Financial advisers see the potential for several strategic uses of the FHSA for both young and older first-time buyers.
Less than a month after the federal budget announced a tax-free savings account for first-time home buyers, financial advisers are finding a slew of potential uses for the new savings tool.
Critics have been quick to note that the proposed tax-free first home savings account (FHSA) will likely mostly benefit high-income Canadians, who will have yet another way to reduce or avoid taxes on savings and investments. But advisers say the FHSA would also be a versatile tool for the group it is primarily intended to help: young first-time home buyers. And it could be useful for some seniors with modest incomes.
As outlined in the budget, the FHSA would allow Canadians to save up to $40,000 – with an annual contribution limit of $8,000 – for a first home purchase. The new account would combine the two main tax perks of the registered retirement savings plan (RRSP) and the tax-free savings account (TFSA). As with an RRSP, deposits into the account would be tax deductible. At the same time, as with a TFSA, eligible withdrawals would be tax-free. Any investment growth within the account would also be tax-free.
Below are some examples of how home buyers at different stages of life and income levels could take advantage of the FHSA. (The government has yet to introduce detailed rules about the account and might still change its mind about significant features. The scenarios here are based on the broad-strokes description contained in the budget.)
Scenario: Young adults planning to buy a house and start a family
Aaron Hector, a certified financial planner at Calgary-based Doherty & Bryant Financial Strategists, noted that young home buyers could strategically use an RRSP and the FHSA to boost tax deductions while saving for a down payment.
With an RRSP and the new FHSA, the size of the tax deduction on a contribution depends on your tax bracket. Usually, the higher your income and your tax bracket, the larger the tax break you’ll receive on your contribution. But with the FHSA, this feature poses a dilemma for young Canadians who haven’t reached their peak earning years yet and are in lower tax brackets yielding smaller tax deductions.
With an RRSP, if you’re a young saver who expects their income to grow in future years you can get around this issue by deferring your tax deductions. Instead of claiming the tax deduction for the year you put money in, you can wait until a future year in which you’re in a higher tax bracket and the deduction is worth more. It is unclear, however, whether Canadians will be able to defer deductions on their FHSA contributions as well.
Early-career adults hoping to start a family
Save in an RRSP while deferring deductions until income rises and/or kids are born. Then transfer funds to FHSA for home purchase.
Assuming FHSA deductions can’t be postponed, early-career home buyers could start saving for a down payment inside an RRSP and wait to claim their tax break until pay raises bump them into a higher tax bracket, Mr. Hector said. Those planning to start a family might be even better off starting to claim their deductions after a child is born, which would result in a sizeable boost to their Canada child benefit (CCB), Mr. Hector noted.
Once prospective home buyers have maximized the deductions, they could then transfer the funds to an FHSA on a tax-free basis and eventually withdraw the funds – also tax-free – from that account as a down payment for a house, Mr. Hector added.
Moving funds from an RRSP to an FHSA will be tax-free, subject to the $40,000 lifetime and $8,000 annual contribution limits, although the transfer would result in a loss of the corresponding RRSP contribution room, according to the federal budget.
Mr. Hector acknowledged that giving up as much as $40,000 of RRSP contribution room would be a downside of the strategy he described. However, the potential upside from larger deductions is significant, he argued.
Imagine, for example, a young Alberta couple – let’s call them Joe and Jane – with a household annual income of $45,000, Mr. Hector said. Next year, they’re expecting a child as well as a raise that will bump their income to $60,000, lifting them from a marginal tax rate of 25 per cent to 30.5 per cent.
Claiming an RRSP deduction next year would result in a tax break of 30.5 per cent, rather than just 25 per cent. But a larger deduction, which reduces the couple’s taxable income, would also boost the size of their child benefit payments. Specifically, every dollar of deduction would increase the CCB by 7 per cent, Mr. Hector said.
In other words, a tax break of 25 per cent on contributions this year could turn into a tax break worth 37.5 per cent next year for Joe and Jane (30.5 per cent from the higher marginal tax rate plus 7 per cent from the CCB boost). That’s a difference of 12.5 percentage points.
“On an annual FHSA contribution of $8,000 that 12.5 per cent is worth an extra $1,000 in your pocket, which is significant,” Mr. Hector noted.
Still, without the ability to defer deductions directly in the FHSA, young home buyers would have to weigh the advantage of a near-term enhanced tax deduction against the downside of a reduced contribution room inside the RRSP, he added.
Another risk of saving in an RRSP only to transfer the funds to an FHSA is that property prices could rise significantly in the meantime, noted Zainab Williams, founder of Elleverity Wealth Management in Milton, Ont. Because of the $8,000 annual limit on FHSA contributions, moving the maximum $40,000 over to the FHSA would take five years, a period during which home affordability could erode considerably in hot housing markets, Ms. Williams noted.
In general, home buyers who have already set aside significant savings for a down payment in an RRSP, TFSA or another savings account might be better off staying the course rather than engaging in a lengthy transfer to the FHSA, which isn’t expected to become available until 2023, she said.
Scenario: A young high-earner hoping to maximize long-term investments in tax-sheltered accounts
The introduction of the FHSA has spurred questions about whether another federal program meant to help young adults to save for a down payment, the Home Buyers’ Plan (HBP), will become obsolete. But Mr. Hector argues some Canadians might be better off using the HBP for a home purchase and the FHSA for added long-term savings.
The HBP allows home buyers to withdraw up to $35,000 tax-free from an RRSP. However, any amounts taken out under the HBP must be put back into an RRSP over a period of up to 15 years or the withdrawals become taxable income and the corresponding contribution room is lost. The FHSA, on the other hand, doesn’t require repayments.
Young high earner hoping to maximize long-term savings
Buy a home with the Home Buyers’ Plan. Max out the FHSA then transfer funds tax-free into the RRSP.
Canadians can’t use the FHSA and the HBP for the same home purchase, according to the budget. But Mr. Hector sees another way to combine the two.
Consider, for example, a high-flying 30-year-old woman – we’ll call her Supriya – with an annual income of $200,000, Mr. Hector said. Supriya, who would be subject to a marginal tax rate of around 45 per cent in most provinces, wants to buy a house and maximize her long-term savings.
Supriya may want to use the HBP for her home purchase, according to Mr. Hector. With no cash flow concerns, she can replenish her RRSP over time without giving up valuable contribution room.
At the same time, she could save $40,000 in the FHSA, with contributions netting her generous tax deductions. But instead of using the FHSA for a down payment, she would eventually move that money to her RRSP.
Canadians would be able to pour FHSA funds into an RRSP regardless of available contribution room and those transfers would be tax-free, the federal budget said. Funds from an FHSA, however, would become taxable when eventually drawn from the RRSP or a RRIF, like any other withdrawal from one of those accounts.
By moving her FHSA savings to her RRSP, Supriya would have “an additional $40,000 into her RRSP, which will be valuable given the RRSP’s ability to let her experience compounding growth without annual taxation for decades,” Mr. Hector said.
Scenario: A modest-income senior buying a home for security in retirement
When the Liberals first floated the idea of a tax-free account for home buyers in their 2021 election platform, the FHSA was meant to be only for Canadians under 40. But with no mention of that age limit in the federal budget, the potential uses of an FHSA extend to seniors.
In particular, the FHSA could come in handy for lifelong renters who retire with limited cash flow and who’d like to buy a home to avoid the risk of rent increases and evictions in old age, some financial experts say.
For example, picture a 64-year old man in Regina – we’ll name him Manuel – with an annual income of $45,000 who has always been a renter and will be able to count on a modest pension and government benefits to support a frugal lifestyle in retirement, Mr. Hector said. Manuel also has $20,000 saved in an RRSP in Mr. Hector’s scenario.
Concerned about the effect of rent increases on his tight cash flow in retirement, Manuel could gradually shift the $20,000 from the RRSP into the FHSA tax-free and use the funds for a down payment on a modestly priced condo, Mr. Hector said. Manuel would then be able to withdraw the $20,000 tax-free from the FHSA to buy the condo.
Modest-income senior buying a home for security on retirement
Transfer funds from RRSP to FHSA for home purchase so the money can be withdrawn tax-free without repayment obligations
A home purchase would have been difficult for Manuel with the HBP, as repayments to his RRSP would have put a strain on his budget, Mr. Hector noted. At the same time, simply withdrawing the $20,000 from the RRSP would trigger tax at a rate of nearly 30 per cent, he added. Instead, “when [Manuel] ultimately buys a home, the withdrawal from the FHSA would allow him to use his RRSP savings without paying any tax, nor having the repayment obligations,” Mr. Hector wrote in an e-mail.
Low-income retirement expert John Stapleton concurred that transferring funds from an RRSP to an FHSA for a down payment could make sense for a small group of modest-income seniors. But there are important caveats, he added.
First, for the strategy to benefit those seniors, the FHSA withdrawals would have to have no effect on their eligibility for the federal Guaranteed Income Supplement (GIS), Mr. Stapleton noted. The GIS is a supplementary, non-taxable amount that nearly a third of seniors in Canada receive along with their Old Age Security (OAS) benefits. Recipients whose income rises above certain eligible thresholds face an aggressive clawback of their GIS payments.
Currently, withdrawals from an RRSP or RRIF are considered income for tax purposes, and can trigger such a GIS clawback. On the other hand, tax-free withdrawals from a TFSA have no effect on the benefits.
While taking money out of an FHSA for a home purchase is also tax-free, the federal budget did not discuss whether the withdrawals would have any effect on other federal benefits. However, an official from the Department of Finance told The Globe and Mail that FHSA withdrawals used to make a qualifying first-home purchase would not affect GIS benefits for eligible recipients.
Still, even with no effect on GIS payments, the new account would likely be of little use to Canadians on provincial social assistance, Mr. Stapleton warned. That’s in part because provincial programs may consider even TFSA withdrawals as income that reduces benefit eligibility.
Mr. Stapleton also noted that moving money from an RRSP to an FHSA for a home purchase would likely only help modest-income seniors who live in low-cost housing markets where a down payment of $40,000 or less may be enough to buy a house.
The benchmark price of a home in Regina in March was $264,000, compared with $874,100 nationwide.
Finally, while homeownership protects seniors from rent increases and evictions, it also comes with maintenance costs and the risk of surprise expenses for repairs, Mr. Stapleton said.
This article was written by Erica Alini and published in the Globe and Mail on May 5, 2022.