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In a cooling housing market, Canadians who are looking to buy their first home have a new tool at their disposal: the First Home Savings Account, or FHSA.

Unveiled with the 2022 federal budget and set to be made available in 2023, this new savings vehicle is the only Canadian savings program that is truly tax-free – a fact that has flown largely under the radar.

Incentivizing savings

One way that governments around the world encourage and help people to save for goals such as buying a house or preparing for retirement is incentivizing them with tax breaks. Depending on the policy goal, the government will attach a tax advantage to some income flow in the savings process – whether it’s in the contributions, the returns on the invested assets and/or the take-home income generated by those savings at some point in the future.

In principle, the money is always taxed at some point. But the 2022 federal budget’s proposed tax-free FHSA is the only Canadian savings program to truly not incur taxes – ever.

Mind your ‘e’s and ‘t’s

Using taxation to encourage savings is so universal that there is an international rubric to compare and contrast the saving structures across and within countries. There are three conventional categories – TEE, EET and TTE – where “T” represents “taxed” and “E” represents “exempt from tax” for contributions, investment income or withdrawals.

International classification of taxation on savings 

NameContributionsInvestment IncomeWithdrawalsCanadian Examples
EETExempt Exempt TaxedRRSP, CPP/QPP, workplace-sponsored registered pension plan
TEETaxedExempt Exempt TFSA, principal residence
TTETaxedTaxedExempt Other financial investments
EEE (new)ExemptExemptExemptFHSA

Source: Bonnie-Jeanne MacDonald 

In Canada, for example, registered retirement savings plans and workplace registered pension plans exist “in order to encourage and assist Canadians to save for retirement. Contributions to these plans are deductible from income, investment income is not taxed as it accrues in the plan and withdrawals are included in income for tax purposes.”

Otherwise known as “tax-deferred savings,” contributions and investment returns in these arrangements are exempt from taxation while they remain in the plan, but the money is taxed as ordinary income when withdrawn – meaning they are “exempt-exempt-taxed” or “EET.”

On the other hand, contributions to tax-free savings accounts are less “tax-free” than they are “tax-prepaid.” Contributions are made with after-tax income, and there is no tax deduction – like you get when you contribute to your RRSPs.

However, once made, TFSA contributions grow tax-free, and withdrawals don’t count as taxable income. This type of plan therefore falls under the “taxed-exempt-exempt” (TEE) category. Your primary residence also operates as a TEE scheme – finding this out is often an “aha!” moment, even for financial experts.

Introducing the FHSA

What’s special about the FHSA is that it’s a way for new homeowners to save that avoids taxes forever. As the budget explains, this program borrows the first “E” from RRSPs and the last from TFSAs, creating a new “EEE” tax savings category:

“Budget 2022 proposes to introduce the Tax-Free First Home Savings Account that would give prospective first-time home buyers the ability to save up to $40,000. Like an RRSP, contributions would be tax-deductible, and withdrawals to purchase a first home – including investment income – would be non-taxable, like a TFSA. Tax-free in, tax-free out.”

In this brave new “EEE” world, prospective first-time home buyers would have the ability to save $8,000 a year for five years, so up to $40,000 a person or $80,000 a couple. The investment returns are not taxable, and neither is the income used to purchase the house.

Thinking beyond these savings to the house purchase, the capital gains on the house are also tax-free, as are the proceeds from its sale down the road, expanding this EEE program into a major long-term tax advantage. Think of it this way: Even if the initial $80,000 grows to $800,000 by the time of sale, there are no taxes on it at any point in the process.

Will it help?

How well this new vehicle will help Canada’s housing crisis isn’t clear. Tax breaks are just one of several ways to support home ownership, and one of the worst in terms of equity, some argue. Other ways to support the same goal include grants and new builds of lower-cost dwellings with special financing from the Canada Mortgage and Housing Corp.

But for those who are looking to buy their first home, it’s a win-win-win and a great way to keep the tax man away from your front door.

Bonnie-Jeanne MacDonald is the director of financial security research at the National Institute on Ageing (NIA) at Toronto Metropolitan University, fellow of the Canadian Institute of Actuaries and resident scholar at Eckler Ltd.

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