What a year we have just seen. From the precipitous market drop, to that quick climb last spring, and on through the current path – it’s been a wild ride.
And what an introduction for the tax-free savings account!
Who would have thought that one of most innovative wealth vehicles in Canadian history would be trying to find its legs in one of the most challenging markets of the past century?
No doubt you’ve been exposed to the TFSA surveys conducted by various industry players. Whether reporting account activity or gauging future intentions, it appears that the take-up on available contribution room has been a bit modest to date.
Rather than being a commentary on the TFSA itself, this is likely a reflection of those tumultuous markets and the general trepidation of the investing public. Through the combination of continuing government support, financial industry promotion, and a return of investor confidence, this hesitation should eventually give way to greater investor understanding and adoption of TFSAs.
Still, even if investors are willing to take the plunge, has recent market turmoil seriously impaired investors’ ability to make best use of TFSAs? Specifically, what effect might the timing of this economic downturn have on TFSA contribution room?
Indexing contribution room
One of the distinctive aspects of the TFSA offering is the manner by which contribution room is designed to keep up with inflation. We won’t see the same kind of year-to-year indexing as is used for most other elements of our tax system, such as the adjustments in brackets and tax credits that get down to the individual dollar.
Instead, the original $5,000 annual TFSA dollar limit available in 2009 is to be bumped every few years by $500 increments. This ‘bump’ is really a rounded representation of an underlying base figure that, like those other indexed elements, is adjusted annually. It is only when this base figure reaches the mid-point (eg., $5,250) that the dollar limit is taken to the next $500 threshold, in this case $5,500.
This process means that inherently the TFSA dollar limit will be slightly behind inflation initially, and slightly ahead as each threshold is reached. On balance over the long term, it keeps in sync with inflation with the further benefit that there is an elegant simplicity to using periodic $500 jumps rather than annual odd dollar changes.
That first $500 threshold?
While somewhat unique in its stepped application, the formula and procedure for determining the dollar limit is roughly the same as for other indexed amounts.
The indexation factor is derived by comparing the annual consumer price index to September 30 for a given year against the preceding year. This means that 2010 indexing is based on CPI growth from September 2008 to September 2009, which computes to a mere 0.6%. Our underlying base figure for TFSA dollar limit in 2010 is therefore $5,029.
TABLE: Recent years’ indexation factors
2006 2007 2008 2009
2.33% 2.10% 1.9% 2.5%
At TFSA launch time in 2009, it was expected that the first increase in the limit to $5,500 would occur in 2012. Indeed, had we experienced constant 2% inflation in the past year and in coming years, that would have held true. Now, we’re looking at 2013 if we immediately come back to 2%, though perhaps we will see a higher factor in the coming year that puts it back on track. Remember though that this “factor” is just a reflection of inflation, so don’t wish too hard.
For some historical context, the indexation factor in the preceding four years has been about 2% or so. (See Table.) As well, consider that the Bank of Canada’s approach is to attempt to keep inflation within the 1% to 3% range, with a target of 2%. Assuming the BoC is effective over the longer term, we can expect to see the limit raised about every 4 years.
Your annual client reminder
Don’t dwell too long on when those increases may be coming. The key is to remind your clients in those annual reviews that they get more room every year, and they should make good use of it. As well, check the age of their children to get them started, too.
In that light, I was floored when I realized that 1992 is the birth year for those turning 18 in 2010, as my own nephew – my parents’ first grandchild – was born that year. Here’s my reminder to my brother:
Happy birthday to you
Born in ninety-two
TFSA room
Is waiting for you
Oh, and many happy returns – both personal and financial!