Saving for a first home is a massive challenge. I first started writing on the subject for Ratehub back in 2015, when we wondered out loud how first-time homebuyers managed to afford an average house price of $451,000. Seven years later, the average has nearly doubled to $816,000. The prospect of buying a first home has never been more daunting.
The Tax-Free First Home Savings Account (FHSA) is a new tax shelter proposed by the federal government as part of its housing plan in the 2022 budget. If you’re curious to learn more about the FHSA and how it works, you’re in the right place.
Tax-Free First Home Savings Account: At a Glance
- The Tax-Free First Home Savings Account (FHSA) is a new tool for Canadians to save to buy a first home
- The program will be open to all Canadians who are first-time homebuyers and at least 18 years old
- Money contributed to an FHSA is tax-deductible, similar to RRSP contributions
- FHSA contributions will be limited to $8,000 per year with a lifetime maximum of $40,000
- FHSA withdrawals will not need to be repaid
- You have 15 years to buy a home from the time you open your FHSA. If you have not done so, the funds can be transferred to an RRSP or RRIF without paying any tax
What is the Tax-Free First Home Savings Account?
The Tax-Free First Home Savings Account (FHSA) is a tax shelter proposed by the federal government in the 2022 budget to help Canadians save money to buy a first home.
The FHSA will combine the features of two savings plans you might already be using: the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). Just like your RRSP, contributions to your FHSA will be tax deductible. This means that any amount you put in your account will be deducted from your taxable income, saving you money on your income tax.
As with your TFSA, any money your FHSA earns will be tax-free. You won’t have to report your investment earnings or pay income tax on them.
The FHSA will have a few advantages over the RRSP. It’s intended specifically as a savings tool for a down payment on a first home, so you won’t have to use up RRSP contribution room to take advantage of the tax savings. And whereas you have to pay yourself back when you withdraw money from your RRSP to buy a first home, your FHSA withdrawals won’t need to be repaid.
Under the proposal, FHSA contributions will be limited to a maximum of $8,000 per year and $40,000 over your lifetime.
What does the Tax-Free First Home Savings Account mean for first-time homebuyers?
If you’re planning to buy your first home, the FHSA will reduce some of the administrative burden that comes with using existing savings programs. You won’t have to open an RRSP or use your contribution room to take advantage of the tax savings. And because there’s no repayment period the FHSA will have less of an impact on your taxes over the long term.
It also means that you’ll be able to save more money tax-free to buy your first home. Currently, you can withdraw up to $50,000 from your RRSP. With the FHSA, you will be able to withdraw as much money as you’re able to earn in your account. If you’re buying a home with another first-time homebuyer, you’ll both be able to withdraw the maximum from both accounts – potentially $180,000 or more.
Who is eligible for the Tax-Free First Home Savings Account?
The FHSA will be open to all Canadians who are first-time homebuyers. When it was initially proposed in last fall’s election campaign, only Canadians between the ages of 18 and 40 were eligible. However, when the budget was detailed earlier this month, the upper age limit was removed.
When can I open a Tax-Free First Home Savings Account?
The government says it’s working with financial institutions to create the accounts, and it hopes the first FHSA accounts will be available in early 2023.
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How does the Tax-Free First Home Savings Account Work?
The FHSA will work similarly to your RRSP, with a few differences.
To get started, you’ll need to open an account with a financial institution. Expect different institutions to offer different products with varying fees and services. When you open an account you’ll need to provide some personal information and sign some forms for tax purposes.
Once your account is open, you’ll be able to contribute up to $8,000 per year, to a maximum of $40,000 in your lifetime. If you open multiple FHSA accounts, you’ll need to track your contributions across all of them to avoid any penalties. At the end of each year, your financial institution will issue a tax slip showing your contributions which you can claim on your income tax. Contributions will be deducted from your taxable income at a 1:1 rate, reducing the overall amount of income tax you will owe for the year you contribute.
When you’re ready to buy a home, you can withdraw money from your FHSA. The criteria are likely to be similar to withdrawing money from your RRSP. You will need to have entered into an agreement to buy a home (i.e., have a finalized agreement of purchase and sale), be a Canadian resident and be a first-time homebuyer. You will have to submit a form to your financial institution, who will then release the funds. You won’t have to pay any tax on the money you withdraw from your FHSA – you also won’t have to show how you use the money.
If you don’t buy a new home within 15 years of opening your FHSA, your FHSA savings will need to be transferred to an RRSP or RRIF, which you can do without paying any tax. Should you choose to transfer the money to an RRSP, you can do so over and above your regular RRSP contributions without worrying about your contribution room.
What are some tips for saving a down payment using an FHSA?
Want to get the most out of your FHSA? Here are some ideas to help you maximize your savings.
- Start saving early - Because the FHSA limits contributions rather than withdrawals, you’ll get the most out of it if you start early. If you save the maximum of $8,000 per year starting when you’re 18 and earn an average return of 6%, you’ll have over $120,000 by the time you turn 40 – not including any money you save on tax.
- Start with your TFSA - The primary benefit of the FHSA is that it reduces the amount of income tax you owe. The biggest drawback is that it restricts how you can use your savings. For both of these reasons, the best strategy is to save in your TFSA until you know you will be buying a home. Earlier in your career, you don’t stand to gain as much in tax savings as you will later on when you’re making more money. You also likely need a bit of flexibility to use your savings from time to time. If you start with your TFSA, you’ll earn tax-free investment income on your savings and be able to withdraw money at any time. When you’re earning more and paying a higher marginal tax rate, you can start moving money from your TFSA to your FHSA to take advantage of the income tax savings.
- Use your FHSA before your RRSP - The program that allows you to withdraw money from your RRSP to buy your first home is intended as a way to access retirement savings. Using your RRSP specifically to save for your first home has advantages, but also comes with some lasting tax implications. Use your FHSA first and only start using your RRSP once you’ve maxed out your contribution room.
- Invest your money - Despite the name “savings account,” the FHSA will allow you to keep all kinds of investments like stocks, ETFs, mutual funds, bonds, and GICs. You’ll get more out of your FHSA if you put it in higher yield investments, especially earlier on. As you get closer to buying a home, transition to a more conservative portfolio of bonds and a high interest savings account to protect your nest egg.
- Don’t use your FHSA for money you might want to spend on something else - The money you put in an FHSA can only be taken out to buy a first home. Withdraw for any other reason, and you’ll have to pay income tax on the amount you take out. If you think you might want to use some of your savings for a different reason, use your TFSA instead. You can always move money from your TFSA to your FHSA; you can’t move it the other way.
The bottom line
We still don’t have all the details about the FHSA but from what we know so far, it looks like the biggest benefit will be the ability to save tax-free for a first home without meddling with your retirement savings. As with all savings plans, the key will be to start early and plan long-term to maximize what you can get out of it.