Understanding Indexing: How Does Indexing Work?

At this time of the year, tax advisors and their clients are familiarizing themselves with the indexing changes that have been applied to tax brackets, and refundable and non-refundable credits. Indexation is based on the consumer price index, but different formulas apply to different provisions.

Here’s the detail, in case your clients want to know:

Indexing of Personal Amounts and Tax Brackets. Personal amounts and tax brackets are indexed annually based on the average monthly consumer price index (CPI) for the twelve months ending September 30 of the previous tax year, divided by the average monthly consumer price index for the twelve months ending September 30 of the second preceding year. The result is rounded up to the nearest 0.1%. For 2015, the computation is 124.57/122.53 – 1 = 1.01659 – 1 = 1.659% which is rounded to a 1.7% increase.

TFSA contribution limits are indexed by the same rate but the maximum contribution is not adjusted until it exceeds the current maximum by $250 and then it’s rounded to the nearest $500.

Indexing of Canada Pension Plan Income. CPP pensions are indexed by a factor calculated as the average CPI for the twelve-month period ending October 31 in the preceding year, divided by the average CPI in the prior twelve-month period. Where the indexation factor for the current year is less than the indexation factor for the prior year, the prior year factor is used. For 2015, the computation is 124.81/122.60 – 1 = 1.01803 – 1 = 1.803% which is rounded to a 1.8% increase. Because the factor for 2014 was 2.5%, the 2.5% factor is used for 2015 instead.

Indexing of Old Age Security. OId Age Security is indexed quarterly rather than annually. The increase is based on the ratio of CPI for the three-month period prior to the last increase, to the three months before that. The January 2016 increase is the ratio of the CPI for the three months ending October 2015, to the CPI for the three months ending July 2015.

Additional Educational Resource: Income Tax Estimator.

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