Simplicity is the ultimate sophistication.
~Leonardo DaVinci
When the Tax Free Savings Account was introduced in Canada in 2009, it was hailed for its practicality and simplicity. Any Canadian 18 years or older can now contribute up to $5000 per year to a TFSA and have those savings grow completely tax free. While TFSA contributions are not tax deductible, you will not have to pay any tax on the money you withdraw from your TFSA.
You can put just about any type of investment in your TFSA, or choose a number of different TFSA accounts for different purposes. You could simply have a TFSA savings account, or you could open a TFSA brokerage account whereby you could include stocks, bonds, ETFs or just about any other type of investment vehicle. Whether you earn interest, dividends or capital gains on your savings, your money can be withdrawn tax free. Sounds pretty simple eh?
A Few Asterisks
While I love TFSAs as an alternate savings vehicle for Canadians, they aren’t always as simple as we’d like them to be. I guess that’s just how these things go. Life is complicated. No matter how much we’d like to simplify things, there are always details, exceptions and little asterisks to contend with. TFSA rules are no different.
There has been some confusion over what happens to your TFSA contribution room if you withdraw your gains as well as your original contributions. We addressed that here in January. The latest question peppering search engines seems to be about the TFSA contribution limit for 2012. Why the confusion? Aren’t we allowed to contribute another $5000 each year?
Inflation Indexation for TFSA Limits
In addition to any unused contribution room from other years, you are usually allowed to contribute an additional $5000 per year. You may notice that there’s sometimes a little asterisk (*) next to this figure because it is indexed for inflation in $500 increments. That means that when the inflation rate applied to that $5000 causes it to rise above $5250, the government will raise the limit to $5500.
The consensus seems to be that if the CPI (Consumer Price Index) runs around 2%, that would mean we should exceed the threshold as of 2012. While that looks likely to happen, the CRA hasn’t officially announced the 2012 TFSA limit as of initial publication of this article. I spoke to someone at CRA last week and they said that the official determination hasn’t been made yet, but that it will (obviously) be out by the end of 2011. He advised us to keep watching the CRA website for TFSA updates. (Update: The CRA has left the TFSA contribution limit at $5000 for 2012.)
With the latest Canadian CPI numbers showing inflation running over 3%, it’s hard to imagine that the TFSA limit for 2012 will not be raised to $5500, but we will find out for sure within the next couple of months. I’m sure that many Canadian financial websites will carry the news once it breaks.
For Math Geeks Only
In case you’re wondering about the details of how inflation indexation is applied to the $5000 contribution limit, I thought I might include a chart* here that shows the calculations. It’s actually very simple math. For this example, I’m using a sample annual inflation rate of 2%. *I shamelessly copied this chart from Gordon Pape’s book on Tax-Free Savings Accounts
Given that the inflation rate is not static, I’m not sure exactly which CPI rate the government uses. They could use an annual average of the monthly inflation data. I’m also not sure whether they use the headline CPI rate or the core rate, which excludes food and energy.
If you follow the chart, you can see that the cumulative inflation factor just adds 2% to the figure from the previous year. So 2% of $5000 is $100 and that is added to the $5000 amount from 2009. For 2011, you just take 2% of $5100 (which is $102) and add it to the 2010 figure like this:
2011 Cumulative Inflation Factor = $5100 x 1.02 = $5202
Since the cumulative inflation factor will put our $5000 over the $5250 needed to round it up to the next $500 increment in 2012, it seems likely that the TFSA limit will indeed be raised for that year. Again, this example is for demonstration purposes only. I’m not sure exactly which CPI rate the CRA will use. If anyone can enlighten us on that, I’d be most grateful.
I hope this answers some of the questions floating around out there regarding the 2012 TFSA contribution limit.
Update: The CRA has left the TFSA contribution limit at $5000 for 2012.
Your comments are always welcome.
