Coming up with a down payment can be a monumental challenge for first-time home buyers. With soaring Canadian real estate prices, crippling student loan debt, and low entry-level salaries, it can take years to save the required minimum down payment of five per cent.
Given the amount of time you’ll be saving, the question of where to park your down payment fund is important. Naturally, you’ll want it to grow tax-free, which means you have two options: One is a Registered Retirement Savings Plan (RRSP), which will allow you to participate in the Home Buyers’ Plan. Another option is a Tax-Free Savings Account (TFSA), which allows for more flexible contributions and withdrawals.
Which is better? For most first-time home buyers, a TFSA works best. Let’s have a closer look at each below.
Using an RRSP
If you save up for your down payment in your RRSP, you can use the Home Buyers’ Plan (HBP) to withdraw up to $35,000 as a loan without paying tax on the withdrawal. Only first-time home buyers are eligible to use the HBP, unless special rules for persons with disabilities apply.
Technically, you are considered a first-time homebuyer if neither you nor your spouse owned a home during the four calendar years prior to the year of withdrawal, and up to 30 days before the withdrawal.
Loan repayment under the HBP must take place over a period of 15 years, or less if desired. The repayments begin in the second year following the year of withdrawal. If the required repayment is not made, an amount will have to be included as taxable income in the year of the shortfall.
If you have previously participated in the HBP, there are certain situations in which you may be able to access it a second time. First of all, the full amount previously withdrawn must be paid back into your RRSP before the beginning of the year that you want to participate a second time. Also, you must still qualify as a first-time homebuyer.
If you contribute an amount to your RRSP, you can’t make a withdrawal under the HBP within 90 days of that contribution, or your ability to claim a deduction for the contribution may be restricted.
As a general rule, you should make your RRSP contribution more than 90 days before the withdrawal. After a waiting period of 90 days or more, your deduction may generate a tax refund, which can also be applied toward your down payment.
Each spouse or common-law partner can withdraw eligible amounts from their RRSPs under the HBP. This also means that each person may withdraw up to the $35,000 limit, or $70,000 total (if purchasing the property jointly).
Using a TFSA
The TFSA is a registered plan like an RRSP, but differs because TFSA contributions are not tax deductible. The flip side is that withdrawals from a TFSA are not taxable, and that includes any gains earned inside the account.
A TFSA is ideal for saving up for a down payment on a house, and can be a viable alternative to the HBP for a first-time homebuyer.
Unlike an RRSP, you don’t need earned income to create room for a TFSA contribution. For instance, a 23-year-old new graduate with a starting salary of $40,000 will create just $7,200 in RRSP contribution room for next year. With the TFSA, she’ll already have $38,000 in contribution room available by 2019 ($76,000 when combined with a same-aged partner).
The other issue with the HBP is that your income is likely to be low when you first enter the job market. Since you’re in a lower tax bracket, your RRSP contributions will result in a lower tax refund — making the TFSA a more optimal choice.
The HBP is a good option for first-time home buyers who have already invested in RRSPs and don’t have any savings outside of their RRSPs.
For young Canadians just entering the workforce without any savings inside their RRSP, it makes more sense to use the TFSA from the beginning to save for a down payment on a house.
By Robb Engen