Understanding Your Payroll Deductions (Canada)

This information was last updated based on the 2007 tax year.

You've just started your first job, and you're making $60,000 a year. This means your monthly paycheque should be $5,000. Right? Not so fast. You have a whole range of payments to make to the Canada Revenue Agency (formerly Revenue Canada) and to other places.

1. Canada Revenue Agency (CRA) Deductions

The main deductions by CRA are for Employment Insurance, Canada Pension Plan (or Quebec Pension Plan in Quebec), and income taxes. Here's what they're all about:

Employment Insurance (EI)

Until the mid-1990s, EI was known as UI (Unemployment Insurance). At that time, the government changed the name and made it harder for people to collect benefits. Essentially, EI is a safety net for people who lose their jobs due to a shortage of work, or who need temporary leaves, such as for lengthy illness.

Here are the basic rules regarding EI:

• You can collect EI benefits only if you've paid into EI through your earnings. Currently, your employer deducts 1.80% of your pay as EI premiums, up to a maximum of $720.00 a year (which is based on maximum insurable earnings of $40,000). In addition, your employer contributes to EI 1.4x what you contribute, so up to a maximum of $1,008.00 a year.

• In the case of leaving your job, you can collect EI benefits only if you were laid off due to a shortage of work. You can't collect if you quit your job or were fired for poor performance.

• To collect, you have to have worked a minimum number of hours during the previous year. The number ranges from 420 to 910 hours (which equates to about 11 to 24 weeks of full-time work), depending on the province/territory and the unemployment rate in your specific region of the province/territory.

• EI pays you 55% of your regular earnings from your last job, up to a maximum of $435 per week. The number of weeks you can receive EI ranges from 14 to 45 weeks, and depends on the unemployment rate in your region and the number of weeks you worked. After your EI runs out, you have to find a job or apply for social assistance. You also can apply for EI to cover the cost of returning to school.

• The government expects you to actively look for work while collecting EI benefits. If you don't, you may lose your EI benefits. Therefore, you might be asked to show your EI officer at the local Human Resources and Skills Development Canada (HRSDC) office which employers you've applied to and what you've been doing to find a job.

The EI fund also pays out a number of other benefits to people who have paid into the system and temporarily cannot work. These people receive the same money as those on regular EI. Here's how it works:

• First, there is so-called "maternity leave." It can be paid for up to 50 weeks per pregnancy, and comes in two parts, the "maternity benefit" and the "parental benefit." Maternity benefits can only be claimed by a birth mother or surrogate mother, and are available to those who have worked at least 600 hours in the previous year. The maternity benefits last for 15 weeks immediately before and/or after childbirth. The parental benefits extend for 35 weeks, and can be used by the mother, or shared with the other parent. In the case of adoptions, only the parental benefit applies.

• If you can't work due to a long-term sickness or injury, EI will pay you benefits for up to 15 weeks. You must have worked at least 600 hours in the previous year to qualify.

• If a family member is terminally ill and at risk of dying within 26 weeks, you may want to take time off to care for her/him. Under EI's Compassionate Care program, a person can receive EI benefits for up to six weeks to care for a terminally ill family member, as long as the person receiving the benefits has worked at least 600 hours in the past year.

Canada Pension Plan (CPP) (or in Quebec, the Quebec Pension Plan, or QPP)

You also pay money to the Canada Pension Plan (or Quebec Pension Plan) to provide you with a retirement fund. Here's how it works:

• Your employer deducts 4.95% of your salary for CPP contributions. Your employer also contributes an equal amount on your behalf. The maximum that can be deducted in a year from you is $1,989.90 (which is based on maximum contributory earnings of $40,200). Since employers pay what you do, a total annual premium of up to $3,979.80 is paid in your name.

• You can begin collecting your CPP benefits at age 60, but your benefits will be lower than what you would receive if you wait until you turn 65. You must apply for your CPP benefit; it does not start automatically when you reach 65.

• The amount you receive is based on how much you contributed. The maximum monthly pension is $1,077.52 (2008) while the average pensioner receives $884.58 (2008).

• CPP also pays a pension to people who have a long-term disability that prevents them from working.

(While it's too early to talk about retirement, you'll also want to know that the government pays everyone, regardless of income, a second pension called Old Age Security when they turn 65. The maximum benefit for 2008 is $502.34 a month, and the average is $476.14).

Income Tax

Both the federal government and your province/territory charge income taxes. Each province/territory sets its own rates, while the federal rate ranges, according to income, from 15% to 29%.

Here is a summary of federal tax rates (2007):

• You pay 15% on the first $37,178 of taxable income.

• You pay 22% between $37,178 and $74,357 of taxable income.

• You pay 26% between $74,357 and $120,887 of taxable income.

• You pay 29% on taxable income over $120,887.

If you're single and made that $60,000 starting salary, here's how your basic federal tax will be calculated (2007):

• $5,577 on your first $37,178,

• plus $5,020.84 on your next $22,822,

• minus $1,846.49 in basic non-refundable tax credits, so …

• your total federal tax would be $8,751.35.

The various provinces/territories have their own tax brackets and tax rates. We'll use Ontario as an example. In Ontario, tax rates range, according to income, from 6.05% to 11.16%. Here is an example of how much provincial income tax you would pay if you lived in Ontario, based on the $60,000 salary (2007):

• $2,147 on your first $35,488,

• plus $2,242.85 on your next $24,512,

• plus $57.97 in Ontario surtax

• minus $681.41 in basic non-refundable tax credits,

• plus $600 for the Ontario Health Premium, so …

• your total provincial tax would be $4,366.41.

A single person making $60,000 and living in Ontario, therefore, would pay a maximum of $13,117.76 in income tax to the federal and provincial governments. Once you add in CPP ($1,989.90) and EI premiums ($720.00), this Ontarian's total government deductions would reach $15,827.66.

You may pay less than this amount, though, once you factor in tax reductions. Besides the basic exemptions, there are many other reductions you may be eligible for, such as credits for children, post-secondary tuition, and interest you pay on your student loans.

2. Other Possible Deductions From Your Pay

Benefits

Your pay stub might also include deductions for "benefits." If your employer provides coverage for healthcare expenses such as prescription drugs or eye care (which are not covered by your provincial health plan), you will pay part of the benefit premiums on your paycheque. Your benefits might also cover dental care and long-term disability leave. In most cases, your benefit plan pays part of your costs for drugs and dental care. So, if you go to the dentist, the plan might pay 80% of the cost while you pay the other 20%.

The other coverage your employer might provide is workers' compensation, which provides you with income if you are injured on the job. It is the employer that pays into the fund, not you. And it is usually only workplaces that involve any danger that pay into workers' compensation.

Union Dues

Another deduction you might see on your paycheque is union dues. If you're part of a union, you have to pay the dues. It is tax-deductible, as are memberships for official associations, e.g., provincial colleges of nurses.

3. RRSPs

The other big thing people talk about is RRSPs. RRSP is an acronym for Registered Retirement Savings Plan. RRSPs are not a deduction from your pay, but they are an important factor to think about when you start working. The advantage of RRSPs is that they allow you to start saving for your future retirement while reducing your taxes now. Here's how it works:

• You can contribute up to 18% of your income from the previous tax year into an RRSP, with a maximum contribution of $19,000 in 2007. (This limit can be increased if one has not contributed their maximum in previous years – for information, see below.)

• So based on a $60,000 income, if you invested the maximum, $10,800, in an RRSP, your taxable income is reduced by $10,800. This means that, essentially, the government considers that your income for the year was $49,200 rather than $60,000. So you would pay $6,375.35 rather than $8,751.35 in federal tax and, based on Ontario numbers, you would pay $3,320.24 rather than $4,366.41 in provincial tax – or a total of $9,695.59 rather than $13,117.76, with the difference of $3,422.17 coming back to you as a tax refund (not to mention $10,800 stashed away for your future)!

To claim an RRSP tax reduction, you have to contribute by March 1 of each year (e.g., for the RRSP deduction to be claimed on your 2007 tax return, you must make the contribution before March 1, 2008). In most cases, you'll go to a financial institution such as a bank or an investment broker to set one up. There are all sorts of RRSP funds you can invest in, including stocks, mutual funds, GICs (Guaranteed Investment Certificates), government bonds, and savings accounts.

As noted, there are limits on how much you can put into an RRSP while still avoiding the tax. But if you don't have enough money to contribute up to your limit, the government allows you to claim what you don't use in future years. For example, if your limit is $10,800, and you only contribute $3,000, the other $7,800 is added to your contribution limit for later years.

And if you're not able to save enough money to buy a lump-sum RRSP by March 1, there are two other options. First, you can ask your bank to take an automatic monthly deduction out of your account to go into an RRSP. Second, many banks will allow you to take out a loan to buy an RRSP. (This is a good option if the interest you earn from the retirement fund and the tax reduction will outweigh the interest you pay on the loan. For example, if you borrow $10,800 and have to pay $500 a year in interest, you'll still be ahead if you pay back the loan in four years given that your RRSP will have saved you over $3,000 in taxes).

In summary, by contributing to an RRSP, rather than paying tax on the money now, you'll pay the tax when you withdraw money from the RRSP. Most people earn higher incomes while they're working, and therefore pay a higher tax rate, but when they retire, they tend to have lower incomes and, therefore, will pay less tax on the RRSP money they withdraw when they retire.

In addition to using the RRSP money for retirement, there are three other ways it can be used:

• You can take money from your RRSP in a year in which your income is reduced. If you lose your job, for example, you can take money from your RRSP and still pay little or no tax since your income has dropped.

The government also lets you use some of your RRSP to make a down payment on a first house or to pay college or university tuition fees without paying tax on the amount you withdraw.

• The former program, the Home Buyers' Plan (HBP), allows you to withdraw a maximum of $20,000, which must be paid back within 15 years, otherwise you will be taxed on the outstanding amount at the end of the 15 years.

• The latter, the Lifelong Learning Plan (LLP), allows you to withdraw from your RRSP up to $10,000 a year to a maximum of $20,000 over a four-year period. In most cases you must be entering a full-time program. You have 10 years to repay the amount borrowed, otherwise you will be taxed on the outstanding amount at the end of the 10 years. (The LLP plan can be used for your education or your spouse's education, but not for your children's education.)

4. Other Retirement Plans

Besides RRSPs, you also might get a pension through your employer. Often, you're expected to pay into the retirement fund through a deduction off your paycheque. In some cases, the company invests the money in an RRSP in your name. Your contribution might be, for example, 2% off your regular paycheque, which your employer matches. At the end of the year, the amount you and your employer put into the RRSP will count against your annual RRSP limit.

It is important to note that many deductions will change each year, because they are subject to governments' annual budgets. While it may be disappointing to find your paycheque is lower than expected, you do receive many benefits from your deductions even though you might not see them until well into the future.

Understanding Your Payroll Deductions (Canada)

1. Canada Revenue Agency (CRA) Deductions

2. Other Possible Deductions From Your Pay

3. RRSPs

4. Other Retirement Plans

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