Canadians pinching their pennies to buy a first home are getting a break from the federal government.
April 1 marks the launch of the First Home Savings Account (FHSA); a savings vehicle with the combined tax perks of a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA).
It’s a small concession for a generation trying to get a foot in the door of an over-heated housing market that has shut them out, and a tiny window of opportunity for a lifetime of building equity and net worth.
HOW THE FHSA WORKS
First-time homebuyers can invest up to $40,000 total or up to $8,000 each year toward the purchase of a home with no tax on contributions or withdrawals.
That means contributions can result in a tax refund like an RRSP, but contributions and gains are never taxed and can be withdrawn at any time like a TFSA.
After withdrawing money from an FHSA, you must purchase a home within a year or it will be taxed as income. If it is not used for a home purchase by the age of 71 or the 15th anniversary of the opening of the FHSA, it can be converted to normal RRSP savings.
UTILIZE OTHER ACCOUNTS TO BOOST YOUR DOWN PAYMENT
Forty thousand dollars is well above the five per cent minimum down payment required on a house under $500,000, but there are ways to boost it by combining the alphabet soup of government registered accounts available to most Canadians.
First, FHSA contributions can be turbo-charged by reinvesting the tax refund or refunds from RRSPs, which would generate further refunds. If you hit your FHSA limit, refunds can be diverted to a TFSA, which can be withdrawn at any time.
Even an RRSP can be utilized through a feature called the Home Buyers’ Plan (HBP), which permits a maximum tax-free withdrawal of $35,000 per person ($70,000 per couple) provided it is returned to the RRSP within 15 years.
THE BEST INVESTMENTS FOR A FHSA
Tax perks aside, it’s important to keep in mind RRSPs, TFSAs, and FHSAs are investment accounts and are only as effective as the investments inside them.
Just about any type of investment - stocks, bonds, mutual funds - are permitted in a FHSA but the short-term nature of an FHSA calls for a short-term investment strategy.
Investments are normally held in an RRSP for decades and withdrawn over a long period of time in retirement. That allows investors to diversify to hedge risk and get exposure to opportunities, sell strong performers when the cash is needed, and wait out weak performers.
TFSAs can be also be used for long-term retirement savings but even if they are used for shorter time horizons investors have the flexibility to delay selling when investments are down.
FHSAs, on the other hand, would likely have a hard deadline to liquidate investments when the opportunity to buy a home arises.
One comparable registered investment vehicle is the Registered Education Savings Plan (RESP), which has a fairly fixed time horizon that comes shortly after the beneficiary graduates from high school.
Some mutual fund companies offer Target Education funds or portfolios suited for RESPs for five or 10-year time horizons, and will likely offer tailor-made investments for FHSAs.
Most financial institutions will offer FHSAs at no cost and recommend the most appropriate investments, but it’s important to keep an eye on the fees that come with those investments. They can gobble up the home equity you are trying to build like termites.