Reaching the Next Tax Bracket Will NEVER Make You Poorer

This is a classic:

“… But if I get a raise, it’ll tip me over to the next tax bracket and I’ll end up paying more taxes… and instead of a salary increment, I might actually earn less after taxes…”

I am not a tax expert, and I do not pretend to be.  But I am absolutely certain that if you get a raise, even after taxes, you will still be earning more than before.

It will take less than five minutes to understand how personal income taxes work.  If you already know this, please feel free to direct your attention elsewhere.  If you are still confused, spending the next five minutes reading the rest of this article may save you some embarrassing moments in future.

The Common Myth

I find it is best to explain how taxes work using a working example.

The following table is a simplified version of the income tax rates table found on the Inland Revenue Board of Malaysia’s website.

Let’s assume you are currently earning RM4,100 per month or RM49,200 per year before taxes.  Based on the table above, you’re in the 12% “tax bracket”.

Things are great. You know it’s about time you get a raise. After all, it is the “salary increment season”. And then one day, your boss says to you “hey, you are doing a great job, and to show my appreciation, I have decided to give you a raise of RM100 per month”.

You are beaming.  You know you have put in the hours and deserved that raise.  You are happy that your effort is finally being recognised, even though it’s really stingy of your boss to only give you an additional RM100 per month.  Surely he can afford to give you a bigger raise!  But hey, a raise is a raise right?

You thank your boss.  And just as you are about to call a few friends out for a celebratory drink, you do a quick calculation. Your new salary of RM4,200 per month works out to be RM50,400 per year.  You look at the table above, and your heart sinks.  Your boss has just brought you up to the 19% “tax bracket”.

With your trusted calculator, you punch in some numbers.  With your new income, you will end up paying RM9,576 in taxes a year (RM50,400 x 19%).  Had you not received that measly RM100 raise, you would only be paying RM5,904 a year (RM49,200 x 12%).  So even though your pay has increased by RM1,200 a year, you’re paying around RM3,600 more in taxes, which actually sets you back by RM2,400.

Congratulations – Your boss just made you poorer by giving you a stupid raise.

@$%@#%

You silently curse your boss.

.

.

.

Does the story above make sense?  I hope not.  Because that’s NOT how personal income taxes work (at least not in Malaysia)!

The buzzword is “Progressive”

Many countries, including Malaysia, use a “Progressive Tax System” to determine the income tax of an individual.  Briefly, a progressive tax system is a tax system where the tax rate increases as an individual’s income increases (click here for a very detailed explanation of progressive taxes).

Importantly, higher tax rates only apply to additional income above some predetermined thresholds.

Which means, in the above example, at the initial income of RM49,200 per year, the tax payable is NOT RM49,200 x 12% = RM5,904.

Yes, at income of RM49,200 per year, you fall under the 12% “tax bracket”.  But (and this is where many people get it wrong) the 12% only applies to the amount above RM35,000.

Got it?

That means, in order to determine how much taxes you are required to pay, you’ll need to firstly break down the RM49,200 into “chunks”, according to the ranges in the personal income tax table.

In this case, the RM49,200 can be broken down into five “chunks”.

As you can see, at an income of RM49,200 per year, you’re only paying RM3,229 in taxes (or RM3,229 / RM49,200 = 6.6% of your income), not RM5,904 (12% of your income).

If you have gotten this far, you might want to try and work out the tax payable on that income of RM50,400 (i.e. after the RM100 raise).  You should get an answer of RM3,401 [RM0 + RM25 + RM450 + RM1,050 + RM1,800 + (RM400 x 19%)].

So back to the example:

Before the RM100 raise, you are earning

• RM49,200 less taxes of RM3,229 = RM 45,971 after taxes. 

After the RM100 raise, you would earn

• RM50,400 less taxes of RM3,401 = RM46,999 after taxes.

Still complaining about the raise?

Final thoughts

Reading tax tables can be confusing. I have put together a simplified tax table for Malaysians to easily calculate their taxes. To read the table, simply find your annual income in the first column, and follow the tax calculations in the last column.

For e.g. if you earn an annual salary of RM60,000, your taxes would simply be RM3,325 + [19% x RM10,000] = RM5,225.

This guest post was written by Ching, the founder of iMoney.my, a price comparison website for Malaysians. Ching is a CFA charterholder, and was formerly an investment consultant and wealth advisor.

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