Save for Retirement? Save for First Home Downpayment? Why not both at the SAME TIME!
Executive Summary
• Canadian Home Buyers’ Plan (HBP), allows for withdrawal of up to 35K from RRSP in an interest free “loan” to yourself
• RRSP contributions shield your income, generating a larger tax return and therefore more cash
• Additional cash from greater tax return further drives first-home downpayment savings
• HBP Loan is repaid over 15 years, interest free, starting second full calendar year after withdrawal
Introduction
Buying your first home, especially in current market conditions, has never been more difficult. A Canadian federal program called the Home Buyers Plan (HBP), which is used in conjunction with your Registered Retirement Savings Plan (RRSP), can be a very effective tool to help you save for your first home downpayment. At the same time as you save, you can generate extra cash flow through tax benefits to help you save more quickly. If you do not have an RRSP account setup at this time, you can easily open one at your local banking institution, at no to minimal fee, and typically with no minimum balance.
What is the Home Buyers Plan (HBP)?
Put simply, the Home Buyers’ Plan (HBP) is a federal program that allows for you to give yourself an interest free loan from your general RRSP account. On a one-time basis, you can withdraw up to $35,000 and use it towards the purchase of your first home without penalty - designating the funds for the HBP at that time. You then repay this loan starting in the second full year after withdrawal, over a 15 year period, without interest! If you fail to repay in any particular year then this amount (1/15th of the original withdrawal) is recognized as taxable income and therefore taxed at your marginal rate. Note that in practice, I always recommend that the loan be repaid, as it will not deplete your retirement savings, while also ensuring additional tax is not paid.
Why should I utilize the HBP?
To answer this question, its easiest to look at the alternative: what happens if you do not use the HBP, and instead just use your own savings or investment account to save for a downpayment. If you choose this route, you will forgo at least one, and likely two major benefits:
1) Tax shield from RRSP contributions: By contributing to the RRSP, your income is reduced on a one for one basis. This means that your tax bill is also reduced by your reduced income, multiplied by the tax rate. This increased cash flow can be contributed right back to your contributions - its a circle of growth!
2) Tax-Free Capital Gains: The funds you contribute into the RRSP can be invested in any number of ways, depending on the risk you are willing to take. More importantly, by placing the funds in the RRSP, any gains you make on the investments are tax-free. So, if you contribute $10,000, and make 7% per year, for 3 years as you save, that initial $10,000 will grow to $12,250 with no extra effort from you! To make things even better, no taxes are owed on the extra $2,250! (Note: this example was shared for illustrative purposes, and while possible to earn 7%, risks do exist, so best to work with a trusted investment advisor when making decisions of this nature). The only other account that allows for tax-free capital gains, is the Tax-Free Savings Account (TFSA), but this account does not provide for the tax shield benefits outlined in the first point above.
In short, utilizing your RRSP to save for a down-payment (through the HBP), generates additional cash flow through reduced tax burdens on your contributions, while also saving funds free from capital gains.
To repay or not to repay?
Congratulations! You have now saved enough cash for your first-home purchase, made your HBP withdrawal and are settling into your new home. Now what? Should I start to repay the loan? I recommend with an emphatic YES!
While there is a seperate discussion around paying off your mortgage faster versus saving for retirement, in regards to the HBP, I recommend repaying based on the schedule set by CRA. This means that in the second full-year after withdrawal you repay 1/15th of the loan (for 15 years). If you decide not to, 1/15th of the loan becomes income each year, and you then have to pay tax on that amount that you actually did not earn! That is not ideal or prudent financial management.
In addition, if you decide to not repay the loan, you will also permanently deplete your retirement savings account. In all likelihood, you will then need to work longer before being able to "kick back and relax". If you purchase your home at age 30, and retire at age 65, and decide not to repay the loan, that $35,000 you withdrew could have been worth $373,000+ (at a 7% return per year). While using the HBP does forgo some savings potential as you repay the "loan", if we take an average of 8 years to repay (50% of 15 years), that amounts to roughly $25,000 in earnings at a 7% rate of return.
As I hope you see, the potential for earnings is tremendous, and not taking on additional tax burden when you don't earn money is also a clear reason to repay your "loan".
Concluding Thoughts
By now, I hope you see that the benefits of using the HBP are quite substantial, and you have gained some clarity in how you can use this program to get into your home faster!
If you would like additional information, or to discuss your particular situation in more detail, please do not hesitate to contact us and we’d be happy to book a FREE, no obligation consultation for you. You can also book for yourself on our website (www.hopefinancialsolutions.ca - top right corner of the home page).
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Next month, I will be looking at the topic of goal setting and New Year’s Resolutions as they relate to finance. If we don’t see you before then, have a very Merry Christmas and see you in 2022!
