Understanding the Tax

Understanding the Tax-Free First Home Savings Account (FHSA) – The FHSA is an innovative financial solution introduced in the 2022 federal budget, which will be accessible to Canadians starting in 2023. This account aims to assist first-time homebuyers by merging the tax advantages found in both a Tax-Free Savings Account (TFSA) and a Registered Retirement Savings Plan (RRSP).

What is the First Home Savings Account?

The First Home Savings Account is a government initiative designed to support Canadians in acquiring their first home. Participants can save a maximum of $40,000 specifically for the purchase of a single-family residence, with a yearly contribution limit set at $8,000. Any contribution not utilized can be carried over to future years, similar to the operation of TFSAs and RRSPs. For instance, if you contribute $5,000 in one year, your contribution room for the following year would amount to $11,000. The ability to carry over unused contributions is a recent update, as it was previously not allowed.

This account is tax-exempt, meaning you won’t incur taxes on any earned capital gains or interest. Furthermore, contributions are tax-deductible. Essentially, the FHSA offers the combined benefits of both RRSPs and TFSAs.

Withdrawals made from the FHSA for home purchases do not require repayment. Nonetheless, the account must be closed within a year following a withdrawal for purchasing a home.

If the funds in your FHSA are not used for a first home purchase within 15 years after opening, you must either close the account or transfer it into your RRSP.

It’s important to note that the FHSA operates on a per-person basis. Therefore, if you are buying a home with your spouse or common-law partner, you can access a combined total of $80,000.

Eligibility for the First Home Savings Account

Currently, the eligibility criteria for this tax-free First Home Savings Account are:

• Must be a resident of Canada
• Must be at least 18 years old
• Cannot have owned a home at any time during the year the account is opened or in the four preceding calendar years

As this initiative targets first-time homebuyers, the FHSA is intended for primary residences, not for investment properties.

It is possible to have multiple FHSAs, but overall contributions must adhere to the annual and total limits.

Is the First-time Homebuyer Savings Account tax-free?

Indeed, the FHSA is entirely tax-exempt, facilitating tax-free growth within the account (similar to both RRSPs and TFSAs). Additionally, like a TFSA, withdrawals are also free from taxation.

However, there are specific tax implications to consider. Any withdrawals not utilized for purchasing your first home will be counted as taxable income. Engaging in frequent trading activities within your FHSA is likely viewed as business income by the government. Furthermore, if the FHSA remains unutilized within the 15-year window, a transfer to your RRSP is required.

Account holders will face a penalty of 1% per month for any overcontributions.

Qualifying Withdrawals from FHSA

The FHSA has been set up to facilitate home purchases, meaning funds can only be withdrawn tax-free for qualifying purposes.

Your withdrawal must satisfy the following conditions:

• You must be classified as a first-time homebuyer
• You must reside in Canada at the time of withdrawal
• A written agreement to buy or construct a home in Canada must be in place before October 1 of the year following the year of withdrawal.
• The home must serve as your primary residence

Funds withdrawn can be allocated for down payments, closing costs, or related home expenses like furniture. However, if the withdrawal is for a non-qualifying purpose, withholding tax will apply, and it will be treated as taxable income.

Do you need to pay back the First Home Savings Account?

No repayment is required for the First Home Savings Account after a withdrawal, unlike the Home Buyers’ Plan. The FHSA is designated primarily for saving towards a down payment for a first home.

However, if you withdraw funds for reasons other than purchasing a home, those funds will be subject to taxation. For instance, withdrawing $2,000 from your FHSA for a non-home-related reason would increase your taxable income for that year by $2,000.

Can you transfer funds out of your FHSA?

You are permitted to transfer funds from your FHSA into your RRSP anytime prior to the year you turn 71, regardless of unused RRSP contribution capacity. If you are over 71, you may transfer your FHSA to a Registered Retirement Income Fund (RRIF). Transfers are not classified as new RRSP contributions, so they won’t garner additional tax deductions. Regardless of your RRSP contribution space, transfers from the FHSA will not affect it.

Additionally, you can transfer money from your RRSP into your FHSA without incurring taxes; still, the FHSA’s lifetime contribution cap of $40,000 and yearly limit of $8,000 will apply, with no new tax deductions available since those were received at initial contribution.

Investment Options within the First Home Savings Account

The term ‘savings’ account could be somewhat misleading, as, similar to a TFSA, the First Home Savings Account offers more than mere savings options. It would be more accurately termed the First Home Investment Account.

You are expected to have access to several investment avenues, including:

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

While having various investment choices is advantageous, many individuals aim to obtain a home in the short term. For those expecting to buy in the next five years, investing in riskier options like stocks, ETFs, or mutual funds may not be advisable.

To put things in perspective, you might benefit from a 20% increase on your investments over five years. However, there’s an equal risk that your portfolio could decrease by the same percentage. Most individuals prefer safer investments, such as bonds or high-interest savings accounts, to protect their down payment.

Is the Home Buyer’s Plan a better option?

Both options present their pros and cons. The Home Buyer’s Plan (HBP) allows a maximum withdrawal of $35,000, and those funds must eventually be repaid. In contrast, the FHSA offers a contribution limit of $40,000 with no requirement for repayment.

If your intention is to purchase a single-family home, it is prudent to prioritize your FHSA contributions first to maximize the benefits of both the RRSP and TFSA. After reaching the FHSA limit, a TFSA should likely be your next focus.

Recently, the government has indicated that first-time buyers may leverage both the HBP and FHSA, while also permitting transfers from RRSPs to FHSAs, providing more options for retirement savers and those with defined contribution pensions.

Does the First Home Savings Account enhance home affordability?

The pertinent question is whether the First Home Savings Account genuinely improves home affordability.

The simple answer is: No.

Creating another tax-exempt account doesn’t lower housing costs; property prices continue to rise rather than fall. The government suggests that tax advantages will facilitate entry into the housing market, but that seems challenging amidst continual price hikes of 20% annually.

Even if everyone leveraged the FHSA as an investment account and experienced significant gains, it would simply enlarge the pool of available funds for purchases, likely pushing prices up further, not down.

Many also argue that numerous young Canadians have yet to fully utilize their TFSAs while also finding it difficult to save for their future. While the First Home Savings Account is a commendable initiative, it may overstretch many young individuals who are already managing several savings and investment mechanisms.

It may have been more effective for the government to revise the existing rules governing the Home Buyers’ Plan instead.

Conclusion

In reality, for the majority, the Tax-Free First Home Savings Account will not hasten the path to homeownership nor make housing more accessible. Given the potential limitations on investment growth time, any earnings may pale in comparison to rising housing prices. Nevertheless, if you are aiming to save for a home purchase, the FHSA is a favorable account for your funds.