On April 1, 2023, the Canadian government introduced a brand-new tax-free savings account that could be extremely beneficial for you.
Are you a first-time homebuyer according to the Canadian government’s definition? That is, you have not lived in an eligible dwelling of which you or your spouse were the owners, either alone or jointly, during the account’s opening year or in the four preceding years.
Please note that, in the paragraph above, there is a possibility that you may be considered a first-time buyer, even if you have already owned a home in your life. Furthermore, the spouse requirement only applies to the opening of the FHSA (First Home Savings Account) and not to withdrawals.
In this article, I will explain why the FHSA should be prioritized over the TFSA (Tax-Free Savings Account) or the RRSP (Registered Retirement Savings Plan). However, it’s important to note that this recommendation applies only if you plan to buy a house within the next 15 years. Otherwise, the FHSA becomes equivalent to an RRSP.
Key takeaways:
- Introduction of the FHSA: The Canadian government introduced a new tax-free savings account known as the First Home Savings Account (FHSA) on April 1, 2023, aimed at assisting first-time homebuyers.
- FHSA vs. TFSA and RRSP: The FHSA stands out as the only account where the money is 100% tax-free.
- Managing Contributions: If you cannot contribute the maximum amount in a year, it’s better to wait, as the unused participation room accumulates up to a maximum of $8,000.
- Strategies to Consider: Various strategies can be used based on individual situations, including opening an FHSA early, timing your first home purchase, carrying forward tax deductions, and using your TFSA strategically.
- Marital Considerations: Consider opening an FHSA before getting married or entering a common-law relationship with someone who already owns a principal residence.
- 15-Year Window: You have a 15-year window from the account’s opening to purchase your first home. If this period elapses without a home purchase, you can transfer your FHSA balance to an RRSP.
- Additional Tax Benefits: Aside from the FHSA, first-time homebuyers can also take advantage of the Home Buyers’ Plan (HBP) and other tax credits when purchasing their first home.
Why prioritize it?
The FHSA is the only tax-free savings account in which the money is 100% tax-free. In contrast to the RRSP, where withdrawn amounts are taxed, and the TFSA, where the invested money is already considered after-tax, you can invest up to $40,000 ($8,000 per year starting from the account’s opening), which will ultimately become entirely tax-free if you purchase an eligible home within a 15-year timeframe.
Short on funds to make maximum contributions?
If you lack the funds to contribute, it’s better to wait. Indeed, after opening, the FHSA accumulates unused participation room. The maximum amount that can be carried forward to future years is $8,000. Once this maximum is reached, you will need to consider contributing again for your participation room to start accumulating again up to the total limit of $40,000. To be clearer, the maximum you could contribute for a given year is $16,000 ($8,000 for that year and $8,000 carried forward from previous years).
Secondly, under certain conditions and market considerations, it could be highly advantageous to borrow the necessary money to reach your FHSA limit and repay the loan upon withdrawal. However, it’s important to factor in the interest incurred on the loan in your calculations.
Finally, you have the option to transfer funds from your RRSP. This transfer won’t grant you a tax deduction since it was already provided at the time of the RRSP contribution. It’s essential to note that this option will not restore your unused RRSP deduction room. Nonetheless, if it’s your only choice, and you’re about to buy your first home, it’s highly advisable to proceed with the transfer because, unlike the Home Buyers’ Plan (HBP), the funds withdrawn from FHSA when buying your first home won’t need to be repaid.
Strategies
Here are some strategies to consider based on your situation:
- As soon as you intend to buy your first home within the next 15 years, it’s important to open an FHSA so that the annual limit begins to accumulate. You should also consider contributing to eventually reach the maximum of $40,000 before purchasing your first home (see the previous section).
- To optimize the tax-free income generated by your FHSA, it is recommended, though not obligatory, to consider purchasing your first home as close as possible to the 15-year limit and to make maximum contributions within the five years following the account opening.
- Your accumulated tax deductions (from your contributions) can be carried forward to subsequent years, even beyond the year of buying your first home. It’s preferable to wait for a year when your income is higher to utilize them. However, don’t wait too long because you will lose the opportunity to generate investment profits on tax refunds.
- If, during a year, you’ve exhausted your participation room and have extra funds for savings, it’s better to invest them in your TFSA rather than your RRSP. In the years to come, you can withdraw funds from your TFSA and transfer them to your FHSA without significant tax consequences, which is not the case with a transfer from your RRSP, as explained earlier.
- Consider opening your FHSA before getting married or entering a common-law relationship with someone who already owns a principal residence.
You Did Not Purchase of a First Home Within the 15-Year Period?
There is a 15-year window from the moment you open your FHSA to purchase your first home. Once this period has elapsed, you can transfer your FHSA balance into your RRSP, tax-free, without affecting your unused deductions. In this case, it is important to proceed with a direct transfer. Otherwise, if you withdraw the funds without either purchasing your first home or transferring them to an RRSP, they will be subject to taxation.
Other Tax Possibilities When Buying Your First Home
In addition to the benefits of the FHSA, a first-time buyer can also take advantage of the HBP (Home Buyers’ Plan) as well as tax credits when purchasing their first home.
Conclusion
In summary, the FHSA is a tax-free savings tool much more advantageous than the TFSA (Tax-Free Savings Account) or the RRSP (Registered Retirement Savings Plan) because the money contributed to it is 100% tax-free if you proceed to purchase your first home within the 15-year period from the account’s opening.
The purpose of this article is to explain why this new tax-free savings account is highly advantageous and not to provide the details of the conditions to take advantage of it. All of these details can easily be found on the Government of Canada’s website.
Certain additional arrangements and strategies may apply to your specific situation, so it’s important to consult with an expert to obtain a proper analysis of your tax planning.
Relevant references:
- Canada – First Home Savings Account (FHSA): https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/first-home-savings-account.html
- Canada – What is the Home Buyers’ Plan (HBP)?: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/what-home-buyers-plan.html
- Canada – First-Time Home Buyers’ Tax Credit (HBTC): https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/budget-2022-plan-grow-economy-make-life-more-affordable/first-time-home-buyers-tax-credit.html
- Quebec – Home Buyers’ Tax Credit: https://www.revenuquebec.ca/en/citizens/tax-credits/home-buyers-tax-credit/
