If you’re intently saving for your first home, you’re probably aware that the new First Home Savings Account (FHSA) is a great tax-advantaged way to build up your down payment.
But the FHSA has broader uses. In the right circumstances, it can also be a good way for renters to save even if they’re not sure about buying a home.
That makes the FHSA a surprisingly versatile addition to the somewhat crowded field of tax-advantaged savings accounts (which seem to follow a common pattern of having four-letter acronyms).
Still, you need to delve into the details to understand when the FHSA works well compared to the main established tax-advantaged savings programs, the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA).
Few Canadians can afford to make maximum contributions to all three, so you usually need to prioritize funding to the tax-advantaged accounts that best suit your circumstances.
It turns out the FHSA combines the best tax-saving features of RRSP and TFSA when used to purchase a first home, making it a superior option for those focused single-mindedly on home ownership.
But if you don’t end up buying a home, the FHSA can function effectively much like an RRSP. That can suit your situation if your focus ends up gravitating instead to building up long-term financial savings.
Newest four-letter account
Legislation to enable the FHSA came into effect April 1. Canadian residents 18 years and older who haven’t owned a home in the current or preceding four calendar years are eligible. After opening an FHSA, you can contribute up to $8,000 per year to a maximum of $40,000. You can also carry forward unused contribution room.
Although the FHSA program is officially launched, few financial institutions are ready to offer them just yet. The Questrade online brokerage is one of few institutions that has them now. Expect other institutions like the big banks to roll them out over the next few months.
You can keep an FHSA open for up to 15 years or until you turn 71 while waiting to buy a home. If you don’t end up making a home purchase within those constraints, you can transfer the money into an RRSP or RRIF (without the need to use existing RRSP contribution room). You can also withdraw the money on a taxable basis, but that usually isn’t wise.
The FHSA combines the best features of the RRSP and TFSA when used for first-time home purchase. For starters, you don’t pay tax on investment income while the money is held within the FHSA, similar to both the RRSP and the TFSA.
You get an upfront tax deduction on your FHSA contribution (like an RRSP), but you also get to withdraw the money tax-free (like a TFSA) when it is used specifically for first-time home purchase.
There can be confusion between the FHSA and an RRSP feature known as the Home Buyers’ Plan (HBP). They have some similarities and many first-time home buyers will have cause to use both in combination. However, if you have limited funds and are trying to compare tax advantages of contributing to either a FHSA or an RRSP, it’s important to understand that the RRSP Home Buyers’ Plan is quite restrictive relative to the FHSA.
The HBP allows you to “borrow” up to $35,000 from your RRSP for a first-time home purchase without triggering tax consequences. But the HBP also requires you to repay the money to your RRSP over 15 years according to a set schedule (starting two years after drawing the funds) — otherwise it’s taxed as income.
If you’ve bought a home in the last few years and are hard-pressed to make hefty mortgage payments, this rigid repayment requirement can be onerous. In contrast, FHSA funds used for first-home purchase are untaxed with no strings attached.
By combining the best tax-saving features of RRSP and TFSA, the FHSA is generally the superior option when the sole objective is saving for a first home purchase.
If no home is bought
The relative benefits of the FHSA, RRSP and TFSA are more complicated if you don’t end up buying a home.
Let’s first discuss the traditional matchup between the RRSP (with its upfront tax deduction) and the TFSA (with its tax-free withdrawals).
The RRSP is usually the better choice in a common but specific circumstance. That typically applies when you’re in a relatively high tax bracket when you contribute (you get a big tax-deduction bang for your buck), but you’re in a relatively modest tax bracket when you take the money out (which is typical for a middle-class retirement).
So the RRSP is usually a great way for people with average or above-average salaries to save for retirement. But if you need to tap into your RRSP during your peak earning years, you pay a lot of tax, so it tends to be poorly suited to short-term saving.
In contrast, the TFSA is more of an all-purpose savings vehicle. It usually isn’t quite as good as the RRSP for high earners saving for a typical middle-class retirement, but it is more versatile. It also tends to be better suited to those with relatively low incomes when they contribute.
Since withdrawals are tax-free, the TFSA is generally the better option for short-term saving when you might be taking the money out while still in your high-earning years.
Now let’s bring the FHSA into the comparison for situations where the funds aren’t used to buy a first home.
In that circumstance, the FHSA works very similar to an RRSP. Like the RRSP, your FHSA contributions earn you a tax deduction up front, and your subsequent investment income is not taxed while held within the FHSA. In addition, your FHSA money is ultimately transferable into an RRSP (or RRIF) if unused for a home purchase. So, if you don’t buy a home with the funds, the FHSA works well in situations where RRSPs work well.
In essence, the FHSA saves more tax than an RRSP if you buy a home with the funds, and has a similar tax impact if you don’t buy a home. So on a combined basis, the FHSA has the overall advantage over the RRSP.
The FHSA also generally saves you more tax compared with the TFSA if you carry through on the home purchase. If you don’t purchase a home, whether the FHSA or TFSA works best varies depending on individual circumstance.
If you have enough money to contribute to two of these tax-advantaged accounts but not all three, figuring out the best combination can get complicated and depends on individual situations. Personally, in many situations, I like the combination of FHSA and TFSA because they are complementary. The FHSA is typically a great way to save for a first home or long-term, but the TFSA is more versatile and usually better for short-term savings.
David Aston, a freelance contributing columnist for the Star, is a personal finance and investment journalist. He has a Chartered Financial Analyst designation and is a Chartered Professional Accountant. Reach him via email: firstname.lastname@example.org