Playing With House Money: Ways to Save for that First Home Part 1

It’s not exactly a newsflash that buying a first home in today’s Canada is only a pipedream for many. Prices soared to new highs across the nation during the heights of the Covid pandemic and, although we are now well off of those highs, the subsequent rampant run-up in interest rates has vastly decreased how much potential buyers can and should borrow. Making things even worse, 2022’s stock market decline chipped away at many potential down payments and the current stratospheric level of inflation means that a portion of many pay cheques earmarked towards home savings have been diverted to things like gas and groceries. The reality is that for many young Canadians, their only chance of getting into the housing market any time soon is from either playing the lottery or with a little help from someone else.

While reading this article will not create a down payment out of nothing or magically reduce mortgage payments, a little strategic financial planning, a lot of patience and a healthy assist from the investment gods may ultimately see you or your loved ones finally in a place of their own. Whether you’re saving up for your own abode or a parent / grandparent looking to give a youngster a leg up, here are a few ways suggestions to help achieve this lofty goal.

What This Article Won’t Do

I don’t plan on talking about any provincial programs that focus on saving property transfer tax, nor any federal or provincial programs that rebate any PST, GST or HST when buying new or substantially renovated homes. I will say in BC that if a couple is purchasing a home and one has already owned a home previously, it’s worth getting legal advice to discuss potentially having solely the first-time buyer on title initially.

I also don’t plan on providing any specific investment recommendations, other than a few quick comments that I’ll make now. First, just like when setting up any other investment account, picking investments that match your time horizon is vital, as is also adjusting this mix as you get closer to the finish line. Although swinging for the fences can pay dividends if you capture a market upturn, the reverse is true if the market swings the other way. If you’ve already saved up enough for that down payment, it’s time to take risk off the table and reduce volatility. This is particularly important for savers already shopping the market or waiting to close on a property, but also applies for those of you perhaps still a year or two away, waiting for prices and / or rates to drop before putting a toe into the property market.  This opportunity might instead pass you by if your investment portfolio suffers a similar decline.

You’ll also need to make your own investment decisions or get professional advice, but a couple types of investments I currently own might not be things many of you have considered before. I currently own both some private mortgage funds (MICs) geared towards residential mortgages and some structured notes that provide both a healthy income and downside protection. There are downsides and risks to both, as there are for any investment, but both of these minimize stock market risk, although you’d also need to confirm that minimum holding period isn’t too long for your purposes, and whether you have sufficient income or savings to meet eligibility requirements.  And, neither of these options are appropriate for all savers.

Setting The Stage

For many, the best path to their first front door will combine several of the different strategies I’ll discuss below – there are contribution or withdrawal limits to some of the government plans meant to assist with first home purchases, which means having to fund more than one type of savings or investment account and deciding what to fund first. Finally, if other family members are also hoping to assist youngsters, they won’t have access to all of the same government-assisted savings plans. Ultimately, if purchasing that home requires a combined family effort, the best strategy may involve different people saving or contributing in different ways. 

Furthermore, just to make this all that more confusing, one size will not fit all, as we all have different financial realities, timelines and goals. Your job after reading this article will be to cherry pick what options best fit your reality and take whatever steps are required to move forward, either on your own, with the rest of your family or with the assistance of whatever advisors you need to make things happen.

I will also wait until next time to discuss some of the considerations parents and grandparents wishing to contribute can do to protect themselves and the lenders in lieu of gifting, such as lending, guaranteeing mortgages or co-owning. 

So, with no further delays, prevarications, or qualifications, here we go . . .

Tax Free Home Savings Accounts (“FHSA”) – Since April 2023 to a financial institution near you

Key Benefits:

■Tax- deductible contributions.

■Tax-free withdrawals with no repayment requirements.

■No cap on the amount that can be used for a down payment, although there is a cap on yearly and total contributions.

■Flexibility to transfer back and forth into RRSPs.

Key Disadvantages:

■$8,000 annual funding limit and $40,000 lifetime funding cap.

■Limited carry-forward room if you don’t maximize each year’s limit.

■A higher income spouse can gift a spouse the money to fund the spouse’s contribution, but the lower income spouse must claim the deduction.

■Although initially, savers were forced to choose between either using the RRSP Homebuyers’ Plan or the FHSA, recent changes now allow them to use both options. Accordingly, this disadvantage no longer applies!

This account combines the best features of both RRSPs and TFSAs. Starting in 2023, everyone over 18 (or over 19 in provinces with a higher age of majority) who hasn’t owned a home in about five years can contribute $8,000 each year if maximizing their yearly contributions into this account, with a lifetime contribution limit of $40,000.  Like a TFSA, contribution room is based on age rather than income. As well, all qualifying withdrawals are tax-free, with no repayment requirements, unlike when borrowing from an RRSP.  Even better, there is no cap on how much you can eventually withdraw, other than you can only keep your account open 15 years. In other words, although you can only put in $40,000 and will have to wait at least 5 years to squeeze in your last dollar, you could potentially withdraw hundreds of thousands tax-free if you corner the stock market and / or get a little lucky, particularly if the money has many years to compound.  Of course, swinging for the fences can also mean watching your contributions vanish, so make your investment decisions with your eyes wide open.

As is true for RRSPs, contributions are tax-deductible, which allows investors to invest more, since contributions either reduce how much they have to set aside for taxes or will result in a tax refund to refill the coffers. And there is no need to deduct contributions in the year they are made if expecting a big bump in salary next January (and thus a bigger refund) or that first real job is many years away. It’s even possible to transfer RRSP money to your FHSA to fund contributions if money is tight one year, although you won’t get any RRSP contribution room back. The reverse is also true if you ultimately never enter the housing market – you can transfer FHSA money into your RRSP without triggering tax and the amount transferred will not affect your regular RRSP contribution limits.

That said, my suggestion is to investigate funding the FHSA if not already attending open houses and schmoozing with mortgage brokers. The funds can always be transferred to the RRSP and used towards that down payment option if HBP ultimately turns out to be the best way forward. And, if that first purchase is delayed a few years and / or the investments in the FHSA do well, the saver can simply fund the down payment from the FHSA. As an added bonus, since money deducted under the FHSA doesn’t count against RRSP contribution limits, if the funds are ultimately transferred to the RRSP anyway, the saver will have more RRSP contribution room for use in the future compared to someone who instead put the same amount into an RRSP instead.

If maximizing FHSA contributions, the next question is where to put your next dollar of savings – a TFSA or RRSP. Generally, savers in a lower tax bracket with a longer time horizon before purchase are often better off putting extra funds into their TFSAs after maximizing FHSA contributions if hoping to eventually save the highest down payment possible --since the HBP caps withdrawals at $35,000, putting the extra cash into a TFSA after funding the FHSA could eventually mean a far larger down payment one day, since both the TFSA and FHSA allow the full account balance to go towards that first home should the investments in them grow like gangbusters, unlike the RRSP Homebuyers’ plan that caps how much you can borrow from yourself at $35,000. Moreover, the saver can always withdraw funds from the TFSA at a later date to make catchup RRSP contributions if that ultimately looks like the best way forward, particularly if the saver is now in higher tax bracket and, accordingly would get a bigger tax refund per dollar contributed. And, if the money has grown inside the TFSA, the saver might actually have more dollars to contribute to the RRSP in the future anyway, which can mean an even higher tax refund and even more money for the pending purchase. Accordingly, as you can see, some savvy savers might actually use all three registered savings plans to maximize their downpayment dollars.

Changing directions, there is one major drawback to the FHSA – this plan offers minimal catchup contributions. Savers cannot carry forward any unused contribution room unless they’ve already opened a FHSA. Moreover, even after a plan is in place, savers who don’t take advantage of their yearly maximum contribution can only carry forward a combined $8,000 to use later, capping out yearly contributions at $16,000. In other words, if you don’t open an account in 2023, you will have no carryforward room for 2024 and can contribute only $8,000. And, if you do open an account in 2023 and contribute $1,000, you’d be able to contribute $15,000 in 2024.  One matter I still want clarified is what happens for a saver who has not made any contributions for many years after opening an account – are they stuck with a single $8,000 catchup contribution when they do have the funds, plus that year’s regular $8,000, or do they get to do the same thing the next year as well until they hit their $40,000 lifetime contribution limit? 

Due to this limited carryforward room, regardless of the answer to this question, if looking to use the plan, it makes sense to start sooner rather than later, even if making only a minimal contribution or perhaps transferring money from an RRSP directly to the FHSA to come up with the necessary cash. One final question that still remains in my mind is whether money in a spousal RRSP (i.e., one funded by presumably the higher income spouse for that other’s benefit) can be transferred to the receiving spouse’s FHSA. Finally, if you are still unable to make your contribution but your spouse has a few extra dollars kicking around, (s)he can lend you the necessary funds, which is an exception to the normal tax attribution rules.

Registered Retirement Savings Account Home Buyers Plan (“RRSP” or “HBP”)– Borrowing from tomorrow to help pay for today

Key Benefits:

■Contributions are tax-deductible and unused contribution room can be carried forward indefinitely.

■Higher earners or those with lots of unused room can maximize funding far sooner, which can be important for savers close to purchasing.

■Flexibility to transfer back and forth with FHSAs.

■Potential tax savings if higher income saver can contribute and write off contributions to a lower income spouse by funding a spousal RRSP, which can be used to increase the down payment.

Key Drawbacks:

■Withdrawals capped at $35,000 and must be repaid within 15 years starting from a couple years post withdrawal in yearly increments.

■Takes away from growth of retirement savings.

■Income-based, so starving students may not be able to contribute until employed and have qualifying income. Savers with defined benefit pensions will have limited RRSP contribution room. 

■Borrowing from your RRSP to fund a down payment disqualifies that saver from also using the FHSA. – No longer true!

Although RRSPs are designed primarily to save for retirement, there is an exception for anyone who hasn’t owned a home in essentially 5 years or, regardless of how long the gap between homes, if you’re recently divorced. You can borrow from yourself interest-free, but you need to start repaying your RRSP account a couple years later according to a 15-year repayment schedule. If you don’t make a repayment, you’re taxed on that year’s minimum repayment amount as if you’d made an RRSP withdrawal of that same sum. On the other hand, you don’t get any new tax deduction when repaying yourself, as you already got your discount when contributing in the first place, which makes repayments more onerous than regular deductible contributions. For couples in different tax brackets, it’s possible for the higher income spouse to make contributions to something called a “Spousal RRSP” and for the receiving spouse to use that money towards the down payment. The contributing spouse uses up their own RRSP room and gets the tax deduction, but the money goes into a separate RRSP that the receiving spouse can use to come up with all or some of their own $35,000 in eligible withdrawals. Ultimately, most couples using this strategy aim to have $35,000 each to put towards a down payment, whether each funds their own plan or if the one in the higher tax bracket helps the other come up with all or some of the necessary funds through spousal RRSP contributions. Using the Spousal RRSP option if there is a big disparity in taxable incomes and the goal to only contribute enough RRSP dollars to max out the HBP, then the Spousal RRSP option can be a gamechanger.

The spousal contribution option is one perk that is exclusive to HBP – the FHSA allows us to only deduct contributions to our own accounts (even though we can lend a spouse the cash for their contributions.) As a result, the HBP is more tax-efficient for couples in wildly different tax brackets, since the higher income spouse can essentially contribute for both of them and have the tax deductions based on that spouse’s income.

Moreover, unlike the FHSA, RRSP room is based on taxable income. Savers without work pensions can contribute 18% of their qualifying income to next year’s RRSP to a yearly cap that will be $30,780 in 2023, plus all previously unused contribution room. The result is that savers that are late to the game can potentially put in and deduct a lot of money in a hurry to fund a HBP withdrawal, unlike the pending FHSA, which is a longer-term play.

Unfortunately, savers with work pensions earn far less RRSP room but might still be able to play RRSP catchup if they have lots of unused room from the past. As a result, although the HBP might not be ideal for some savers with significant work pensions and microscopic RRSP room, all is not lost if they already have a sufficient RRSP, a spouse that could make a spousal RRSP contribution, or enough RRSP room from the past to get there on their own.

Tax-Free Savings Account (“TFSA”)– Maximum flexibility, but no write-off

Key Benefits:

■Maximum flexibility, as this account can be used for any other purpose without triggering tax if plans change.

■Not income-based, so savers over 18 or 19 can start funding contributions even if not working, should other family members wish to lend a hand.

■Any withdrawals can be recontributed in the next tax year onward.

■All unused contribution room can be carried forward indefinitely, which can allow large initial contributions for older savers.

■Can be used in conjunction with either the FHSA and the RRSP Homebuyers’ Plan, or both.

Key Drawbacks:

■No deduction for contributions.

■Limited annual new contribution room (i.e., $6,500 for 2023.)

The TFSA is a general-purpose savings account with no deduction for contributions, but both tax-free growth and tax-free withdrawals, regardless of how the money is used. Everyone 18 or older earned $6,500 in new contribution room for 2023 and can contribute any unused room from past year whenever the heart desires and finances allow from the year they turn 18 onward (or 19 in places like BC.) Moreover, any withdrawals may be recontributed in later years, which is an important benefit to this program that I’ll say more about later.

The major advantage of the TFSA is that it can also be used in conjunction with either or both of the other two options, either to augment savings after maximizing contributions to either RRSPs or FHSAs, or as way to build savings until the saver has enough taxable income to benefit from either of the other plans. In other words, rather than funding an RRSP initially when in a low tax bracket, the money could instead grow tax-free in a TFSA first before eventually going towards RRSP contributions when the saver can actually benefit from claiming the RRSP deductions. Even better, when the money is eventually contributed to the RRSP, hopefully the amount that can be contributed will have grown due to savvy investing while the money was in the TFSA, which means a bigger tax refund that would have been possible if the money had gone straight into one of the other two options.

The same applies for FHSA contributions as well if the saver isn’t in a high tax bracket, although savers would still likely want to max their $8,000 per year contributions to that plan asap and only use the TFSA for the excess. That’s because the $8,000 that goes into the FHSA is tax deductible (unlike TFSA contributions) and the saver can wait until in a high enough tax bracket to make claiming the deduction worthwhile.

Finally,  unlike the HPB, there is no maximum withdrawal limit on a TFSA, nor any repayment requirement. An investor maximizing both TFSA and FHSA contributions could hypothetically fund the entire purchase using these plans if they hit an investment grand slam or didn’t live in a place like Vancouver or Toronto.  And, the previously mentioned ability to recontribute any withdrawals will increase how much (s)he can shield from tax in the future if they strike it rich or want to tax shelter some of their inheritance one day – someone contributing $50,000 to a TFSA but later withdrawing $150,000 would be able to shelter $100,000 more when their ship comes in later in life than someone who never used their TFSA in the first place! When the tax savings from having that extra hypothetical $100,000 to recontribute and grow tax-sheltered  for perhaps decades are factored into the mix, the TFSA starts to look better and better.

Buying a first home in Canada has never been more difficult, and unless today’s combination of high prices and high-interest rates ease off, things may not be changing any time soon. For that reason, more than ever, knowing how to maximize every saving and funding opportunity that can still make this dream a reality is critical. On the other hand, options and strategies do exist. Your job is to review the information I’ve provided and what you can find from other sources and do what you can to make every dollar go as far as possible, whether you’re saving for that house yourself or helping someone you love to get their first home.

Colin S. Ritchie, BA.H. LL.B., CFP, CLU, TEP and FMA is a Vancouver-based fee-for-service lawyer and financial planner who does not sell investment or insurance, just advice. To find out more, visit his website at www.colinsritchie.com.