WEALTH Matters — Winter 2011-2012

INFLATION AND THE INDEXING OF GOVERNMENT BENEFITS

Many government figures related to income tax and social benefits are ‘indexed to inflation’ meaning that their levels increase over time as the cost of living increases. Canada Pension Plan and Old Age Security are indexed in this way. The Income Tax Act also provides for tax bracket limits, the Basic Personal Exemption amount and other credits to be increased a little each year so that these tax policies continue to focus on the lowest earners even when their earnings are increasing over time. RRSP and TFSA contribution limits are also indexed. The trouble is that not all items are indexed in the same way, and this can be confusing.

 

We wrote this article to help clarify how these things work.

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Inflation and the indexing of Government Benefits

Interest Rate Trends

Investment Market Commentary

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Core Inflation

Household Another important inflation rate is the ‘Core Rate’, which excludes the impact of 8 of the most volatile expenditure sub-components (fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, intercity transportation, and tobacco products). These 8 items fluctuate widely in price, both upward and downward, which tends to mask longer-term price trends, and can even cause the All-Items rate to become negative at times.

The table below shows the CPI All-Items and Core CPI annual figures based on the average of 12 monthly CPI measurements ending in December of each year. (Source: Statistics Canada, Bank of Canada, December 2012 values estimated).

Fortunately, In Canada, the ‘index’ figure most often used to represent inflation is the Consumer Price Index (CPI) published by Statistics Canada. The tricky part is that there are several different published inflation rates.

Measuring Inflation

The table also shows the cumulative impact of the annual changes since 2006 and 2008. Note how the Core rate fluctuates much less than the All-Items rate, but the cumulative impacts since 2006 are within 0.2% of each other. The Bank of Canada uses the more stable Core rate to help it set monetary policy, but government benefits are usually based on the All-Items rate.

The last rows of the table show the CPI All-Items rate based on the 12-month average ending in September of each year. We show this set of figures because these are the ones used to calculate the contribution limit for Tax Free Savings Accounts (TFSAs). CPP pensions are indexed based on the monthly average ending in October of each year, and OAS benefits are indexed quarterly based on the most recent 3 month average.

It is because of these differences in the index used, and the time period used, that the various government benefits and limits don’t all increase at the same rate.

What about you?

Please call us to discuss your savings goals, as an RRSP contribution may not always be your best course of action.  You can click here to read our article on making the decision between TFSA and RRSP contributions, or just give us a call to discuss your particular situation.

TFSA Contribution Limit for 2012 Remains at $5,000

When Tax Free Savings Accounts were introduced in 2009, the annual contribution rate was set at $5000. An indexing provision was included to reflect the CPI All-Items rate, but to round this limit to the nearest $500. So when CPI had increased 5.1% from 2008, the limit would have been nearer to $5,500, and when it had increased 15.1% from 2008 then the limit would rise to $6,000. It was widely expected that the first increase in the annual limit would occur in 2012, and that would have been true if it were based on the December CPI averages. But the reference index is the CPI monthly average ending in September of each year, and the cumulative increase in that measure is only 4.9% since 2008, so we’ll have to wait another year for the annual contribution limit to go up. Oh well, we can still put in $5,000 and we hope everyone takes advantage of this.

 

RRSP Contribution Limit for 2012 is $22,970

RRSP and Money Purchase Pension contribution limits are indexed based not on CPI but on the Industrial Aggregate average wages and salaries. Pension plan contribution limits are based on earnings in the same year, so the contribution limit for 2012 has already been set based on wage and salary inflation in 2011. RRSP limits lag by one year because the 2012 maximum is based on 18% of earnings in 2011. So the 2012 RRSP contribution maximum is the same as the 2011 pension contribution limit, which was based on 2010 wage and salary inflation.

If you are making an RRSP contribution to be deductible against 2011 income, you’ll have to make that contribution by the February 29th deadline. Your limit for 2011 will already have been calculated for you on your 2011 Income Tax Notice of Assessment. If you want to get a head start on 2012 contributions, you can calculate your 2012 limit as 18% of 2011 Earned Income, to a maximum of $22,970.

The most commonly quoted rate is the ‘All-Items CPI’ Rate, which is generally intended to track ‘observed’ inflation – the rising cost of living as it affects a typical citizen.

It is based on a standard ‘basket of goods’ that represents what the average household buys in a typical month.

The pie chart shows the relative weights of the different major component of expenditure.

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Comparison of Inflation Rates

 

 

Year

 

 

 

 

2007

2008

2009

2010

2011

CPI All-Items

Annual Increase

2.20%

2.33%

0.26%

1.84%

2.92%

 

Cumulative % (2006)

2.20%

4.58%

4.86%

6.78%

9.90%

Dec. Average

Cumulative % (2008)

 

 

0.26%

2.10%

5.08%

CPI Core

Annual Increase

2.52%

1.55%

1.88%

1.67%

1.73%

 

Cumulative % (2006)

2.52%

4.10%

6.06%

7.84%

9.70%

Dec. Average

Cumulative % (2008)

 

 

1.88%

3.58%

5.38%

CPI All-Items

Annual Increase

1.84%

2.53%

0.53%

1.40%

2.85%

 

Cumulative % (2006)

1.84%

4.41%

4.96%

6.43%

9.47%

Sept. Average

Cumulative % (2008)

 

 

0.53%

1.94%

4.84%