RRSP, TFSA or HBP: Which Strategy is Best When it Comes to Buying Your First Home?
Published on Monday January 21, 2013
Buying your first home can be an incredibly exciting time. Finding that perfect space and planning your life within its walls is a thrilling rite of passage you’ll remember forever.
But because it’s often the first major expenditure that someone has undertaken, buying for the first time can also be confusing. You’ve been diligent enough to squirrel away a significant nest egg to put towards your first home, but the question then becomes: What’s the most advantageous way to utilize those funds?
The Tax-Free Savings Account (TFSA) is often recommended as the savings vehicle of choice for young people. But when it comes to buying a home, should you transfer the money you have accumulated in your TFSA to a Registered Retirement Savings Plan (RRSP) and use the Home Buyers Plan (HBP) strategy?
So many options, so many questions.
First, a bit of background about how the Home Buyers’ Plan works:
With the HBP, first-time homebuyers can make a tax-free withdrawal of up to $25,000 from their RRSP ($50,000 when combined with a spouse) to use towards their new home.
However, to avoid taxation, the amount of principal withdrawn must be repaid over 15 years, starting two years after the withdrawal. The homebuyers will need to deposit at least 1/15 of the amount withdrawn from their RRSP on an annual basis. (This is the minimum payment; you can make additional payments without penalty.)
If you don’t contribute the minimum payment each year, the amount owing in any year will be included in your income and subject to tax.
At first glance, the idea of transferring your TFSA funds to an RRSP (assuming you have the RRSP contribution room) and then withdrawing them through the HBP program seems like a slam dunk: You get access to more funds for your first home and the opportunity to pay it back over 15 years, tax-free. Plus, you get a tax refund for your contribution to the RRSP, which you can also put towards your down payment.
However, a sharp investor might ask: Wouldn’t I be better off just leaving my funds in an RRSP and accumulating growth, especially if my rate of return is going to be more than my borrowing rate?
It is something to consider, says Marie C. Blanchet, Senior Consultant, National Bank Financial Planning. Because the principal is repaid interest-free to your own RRSP over 15 years, the lengthy repayment period has a negative effect on the RRSP’s growth.
As an example, a $25,000 RRSP would be worth $59,914 at the end of 15 years, assuming a 6% rate of return. However, if you took that $25,000 out to use it towards your home and repaid it gradually over 15 years, the RRSP would only be worth $39,019 at the end of the 15-year period.
However, the benefits of the HBP may still outweigh the shortfall, says Ms. Blanchet.
“Although it is clear that there will be less accumulated capital in the RRSP, the HBP basically presents three main advantages,” says Ms. Blanchet. “[It] creates immediate liquidity for the down payment, potentially reduces the insurance fee required by CMHC [Canadian Mortgage and Housing Corporation] and the reduced borrowing costs will increase your available cash flow.”
It’s that last point that makes up for the shortfall in the RRSP growth. If you withdraw $25,000 from your RRSP instead of borrowing $25,000, it will create a surplus of funds in your budget resulting from the reduced borrowing costs. Reinvesting this difference into a TFSA will mitigate the shortfall.
“When you pay back your HBP over 15 years and if you have made good use of the annual surplus generated, the impact (positive or negative) is never enough to upset your retirement plans,” says Ms. Blanchet.
“Often, being able to buy a home faster and enjoying a better quality of life is worth more than anything!”
If you do decide to take advantage of the HBP, however, don’t use this strategy as a pretext to buy a home worth $25,000 more than you can afford, warns Ms. Blanchet.
“It is still advisable to limit yourself to a reasonable purchase price based on your financial resources, with or without the HBP,” she says.
Of course, the best person to advise you on the various strategies when it comes time to become a homeowner is your financial advisor.
At National Bank, our advisors can help guide you through all the options available to you when buying your first home, and help you make the financial decisions that make the most sense to you.
But because it’s often the first major expenditure that someone has undertaken, buying for the first time can also be confusing. You’ve been diligent enough to squirrel away a significant nest egg to put towards your first home, but the question then becomes: What’s the most advantageous way to utilize those funds?
The Tax-Free Savings Account (TFSA) is often recommended as the savings vehicle of choice for young people. But when it comes to buying a home, should you transfer the money you have accumulated in your TFSA to a Registered Retirement Savings Plan (RRSP) and use the Home Buyers Plan (HBP) strategy?
So many options, so many questions.
First, a bit of background about how the Home Buyers’ Plan works:
With the HBP, first-time homebuyers can make a tax-free withdrawal of up to $25,000 from their RRSP ($50,000 when combined with a spouse) to use towards their new home.
However, to avoid taxation, the amount of principal withdrawn must be repaid over 15 years, starting two years after the withdrawal. The homebuyers will need to deposit at least 1/15 of the amount withdrawn from their RRSP on an annual basis. (This is the minimum payment; you can make additional payments without penalty.)
If you don’t contribute the minimum payment each year, the amount owing in any year will be included in your income and subject to tax.
At first glance, the idea of transferring your TFSA funds to an RRSP (assuming you have the RRSP contribution room) and then withdrawing them through the HBP program seems like a slam dunk: You get access to more funds for your first home and the opportunity to pay it back over 15 years, tax-free. Plus, you get a tax refund for your contribution to the RRSP, which you can also put towards your down payment.
However, a sharp investor might ask: Wouldn’t I be better off just leaving my funds in an RRSP and accumulating growth, especially if my rate of return is going to be more than my borrowing rate?
It is something to consider, says Marie C. Blanchet, Senior Consultant, National Bank Financial Planning. Because the principal is repaid interest-free to your own RRSP over 15 years, the lengthy repayment period has a negative effect on the RRSP’s growth.
As an example, a $25,000 RRSP would be worth $59,914 at the end of 15 years, assuming a 6% rate of return. However, if you took that $25,000 out to use it towards your home and repaid it gradually over 15 years, the RRSP would only be worth $39,019 at the end of the 15-year period.
However, the benefits of the HBP may still outweigh the shortfall, says Ms. Blanchet.
“Although it is clear that there will be less accumulated capital in the RRSP, the HBP basically presents three main advantages,” says Ms. Blanchet. “[It] creates immediate liquidity for the down payment, potentially reduces the insurance fee required by CMHC [Canadian Mortgage and Housing Corporation] and the reduced borrowing costs will increase your available cash flow.”
It’s that last point that makes up for the shortfall in the RRSP growth. If you withdraw $25,000 from your RRSP instead of borrowing $25,000, it will create a surplus of funds in your budget resulting from the reduced borrowing costs. Reinvesting this difference into a TFSA will mitigate the shortfall.
“When you pay back your HBP over 15 years and if you have made good use of the annual surplus generated, the impact (positive or negative) is never enough to upset your retirement plans,” says Ms. Blanchet.
“Often, being able to buy a home faster and enjoying a better quality of life is worth more than anything!”
If you do decide to take advantage of the HBP, however, don’t use this strategy as a pretext to buy a home worth $25,000 more than you can afford, warns Ms. Blanchet.
“It is still advisable to limit yourself to a reasonable purchase price based on your financial resources, with or without the HBP,” she says.
Of course, the best person to advise you on the various strategies when it comes time to become a homeowner is your financial advisor.
At National Bank, our advisors can help guide you through all the options available to you when buying your first home, and help you make the financial decisions that make the most sense to you.
Courtesy of:
http://www.thestar.com/specialsections/rrsp2013/article/1315150--rrsp-tfsa-or-hbp-which-strategy-is-best-when-it-comes-to-buying-your-first-home
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