One thing we’ve heard clients many, many times is, “I’ll never be able to buy a home.” We’re well aware that this is a massive stressor on the psyches of these people. This article will discuss how to have hope and prepare to buy your first home – from a tax perspective.
Mindset Matters
Often, it’s easier to say you can’t do something than to do it. We’ve all said this at different points in our lives. One of my favourite quotes is from Henry Ford, “If you think you can do something or if you think you can’t do something, you’re right.”
How we frame this challenge to ourselves and our own self-talk informs the actions we are willing to take. You can stop reading here if you are firmly set in the “Can’t” category.
If you want to learn some valuable tools and planning you can do to further your dream of home ownership, keep reading.
RRSPs
Contributions to your Registered Retirement Savings Plan (RRSP) reduce your taxable income. Then, when you retire and withdraw from your RRSPs, you are taxed on that income. This creates a situation of tax deferral. You’ll pay tax eventually, but not right away.
Many taxpayers use RRSPs to get a bigger refund – but there are other things you can do with RRSPs. For today, we’ll focus on buying a home.
First-time Home Buyer’s Plan (HBP)
In 2023, taxpayers can withdraw $35,000 from their RRSP without withholding tax to buy their first home. If you’re going to do this, make sure you consult with your bank to do the appropriate paperwork and ensure they don’t withhold the tax.
Then, you get a 2-year break. After that, you must repay the amount borrowed from your RRSP over the next 15 years. To repay your HBP, contribute to your RRSP and allocate the repayable amount to the HBP repayment required when you do your taxes. You won’t get the reduction in your income since you’re paying back the “loan” from your RRSP.
If you miss repaying it, the repayment amount is added to your income, and you pay tax that year. If you choose to, you can repay the total amount earlier.
There is no interest on this “loan” from your RRSP, and you didn’t pay tax on the funds that went into the RRSP in the first place. The RRSP may have earned income for which you haven’t paid tax yet, and you may withdraw more than what you initially contributed.
A Quick Story
When the HBP amount was only $25,000, we had a client who had $25,000 and no RRSPs. He wanted to use this money on a downpayment for his first home the following year.
We had him contribute it to his RRSP instead, resulting in a tax refund of about $8,000. He put that money in his TFSA and started earning investment income on it, tax-free.
Then, when he went to buy his first home, he borrowed $25,000 from his RRSP using the HBP. Through some tax planning, his downpayment went from $25,000 to $33,000+
I haven’t included what he earned in his TFSA; it was more.
Note that this situation could differ from yours, so your numbers will look different if you try this technique.
About the Rules
Of course, there are rules about eligibility to participate in this program and how far ahead of time the RRSPs must be contributed to withdraw them using the HBP. Please make sure you consult the rules before proceeding.
A Quick Warning
Well-meaning bank employees may suggest specific actions when you do something like this. They usually do not have access to your complete financial records and are not qualified to give tax advice. Ensure you have a very strong understanding of your financial situation, or work with an accountant to ensure you do things appropriately, especially if you have RRSPs with different banks.
First Time Home Savings Account (FHSA)
This has us excited.
The FHSA is a registered account for the purpose of saving for a first home purchase. First-time home buyers can save up to $40,000 tax-free and earn tax-free investment income within the account. Combining this with the RRSP Home Buyer’s Plan means an individual can get $75,000 plus the investment income from the FHSA toward a down payment! That’s enough to put a down payment on a home purchase. Any bank that provides RRSPs can provide an FHSA. However, work with your accountant to ensure you have sufficient room to make contributions. Banks don’t know about your tax situation or any other registered accounts (FHSA, TFSA, RRSP) that you may have at other financial institutions.
Tax-Free Savings Account (TFSA)
The Tax-Free Savings Account is a fantastic program. Although you pay tax before contributing to the account, the investment income it earns is not taxed. Make sure you invest your contributions to this account to get the full benefit of the tax-free component. We’ve seen many people discouraged because they contributed the funds in a low-interest savings account for years, effectively losing buying power against inflation. The funds in this account can also be withdrawn as part of your down payment, so don’t forget about this tool.
Best of Both Worlds
The FHSA, a new program that began on April 1, 2023, provides the best of both worlds.
Contributions to your FHSA reduce your income, just like an RRSP. Once opened, you can contribute $8,000 for up to 5 years to your FHSA and let it grow for up to 15. After that time is up, you’ll need to move it to an RRSP or withdraw it, which becomes taxable. (Remember to do something with the money after you’ve made your contributions, you want it to grow!)
Not only do the contributions come off of your income, resulting in higher tax refunds in the short term (that you can put in your TFSA), the earnings within the account are tax-free as well! (Note that if you’re required to transfer them to an RRSP, they essentially become tax-deferred instead of tax-free).
Obey the Rules
Remember to research or work with a tax professional when using these tools. We haven’t discussed the rules in-depth here, but there are a lot of articles (including a blog post we did) about the subject, and there are a lot of people who can help.
Crunching the Numbers
Let’s say you’re a single person who is financially intelligent and saving. Let’s put that amount at $1,250. This isn’t possible for everyone, but this is just an example. If you can’t save in these amounts, that’s completely normal. The point is to create, implement and adhere to a plan to get you where you want to go.
With this $1,250, we’ll contribute $666.67 per month to the FHSA and $583.33 per month to your RRSP. (Note that if you’re contributing less to your RRSP, but it is growing well, you may still be able to achieve the $35,000 HBP withdrawal amount.) Using these amounts, you’ll contribute $8,000 per year to the FHSA and $7,000 per year to your RRSP, ensuring that these amounts are available after five years to get what you need to buy your home.
After five years, you can withdraw the $35,000 using the HBP, and the entire amount of your FHSA to buy your home. This is $75,000! If you invest wisely, you’ll still have money in your RRSP (no matter how much it grows, you can still only withdraw $35,000), and you’ll have even more coming out of the FHSA. If you partner up with someone, that could be $150,000!
Home Ownership Within Reach!
The dream of home ownership is not dead. It isn’t easy to achieve and shouldn’t be, but it is possible. Don’t lose hope. Do the research, crunch the numbers, make a plan and stick with it!
Remember, if you think you can, or if you think you can’t, you’re right!