Canada’s new Tax-Free First Home Savings Account has recently been announced and would-be home buyers are buzzing. But what is this account and how will it help Canadians purchasing their first homes?
The Tax-Free First Home Savings Account combines the benefits of an RRSP with a TSFA. It allows users to deposit and withdraw funds tax free, providing significant savings. The advantage of tax savings could lead to more available cash to speed up the savings process. But to understand this product one needs to compare it to the alternatives to see how it stacks up.
Types of down payment savings accounts
A standard savings or investment account allows you to save after-tax income, grow it, and pay tax on any growth. A Tax Free Savings Account differs in that any growth your account experiences will not be taxed. Both types of accounts can be withdrawn from at any point for any purpose, allowing the flexibility that many low income earners feel is very important.
A Registered Retirement savings plan works in the opposite way. The money you originally deposit in an RRSP is tax deductible, meaning you will not pay income tax on it when it’s deposited. However it will be taxed as income when you withdraw it in retirement. There are specific requirements concerning when and for what purpose funds are withdrawn, and penalties for doing otherwise.
A Tax Free First Home Savings Account is somewhere in the middle, but I will refrain from calling it the best of both worlds. When you make a deposit to this type of account, it is tax deductible like an RRSP. When you withdraw funds to use for a down payment, it will also not be taxed, like a TSFA. So overall you can earn, save, grow and withdraw these funds without ever paying tax on it. And a tax savings is money in your pocket, and that’s always a good thing.
How the Tax-free First Home Savings Account works
This account allows Canadians under the age of 40 to save up to $8000 per year to a maximum of $40,000 as a down payment on their first home. As previously mentioned the funds are not taxed going in or coming out. Members of a household can save individually as well, reaping further savings. It is slated for introduction in 2023 as a measure to make saving a down payment accessible to more Canadians.
If the funds are not used by the age of 40, they will be rolled over for retirement. RRSPs can still be used as a down payment under the Home Buyer’s Plan, but the funds need to be paid back within 15 years.
If you were planning to use an RRSP for a down payment, and are not likely to come up against the 40 year deadline, this type of account will be a great saving tool.
Disadvantages of the Tax-free First Home Savings Account
To begin with, those of us in our late thirties likely wont have enough time to take advantage of this new account. To say nothing of those over 40 who are entirely excluded. Also my experience indicates that most of us who struggle with financial stability are uncomfortable locking money in an account that is not designed for flexibility. If you require the funds you’ve saved for an emergency, you will be penalized, negating the benefits of having the account in the first place. Overall, in the right situation I think it is still a very good option and should be considered.
Where to put your Tax-free First Home Savings Account
When this new account type is rolled out, I suspect that most financial institutions will begin promoting it’s use, and it should become widely available, akin to RRSPs and TSFAs. The big banks tend to offer lower interest rates, but I will be on the lookout for great introductory offers. Online banks often provide better interest rates, so if an interest generating savings account is your preference, be prepared to shop around.
Investing the funds in your account is another option. Long term growth tends to be significantly higher, but it comes with higher risk. The right solution depends on your timeline, market conditions and your personal risk tolerance. I have been using Wealthsimple for my investments, so I will be following closely to see what they offer. Check out this post about my experience with them or visit their website here: Wealthsimple
Ultimately, saving tax on the growth of your money is most important if your money is actually growing. Smart investing is the key to making that happen. And this new account could be a great place to start.
More information is sure to become available as we get closer to the launch of this new product. I think for anyone under 35 in a stable financial situation, who is dedicated to saving for a home could benefit from this type of account. While that eliminates a large portion of the population, including many of my readers, I hope it will be widely adopted and encourage many younger people to save. Starting early is a powerful tool in financial security.