No question that saving for a first home is difficult. The latest Federal budget contained several housing measures, including a new First Home Savings Account (FHSA), which is expected to be available at financial institutions later in 2023. If you or a young adult you know are planning on buying your/their first home in the next few years, you’ll want to consider incorporating this type of account into your down payment savings plan.
How do First Home Savings Accounts (FHSA) work?
These accounts are very attractive in that contributions are tax deductible. In that sense, First Home Savings Accounts (FHSAs) work similarly to Registered Retirement Savings Plans (RRSPs). You deposit funds, deduct the contribution from your income on your tax return, and reduce your taxes by your marginal tax rate. Your marginal rate can be anywhere from 0% if your income isn’t high enough to pay any tax to upwards of 53% for high-income earners. So, if you contribute $8,000 to an FHSA, you could reduce your taxes by up to about $4,240, depending on your income and your province of residence.
FHSAs go a step further in that withdrawals from the account to purchase a qualifying home are tax-free. You get a tax deduction when the money goes in but don’t have to pay tax when it comes out – an infrequent opportunity!
Here are some technicalities you should be aware of with First Home Savings Accounts (FHSA)
Age and Eligibility
You must be at least 18 years old to open an FHSA, and you cannot have lived in a home that you or your spouse owned at any time in the year the account was opened or in the four preceding calendar years.
Maximum contribution room and deadlines
The maximum contribution per year is $8,000, and the lifetime limit is $40,000. Contributions are based on the calendar year. Unlike RRSPs, you cannot apply contributions in the year’s first two months against the previous year. So, the deadline for contributions you want to deduct in 2023 is December 31, 2023.
Contribution room carryforward
If you don’t use your full contribution room in any given year, it carries forward to a maximum of $8,000 once the FHSA has been opened. For example, if you open an FHSA in 2024 and contribute $1,000 at that time, your FHSA room for 2025 would be $15,000 (that is the $8,000 for 2025 plus the $7,000 you didn’t use in 2024).
Undeducted contributions
You don’t have to claim a tax deduction for FHSA contributions in the year you make them. Like RRSP contributions, you can carry forward the deduction to a future year if it would be more beneficial to use the deduction later. Your McCay Duff LLP consultant can help you optimize the timing of deducting FHSA contributions.
Time limit and age limit
Once the FHSA has been open for 15 years or you reach the age of 71 (whichever comes first), if the funds have not been used to purchase a qualifying home, the account balance must either be withdrawn or transferred to an RRSP/RRIF. If you withdraw the funds, the withdrawal is added to your income, and you pay tax on it. If you transfer the balance to your RRSP/RRIF, there is no immediate tax to pay. Instead, the funds are pooled with your other RRSP contributions, and you pay tax when you eventually withdraw the money.
Other savings account options
An FHSA can be combined with a Tax-Free Savings Account (TFSA), the Home Buyers Plan (HBP), and regular savings. These other options have been around for a while, but here is a quick refresher on how they work:
Tax-Free Savings Account (TFSA)
Contributions to TFSAs are not tax deductible, and any investment income earned in the account is tax-free. Withdrawals are not taxable. The TFSA contribution limit for 2023 is $6,500. You can catch up if you have not used your full contribution room for previous years. Please get in touch with your McCay Duff LLP advisor for help in determining your contribution room.
Home Buyers Plan (HBP)
The Home Buyers Plan allows you to borrow up to $35,000 from your RRSP. The money comes from your RRSP tax-free but must be repaid over 15 years, beginning the second year after the funds were withdrawn. If you withdrew $35,000 in 2023 using the HBP, you would need to repay $2,333.33 per year for 15 years, beginning in 2025. You could repay the money earlier if you wanted to. If you don’t make the minimum repayment in any given year, the required payment amount is included in your income, and you pay tax on it.
Regular savings accounts
No special tax treatment for these accounts. Any investment income earned is taxable.
What is the most tax-effective way to save for a down payment?
The optimal way depends on your income, timeline, and the amount you plan to save.
Your McCay Duff LLP advisor can help you determine the best time to open an FHSA and maximize your tax deductions while staying within the account’s time limits. Saving for a first home will never be painless, but adding a First Home Savings Account to your plan should make the process easier.
Contact McCay Duff LLP in Ottawa to Help You With Your Tax Needs
A skilled tax advisor can help you plan your estate transfer in the most tax-efficient manner. At McCay Duff LLP, our tax experts can provide services to support your tax and estate planning function, whether you need partial or complete support. In addition, we can provide you with recommendations on storing wealth in structures best suited for your business. To learn more about how McCay Duff LLP can provide you with estate planning expertise, don’t hesitate to contact us online or by telephone at 613-236-2367 or toll-free at 1-800-267-6551.