Understanding the Tax

What is the Tax-Free First Home Savings Account (FHSA)? This new financial tool was introduced in the federal budget of 2022, with availability for Canadians beginning in 2023. The FHSA is designed specifically for first-time home buyers, offering a savings account that merges the tax advantages associated with both a Tax-Free Savings Account (TFSA) and a Registered Retirement Savings Plan (RRSP).

Understanding the First Home Savings Account

The First Home Savings Account is a governmental initiative aimed at assisting Canadians in acquiring their first home. Eligible individuals can contribute up to a total of $40,000, intended specifically for the purchase of a single-family residence. There is an annual cap on contributions, set at $8,000. Just like with TFSAs and RRSPs, any unused contribution room can be carried over. For instance, if you contribute $5,000 in a given year, you can add $11,000 in the following one. This carry forward option was introduced recently; prior to that, carryovers were not permitted.

Being a tax-free account, you won’t incur taxes on any capital gains or interest accrued. Furthermore, contributions you make to the account are tax-deductible, combining the favorable aspects of both the RRSP and TFSA.

There is no requirement to repay any amounts withdrawn from your Tax-Free First Home Savings Account. However, after making a withdrawal for a home purchase, the FHSA must be closed within one year from that first withdrawal.

If funds in your FHSA are not utilized for a first home purchase within a span of 15 years from when the account was first established, it will need to be closed or transferred into your RRSP.

It’s important to note that the FHSA is an individual account. If you are purchasing a home jointly with a spouse or common-law partner, you may access a combined total of $80,000.

Eligibility Requirements for the First Home Savings Account

The current eligibility criteria for this tax-free First Time Home Savings Account include:

• Must be a resident of Canada
• Must be at least 18 years old
• Must not own a home in the year the account is opened or in the previous four years

As this program is intended for first-time homebuyers, it is expected that the FHSA is reserved for primary residences rather than investment properties.

You are permitted to maintain multiple FHSAs; however, contributions across all accounts must not exceed the specified annual or total limits.

Is the First-Time Homebuyer Savings Account Tax-Free?

Indeed, the FHSA operates entirely tax-free. This allows for tax-exempt growth while funds remain in the account, akin to both RRSPs and TFSAs. Additionally, withdrawals made from the account will also be tax-free.

However, tax implications may arise under certain circumstances. Withdrawals not used for a first home purchase will be considered taxable income. Moreover, the government may prohibit day trading within an FHSA as such activity might be classified as business income. If the FHSA is not utilized within 15 years, a transfer to the RRSP is required.

Additionally, a penalty of 1% per month is applied for any overcontributions to the account.

Qualified Withdrawals from FHSA

The FHSA was established to support homebuyers, which means withdrawals can only be made tax-free for qualifying expenses.

To qualify for a withdrawal, you must fulfill the following criteria:

• Be a first-time homebuyer
• Reside in Canada at the time of withdrawal
• Have a documented agreement to buy or build a home in Canada completed before October 1 of the year following the withdrawal
• Utilize the home as your primary residence

Once amounts are withdrawn, they can be allocated toward down payments, closing costs, or even expenses related to the home such as furniture.

If funds are taken out for non-qualifying reasons, they will be subject to withholding taxes and treated as taxable income.

Is Repayment Required for the First Home Savings Account?

Unlike the Home Buyers’ Plan, repayment is not mandated for amounts withdrawn from the First Home Savings Account. The FHSA is explicitly designed for financing a down payment on a first property.

Nevertheless, if funds are withdrawn for any other reason apart from purchasing a home, they will be taxed. For instance, withdrawing $2,000 for a non-home buying purpose would increase your taxable income by the same amount.

Can You Transfer Funds from Your FHSA?

Funds can be transferred from an FHSA to an RRSP any time before you reach 71 years of age without needing any unused RRSP contribution room. If you are over 71, you may transfer your FHSA to a Registered Retirement Income Fund (RRIF). These transfers do not count as new contributions to the RRSP, so no additional tax benefits are granted. Also, if you lack contribution room in your RRSP, these transfers will not affect it.

Moreover, funds in an RRSP can be moved to an FHSA tax-free, provided you adhere to the $40,000 lifetime contribution limit and the $8,000 annual limit. However, you would not receive a new tax deduction since the tax benefit was already applied when you initially contributed to your RRSP.

Investment Options in the First Home Savings Account

Despite being labeled a ‘savings’ account, the First Home Savings Account functions much like an investment account, similar to a TFSA.

Eligible investments include:

• ETFs
• Stocks
• Bonds
• Cash
• Mutual funds
• GICs

While diversifying your investments is advantageous, many individuals view home purchases as a short-term goal. If you intend to buy a home within the next five years, investing in equities or high-risk assets may not be wise, as their value can fluctuate significantly.

For context, a 20% increase in investment value over five years is plausible, but so is a downturn of the same magnitude. Most people prefer safer investment options like bonds or high-interest savings accounts to protect their down payment.

Comparing the First Home Savings Account to the Home Buyer’s Plan

Both options have their advantages and disadvantages. The Home Buyer’s Plan allows for a withdrawal up to $35,000, but these funds must be repaid over time. Conversely, under the FHSA, you can contribute a total of $40,000 without any repayment requirements.

For individuals looking to buy a single-family home, it is advisable to prioritize funding the FHSA first to take advantage of its dual benefits of RRSP and TFSA. After maximizing contributions to the FHSA, utilizing a TFSA may be the next logical step.

The government has recently indicated that first-time buyers may utilize both the HBP and FHSA together. Furthermore, funds from RRSPs can be transferred into the FHSA as needed, providing flexibility for those planning for retirement.

Does the First Home Savings Account Enhance Home Affordability?

The pressing question remains: Does the First Home Savings Account make homeownership more attainable?

The straightforward answer is: No.

Establishing another tax-free account does not automatically result in lower housing costs. Price drops are unlikely. While the government posits that the tax advantages will ease entry into the housing market, this argument is weakened by the reality of escalating real estate prices, which have soared by 20% annually.

Even if the FHSA is employed as an investment account generating substantial gains, this increased purchasing power would likely elevate overall market prices rather than reduce them.

Many young Canadians have yet to fully utilize their TFSAs and face challenges in saving for retirement. Thus, while the concept of the First Home Savings Account is appealing, there’s a high probability that many young Canadians will struggle to contribute alongside existing savings and investment commitments.

In summary, while the account is a positive initiative, it may have been more effective for the government to reform the existing Home Buyers’ Plan instead.

Concluding Thoughts

For most individuals, the Tax-Free First Home Savings Account is unlikely to expedite the dream of homeownership or contribute to greater affordability. Any funds invested may only experience limited growth, yielding minimal impacts in the face of rising home prices. However, if you are actively saving for a home, the FHSA represents an excellent vehicle for your financial resources.