This article appears in the September 2022 issue of Investment Executive and was originally published on August 22. Subscribe to the print edition, read the digital edition or read the articles online.
Tax experts are strategizing over how to use the new tax-free savings account for first-time homebuyers and how it will interact with other registered accounts.
The proposed rules governing the Tax-Free First Home Savings Account (FHSA), released for comment in August by the Department of Finance, allow for plenty of flexibility regarding contributions, deductions and investments.
As with an RRSP, contributions to an FHSA are tax-deductible. Withdrawals to purchase a first home — including from investment income — are non-taxable, like with a TFSA.
“If you’ve got some runway [and] you’re going to be buying a home, then [the FHSA] and tax-free income is great,” said Wilmot George, vice-president of tax, retirement and estate planning with CI Global Asset Management in Toronto. “You don’t get much better than that.”
The draft legislation introduced two key features: unused FHSA room of up to $8,000 can be carried forward to future years, and deductions for contributed amounts can be claimed in the tax year they were made or in future years.
“[That’s] good news in terms of additional flexibility,” said Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth.
Clients who want to buy a home and have the money to make contributions should consider opening an FHSA as soon as possible, wrote Aaron Hector, vice-president and financial consultant with Doherty & Bryant Financial Strategists in Calgary, in an email to Investment Executive. Contributing early will allow for tax-free compound growth, and the ability to defer a deduction eliminates a reason to wait.
“If someone does not buy a home within 15 years, they can transfer their FHSA funds into their RRSP, where they could then utilize the [Home Buyers’ Plan (HBP)],” Hector wrote. “That’s not a bad Plan B.”
The FHSA is set to launch in 2023.
Since carry-forward amounts begin accumulating only after an FHSA is opened, prospective homebuyers could open an account in 2023 even if they don’t have money to contribute, Hector suggested. That would mean they could contribute up to $16,000 ($8,000 annual contribution plus $8,000 carried forward) in 2024 rather than waiting until 2025 for more room.
An FHSA can hold the same investments that are currently allowed in a TFSA.
“If someone is actively shopping for a home, it would be wise to keep their FHSA money very conservatively invested,” Hector said. “You would not want to be counting on a certain dollar amount in your FHSA to buy your home, only to find that when you are ready to make an offer, that your investments have suffered from a market decline.”
According to the proposed legislation, people cannot use withdrawals from both an FHSA and an HBP to buy the same home. The FHSA, therefore, could supplant the HBP as the favoured way to fund a down payment.
With an HBP, “you’re borrowing from your RRSP, but you’re going to have to repay yourself within 15 years,” said Carol Bezaire, senior vice-president of tax, estate and strategic philanthropy with Mackenzie Investments in Toronto. “With the FHSA, money will come out tax-free and you don’t have to pay it back, plus you get a deduction for your contribution.”
While spousal FHSAs aren’t allowed, a person can give their spouse (or common-law partner) money to contribute to an FHSA without triggering income attribution on that amount.
A couple, then, could contribute $80,000 for a down payment, which would grow tax-free, Bezaire said.
As there are no attribution rules on gifts to adult children, parents could give their adult kids money to contribute to their FHSAs. However, that gift becomes the child’s property, Bezaire said, and the child doesn’t have to use it to buy a home.
The proposed rules allow for tax-free transfers from an RRSP to a FHSA, up to the individual’s FHSA contribution limits. But such transfers wouldn’t be deductible, George said: “There’s no double deduction scenario.”
But since transfers between plans are allowed, should a prospective homebuyer contribute to an RRSP or an FHSA if they don’t have enough to contribute to both? “The benefits are stacked in favour of starting with the FHSA,” Hector said.
Contributions of $8,000 a year for five years to an RRSP, rather than to an FHSA, might grow to, say, $60,000, but only up to $40,000 of that amount could be transferred to an FHSA, depending on the annual and lifetime contribution room available.
The $20,000 of growth would be “trapped” in the RRSP, Hector explained, and taxable when withdrawn. In contrast, $40,000 contributed to an FHSA could grow to $60,000 and be used to purchase a home. The amount would escape taxes again if the home qualifies for the principal residence exemption.
“Also, if you start [contributing to] the RRSP and transfer [money] into the FHSA, then you have lost the RRSP [contribution] room forever,” Hector said. “If you start [with] the FHSA, you maintain your ability to also use your full RRSP room.”
The design of the FHSA allows a renter with no intention of buying a home to open an FHSA, contribute to the plan and then transfer the amount, plus growth, to an RRSP when the plan closes. Such a strategy would effectively allow that person to create more RRSP room.
Golombek said he was “somewhat surprised” the draft legislation didn’t address this issue, as many tax experts identified that loophole when the FHSA was first proposed. However, he said the opportunities for this kind of tax planning are “somewhat limited.”
“You really have to look at someone who has maximized their entire RRSP contribution room, which is very few people — only the very wealthy — and doesn’t own a home,” Golombek said.
Bezaire said she believed Finance could adjust the draft legislation to address the issue: “They’re trying to make [the FHSA] more flexible and more attractive, but if they see loopholes, they’re going to close them.”
FHSA basics
The FHSA provides first-time homebuyers the ability to save up to $40,000 on a tax-free basis, with an annual contribution limit of $8,000.
To open an FHSA, an individual must be a Canadian resident at least 18 years of age who hasn’t owned a home during either the current year or the preceding four calendar years.
An FHSA can be open for only 15 years, and only until the accountholder turns 71. Any savings not used to purchase a home can be transferred to an RRSP or RRIF on a tax-free basis or withdrawn on a taxable basis.
An FHSA also stops being an FHSA by the end of the year following the first qualifying withdrawal to buy a home, with any amount not used to purchase a home transferable tax-free to an RRSP or RRIF, or withdrawn on a taxable basis. Once an FHSA is used to buy a qualifying home, or stops being an FHSA after 15 years or at age 71, an individual can’t open another FHSA.
For an FHSA withdrawal to be a qualifying (i.e., nontaxable) withdrawal, the taxpayer cannot be a homeowner but must have an agreement to buy or build a home in Canada by Oct. 1 of the following year. If the conditions are met, all FHSA funds may be withdrawn, tax-free, in a single withdrawal or a series. Contributions made following a qualifying withdrawal are not deductible.