If buying your first home is on your mind, you may be considering what is the best way for you to save your down payment funds. 'Best' is subjective to what you are looking to accomplish and there are more ways than one to achieve your financial savings goals. Let's explore 2 of the most popular savings options and delve into ways you can use these products to suit your goals.
How do they work?
RRSP's and TFSA's are both designed for long term savings plans, but are based on 2 different tax path's.
In an RRSP, when you contribute the funds, the contribution is deducted from your taxable income in the year you contribute. You then pay tax on money you withdraw from the RRSP when you take it out -presumably at a lower tax bracket later in life (aka retirement) when you are earning less. For example, if you earn 100k per year and contribute 10k to your RRSP this year, you are now taxed on 90k of income instead of 100k. This often results in less personal income taxes owing to the CRA in the current year. Let's say you took that 10k and invested it within your RRSP and that money over a 20 year period of time grew into 30k. When you withdraw the 30k you will be taxed on that 30k as taxable income at the tax bracket at the time of withdrawing. The goal for this is to reduce your taxable income now, when you are earning more, in favor of paying tax on the income in the future when you are retired and earning less.
In a TFSA, any money you contribute is still taxable income in the year you contribute. However, any income earned on the money saved is non-taxable. So let's say you put the 10k into a TFSA instead of the RRSP and it grew into 30k over 20 years. You paid tax on the 10k as taxable income in the year you earned it, however, the additional 20k you grew the account by in investment income, is tax free upon withdrawal. The advantage of the TFSA is the tax free status of any income you earn within the account from investing your funds (think, no taxes paid on the withdrawals in retirement).
Both accounts have contribution limits to restrict how much Canadians can use these programs each year. RRSP contribution limits are based on earnings, up t0 18% of your employment income earned in the prior calendar year up to the maximum threshold of 29k and this is cumulative for any income you have earned since you started working. TFSA limits are set each year and have changed since they were started in 2009, the current TFSA contribution limit for 2022 is $6,000. The contribution limits are cumulative as well, but only for the years since you turned 18. For example. If you turned 18 in 2020, you would have 2020-2022's contribution room cumulated as your maximum.
RRSP First Time Home Buyer Plan
In order to make it easier for Canadians to tap into their savings for the purposes of buying their first home, the government introduced the RRSP FTHBP for clients to be able to withdraw their RRSP savings for a down payment on a home without the tax implications in the year of withdrawal.
Some key points to note:
- the money must be in the RRSP for a minimum of 90 days before it can be withdrawn under the FTHBP
- the money is not taxed in the year you withdraw, however, you have 15 years to repay the funds to the RRSP or 1/15th of your withdrawal will be added to your taxable income each year for 15 years (in short - spreading the taxes over 15 years instead of all at once in the year you withdraw if you do not recontribute the funds)
- a first time home buyer for the purposes of this program is considered someone who has not been on the title of a property in the 4 years preceding the purchase. As in, you can qualify to use this program again even if it is not your first home, as long as 4 years have passed since you have owned a home.
- you can qualify for this program for the first purchase after a major relationship breakdown regardless of the 4 years off title item. So, if your common law relationship ended and you owned a home together, you can qualify to use this program right away to purchase the first home after a relationship breakdown once you are off the title of the other house.
- the maximum withdrawal amount is currently 35k, so if you have 50k in your RRSP you want to use, only 35k can be withdrawn under this program. The other 15k would be withdrawn as normal and taxed as income.
TFSA Tax Free First Home Savings Account (FHSA)
In the 2022 Federal Budget it was announced that the government is rolling out a new program to help Canadians save for their first home. This program is being designed currently and will be rolled out at some point in the 2023 calendar year. This will be a hybrid product combining the benefits of both an RRSP and TFSA. The contributions to the account would be tax deductible, reducing your taxable income in the year of contribution and the withdrawal will also be non-taxable like a TFSA. There will be an $8,000 annual contribution limit, with a maximum contribution limit of $40,000.
Withdrawals for first time home buyers purchasing their first home in Canada will be non-taxable, however, withdrawals for any other purpose will see that money added to their taxable income for that year similar to a regular RRSP withdrawal.
You will not be permitted to combine this program and the RRSP FTHBP and withdraw from both at the same time.
More details will be announced when the program rolls out so stay tuned to government announcements for this one in 2023.
Which should I choose?
Which path you choose to go down will greatly depend on your own personal factors and there is no right or wrong choice. I highly recommend contacting your accountant to work out which path is the best one for you based on your plans and income/tax situation before you make any big decisions.
For example, do you already have a large amount of savings, have a higher personal income and are planning to purchase in the new year? If so, you might have a large contribution limit on your RRSP which would be beneficial to take advantage of right away. Contributing your savings (remember, up to 35k per person withdrawal amount) to your RRSP right now would reduce your taxable income for the year, perhaps giving you a tax refund you can add to your pot of savings. Then in 3 months time, you are eligible to withdraw the funds under the FTHBP and spread out either the taxes or the repayment over 15 years. This is also particularly helpful for those with employer paid RRSP plans or RRSP matching as it makes it very easy for your RRSP to be repaid by someone else essentially.
An example, someone earning $100,000 per year would normally pay around 23k in income taxes (In Alberta). However, a contribution of 30k to their RRSP would reduce their taxable income to 70k and reduce their income taxes to approx. 13k. Resulting in a tax break of 10k. That extra 10k could then be added to your 30k withdrawal from the RRSP under the FTHBP for a total down payment of 40k when the time comes to purchase a home.
However, if you are planning for the long haul - it may be more beneficial to look at the FHSA when it is rolled out. You would be capped at contributing 8k per year for 5 years to a maximum of 40k. However, that money can be invested and grown into a higher down payment tax free. If you are 18 (or have a child turning 18) you might consider setting this up to help them invest and save for their first purchase down the road. Invested funds may grow in value and would not have tax implications or repayment requirements down the road.
Your choice may also be regional or location based, for example, saving for a down payment in Vancouver or Toronto may take a substantially longer amount of time due to the higher price points of properties, whereas, in a small town in Alberta the amount of savings required is a lot lower based on lower property values. This may help you determine which program will benefit you the most based on the annual contribution limits and timeframe for reaching your goals.
If you are a parent planning on gifting your adult children their down payment for their first home purchase, consider gifting it to them early and having them contribute it to their RRSP or TFSA so that they can take advantage of the tax benefits if it applies to them.
Sum it all up
Whichever way you plan to save your down payment, keep in mind that you are required to show a 90 day paper trail history of your down payment savings for any property purchases in Canada. Large deposits to bank accounts need to be explained with paperwork provided to show where it came from, as a result, cash under the mattress or saved at home is very difficult to explain or use as down payment. However you plan to save for your down payment - make sure it is in a bank account!
As noted above, there are many factors that may affect which path you plan to take for saving a down payment for yourself or for your children. Make sure you speak to your accountant regarding the different plans available in order to choose the right path that suits you.
As always, if you have any questions, reach out at 780-720-4034 or Jill@JillMoelleringMortgages.com