace your paycheck with these streams of income, you’ll be paying less tax than you are today.
Now, why is it so important to learn how to pay less tax? Over the course of your lifetime, taxes will be your single biggest expense. The average Canadian will spend more money paying their taxes than they will on homes, cars, lifestyle, you name it. Most of the outflow of money in your life will go towards paying your taxes. And this is SO important for everybody to understand because most traditional finance advice focuses on telling people to save more money by making lattes at home or reducing the amount that you eat out every week, when the truth is most people could save so much more money by learning how to manage their taxes properly that they ever could by cutting out their indie coffee shop habit. So, if you’ve been trying to save more money through the ‘deprive yourself of fun things’ method, I’m not saying you should stop doing this all together, but I am suggesting that we all take a page from the millionaires book, and learn to save money first and foremost on taxes.
So, if you’ve been sitting there so far thinking well that’s great for millionaires but how do I get to pay less tax? There’s an overall blueprint you can follow that will get you to slowly start working towards this nirvana of earning money that you hardly have to pay tax on. It’s not a get rich quick scheme, but this blueprint is something that everybody can get started on this year for tax season and it will help you build long term wealth and work towards your millionaire status. Here are the steps you can start taking:
First it’s time to start learning just the basics about how the tax code works. You need to learn how to use tax deductions, write-offs, and tax advantaged accounts to either lower your taxable income or get tax rebates. I have a few episodes that introduce you to the basics of this (‘10 Tax Write Offs That Aren’t Just For Entrepreneurs’, ‘How To Use Your RRSP To Pay Less Tax’) and from there I recommend looking at learning from accountants! Look for someone who’s willing to go back and forth with you a little bit about your life expenses and financial habits, and who can recommend the best way to use a tax advantaged account like your RRSP or your TFSA.
Once you learn how to use the tax system properly and can lower your tax bill, you’re going to get a larger tax return from the government. Don’t use that tax refund to fund your life, instead take that extra money you’re getting back, and use it to fill up your RRSP and your TFSA. These are Canadian investing accounts that offer a ‘tax shelter’. What this means is you deposit money into these accounts, you use that money to buy investments, and those investments grow over the course of your life and you don’t have to pay tax on the growth or dividends within those accounts. These accounts offer other tax benefits too, the RRSP offers a tax deferral and the TFSA allows you to pay no tax when you withdraw the money in that account as your income in retirement. This means, that if you save enough money in your TFSA to provide you with a $50,000 salary that replaces your $50,000 salary from your job, you get to keep all $50,000 that you get out of your TFSA while you pay tax on the 50k you earn from your job.
Once you’re minimizing your tax burden with a good accountant, and are funding your RRSP and TFSA to grow your wealth tax free for your retirement, then you can start to use any other money you have to develop more income streams that are either passive or taxed at a lower rate. This could mean investing more money through other accounts, investing in real estate, starting a small business, or starting a corporation. These are all things that require some money to get into doing to start with, but that can pay you out in spades from both an income and a tax perspective in the future.
If you’re smart, if you’re diligent, and if you learn enough to play this game the right way, you can absolutely work towards becoming one of the ‘millionaires’ paying a low tax rate. I just want to finish by saying, yes we all love having roads, and schools, and healthcare, so I hope it goes without saying: don’t do dodgy things to evade paying your taxes. BUT, why should you allow yourself to struggle financially because you’re paying far more tax than is necessary?
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