Let’s talk about Registered Retirement Savings Plans (RRSPs). More specifically, let’s talk about why the name is somewhat of a misnomer these days since nowadays they’re used for so much more than just retirement planning.
First introduced in 1957 by the Canadian government to encourage saving for retirement, they have since become one of the leading investment choices among Canadians for that very purpose.
RRSPs are investment accounts that can hold a number of assets, including; savings accounts, GICs, mutual funds, exchange-traded funds (ETFs), mortgage loans, and other investments. Money contributed to RRSP accounts is tax-deductible; it reduces the amount of tax a person is required to pay on income and allows capital gains and dividends to grow tax-free while money remains in the account.
There are several rules RRSP holders must abide by, including contribution limits (18% of earned income up to a maximum of $26,230 this year) and withdrawal rules. RRSPs can only remain open until the age of 71, when they must be converted into a Registered Retirement Income Fund (RRIF).
However, while RRSPs are traditionally viewed as retirement savings plans that isn’t their sole purpose. They can also be a useful down payment tool when purchasing a home. Let us explain how it works.
Home Buyers’ Plan
First introduced in 1992, the RRSP Homebuyers Plan (HBP) was launched with the intention of giving first-time homebuyers a leg-up getting into the housing market (in this case, a first-time homebuyer is anyone who has not owned a home within the prior four years of purchase).
The plan allows Canadians to withdraw up to $35,000 from their RRSP savings to purchase or build a new home. If purchasing or building a home with a spouse or common-law partner who is also a first-time homebuyer, both people can access $35,000 from their own individual RRSPs for a combined total of $50,000.
Many Canadians struggle to cobble together enough money for a down payment which is unsurprising, especially today, with the average Canadian home costing $496,500, and requiring a minimum 5% down payment of $24,825.
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The HBP allows Canadians to borrow from their own retirement fund tax-free to contribute to their down payment. This is especially useful for those who have a substantial down payment already, but need a top-up to make up the 20% down required for a conventional mortgage (and, as a result, save themselves from having to take out mortgage default insurance).
There are some rules, however, they must abide by to do so.
To qualify, the applicant must be a Canadian resident with an RRSP. They must provide written proof of their intention to purchase a home and must not own it for more than 30 days prior to receiving the funds. And the funds used must have been within an RRSP account for at least 90 days.
Applicants must also live in the home purchased with the HBP within one year of purchase.
Sure, you can borrow from your RRSP to help fund a home purchase. However, the money must be repaid. Think of it as an interest-free loan to yourself.
HBP borrowers have 15 years to pay themselves back, commencing two years after receiving the funds. So, if someone taps into their RRSP for the HBP this year, they will have to have paid back the loan by 2035. You can, however, pay the loan back in full before the deadline.
Let’s look at the repayment schedule for someone who borrows $25,000, which is less than the maximum amount. According to the repayment rules, a borrower must pay back at least 1/15 of the total amount per year.
That means someone borrowing the maximum amount under the Home Buyers Plan must pay back $1,667 per year. To make life easier, a good plan of action would be to set aside monthly payments, which would amount to $139 per month.
Remember: Even though you’re technically paying back a loan, that money is going back into your RRSP account. So, essentially, you’re just paying yourself back.
Why use an RRSP?
You may be sitting there wondering why, if you have to pay the money back, you should tap into your RRSP for a home down payment. And that’s a fair question. The Home Buyers Plan is perhaps best suited for younger buyers – those who have several years to pay themselves back and mitigate the lost earnings potential. After all, you have to keep in mind that you’d be sacrificing part of your retirement fund – at least temporarily – which includes any interest those funds would have made within the years it takes to pay yourself back.
It also allows homebuyers to use tax-free money as part of their mortgage down payments. That is, as long as the repayments are properly made. Failing to do so will result in having to pay tax on whatever portion of the loan that isn’t paid back.
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