When you’re on the hunt for your first home, finding that perfect place after a long, hard search can be an exhilarating experience. But deciding how to pay for your dream home isn’t always so easy.
If you’ve diligently put aside funds in a Tax-Free Savings Account, now you have to decide on the most financially advantageous way to utilize that nest egg. Should you transfer your TFSA money to a Registered Retirement Savings Plan (RRSP) and use the Home Buyers Plan (HBP) strategy?
At first glance, the HBP seems like the obvious way to go. Under this program, homebuyers can make a tax-free withdrawal of up to $25,000 from their RRSP ($50,000 when combined with a spouse) to use towards their first home.
Once the funds have been withdrawn from your RRSP, they need to be paid back over the next 15 years, starting two years after the withdrawal. To avoid taxation, homeowners must deposit at least 1/15 of the amount withdrawn from their RRSP annually. (That’s the minimum – you can make additional payments at any time without penalty.)
If you don’t make your minimum payment each year, the amount owing will be included in your income and subject to tax.
The main benefit of transferring your TFSA funds to an RRSP (assuming you have the RRSP contribution room) and then withdrawing them through the HBP program is obvious: More funds for your first home. Repayment is over 15 years and tax-free. On top of that, you get a tax refund for your contribution to the RRSP, which can also go towards your down payment.
However, there is a downside to the HBP: You lose the growth potential of your RRSP for those 15 years. Because the principal is repaid interest-free to your own RRSP over 15 years, the lengthy repayment period has a negative effect on the RRSP’s growth.
For example, a $25,000 RRSP would be worth $59,914 at the end of 15 years, assuming a 6% rate of return. However, if you used that $25,000 towards your home through the HBP and repaid it gradually over 15 years, the RRSP would only be worth $39,019 at the end of the 15-year period.
Clearly, you’re losing out on some potentially lucrative growth, and it begs the question: Aren’t you better off just leaving the funds in the RRSP and accumulating interest, especially if your rate of return is going to be more than your borrowing rate?
“There certainly is a long-term impact on your RRSP when you withdraw the funds from your RRSP for the Home Buyers Plan,” says Marie C. Blanchet, Senior Consultant, National Bank Financial Planning. “But there is a way to mitigate the withdrawal of those funds and the loss of the long-term growth.”
“Because you’re not going to have to borrow that amount of money, your mortgage payments should be smaller, your line of credit may also be smaller, and you will now hopefully have a little more room in your monthly expenses so that you can start a systematic savings plan,” she says.
In other words, if you withdraw $25,000 from your RRSP instead of borrowing $25,000, you will end up with surplus funds because of the reduced borrowing costs. If you take that surplus, and reinvest it into a TFSA, the RRSP shortfall is mitigated.
In addition, says Ms. Blanchet, homebuyers can take advantage of another potential benefit of the HBP -- a reduction in the insurance fee required by the CMHC (Canadian Mortgage and Housing Corporation).
A word of warning though: If you do decide to take advantage of the HBP, don’t utilize that $25,000 to purchase a home that’s worth more than you can afford. Limit yourself to a reasonable purchase price based on your financial resources, with or without the HBP, says Ms. Blanchet, and be sure to reinvest your budget surplus rather than spending it on luxury splurges.
“People do need to add a little bit of discipline to their financial approach, making sure that you don’t just discuss the strategies, but implement them,” says Ms. Blanchet. “And the best way to do that is to sit down with a financial advisor and put in place a plan.”
National Bank’s experienced financial advisors can help you understand your options when it comes to buying your first home, and help you formulate the right strategy to make the most of your money.
