In 2019, the average home price in Canada was $480,000. In the Greater Toronto Area, a whooping $823,703. And, in 2020 the market looks no different; Housing prices will continue to rise, buyers will still face bidding wars for hot neighbourhoods, and demand will grow for properties away from the downtown core.
In this market, saving for a down payment can feel like an impossible task. If you’re a first-time home buyer in Canada, you may be eligible to withdraw up to $35,000 from your RRSP, tax free, for a down payment on your first home.
With the RRSP contribution deadline just around the corner and so many questions still unanswered, we’re breaking down the basics of RRSPs and specifically, the Home Buyers Plan to help you simplify your mortgage and invest with confidence.
What is an RRSP?
An RRSP is a Registered Retirement Savings Plan. It’s a personal savings account that’s registered with the federal government. Its designed to encourage Canadians to save for retirement. It acts as a tax shelter that holds investments from mutual bonds to stocks and cash.
The RRSPs benefit salaried and self-employed professionals for multiple reasons. First, it reduces your taxable income every year you contribute. Second, you’ll only pay tax on the funds at the time of withdrawal, where you’ll like fall into a lower tax bracket. And third, you will accumulate compound interest while the funds are in your account, further increasing the value of your investment.
What is the Home Buyers Plan?
Investing in an RRSP is not only beneficial for retirees. The Home Buyer’s Plan was introduced as an RRSP initiative to improve housing affordability and help Canadians save for their first home. This incentive allows first time home buyers to borrow up to $35,000 from their RRSP, tax free to put towards their down payment.
To be eligible for the Home Buyer’s Plan you must meet the following requirements:
- You are a Canadian citizen
- You cannot have owned a home within the past four years
- You must intend to live in the home within one year of purchase
- The RRSP funds you withdraw must stay in your account for at least 90 days prior to withdrawal
- If you have used the Home Buyers’ Plan before, you cannot have any outstanding balance due
If you do not meet the requirements, the withdrawal will no longer be protected under the Home Buyer’s Plan. Meaning, you won’t reap the tax deference benefits that come along with it.
If you do satisfy all the eligibility requirements, then you can withdraw up to $35,000 for a down payment. If you’re purchasing a home with a spouse or common law partner and you both fulfill the eligibility requirements, then both partners can withdraw up to $35,000 each for a combined total of $70,000. If only one partner is eligible, that individual can still borrow up to $35,000 from their RRSP for the shard down payment.
Who can Contribute?
Any Canadian under the age of 71 can contribute to an RRSP. The contribution limit is the maximum amount a taxpayer can deposit into the account annually. This amount is established and released on a yearly basis by The Canada Revenue Agency (CRA).
The contribution limit for this year is $27, 230. So, you can contribute as much as 18% of your prior year’s income up to a maximum of $27, 230, plus any unused contribution room. The deadline for the 2019 tax year is March 2nd, 2020, which means the so the deadline is fast approaching!
How Does Repayment Work?
Now that you have a good understanding of what an RRSP is, what the contribution limits are and what the home buyers plan is let’s look at how repayment works.
Let’s say that in 2019 our home buyer withdraws the maximum amount of $35,000 from their RRSP for a down payment on their first property. The government requires you to make your first minimum payment 2 years after the withdrawal date.
To calculate this payment, we’ll begin by dividing the total withdrawal amount ($35,000) by 15 years, which gives us a minimum payment of $2,333. Beginning in 2021 and ever year thereafter, our homebuyer must repay the minimum payment of $2,333 until the loan is paid off.
| Home Purchase:|
|X|| First Payment:|
$35,000 / 15yrs =$2,333.00
Now, if you don’t make the minimum payment, the difference must be claimed as taxable income on your annual tax return. For example, if one year you make a payment of $2000. But, we know that our minimum payment is $2,333. In this case, the $333 difference must be reported as taxable income on your annual tax return.
Now, let’s say in 2022 we made a payment of $4,687. Because we made a payment that’s more than our minimum ($2,333), we have to calculate a new minimum payment going forward.
We would do this by taking the original withdrawal amount ($35,000) subtract the total payments made thus far ($4,682+$2,333=$7,020) and then divide that number ($27,980) by the # of years remaining (13 years). That gives us a new minimum payment of $2,152 going forward.
|Home Purchase $35,000 withdrawal||X||1st Payment $2,333.00||2nd Payment $4,687.00||New Minimum $2,152.00|
Think of the withdrawal as a loan from the government. And just like any loan, the funds must be paid back or penalties will apply. The government requires you to repay the loan within 15 years from the withdrawal date or, you’ll have to report the remaining balance as taxable income on your annual tax return.
Is Investing in an RRSP Right for You?
Although the RRSP is designed for retirement, it’s also beneficial for throughout your lifetime. Let’s recap why contributing to an RRSP is beneficial to save for your nest egg or for your first home:
- The RRSP is a tax advantaged account that allows you to save for the future.
- Contributing to an RRSP throughout your working career allows you to gain immediate tax benefits at a time when your income is at its peak.
- The funds in your RRSP are tax sheltered; you do not have to include them on your income tax until you withdraw the funds at retirement. By this time, you will probably be in a lower tax bracket with a lower tax rate.
- And finally, first time home buyers can borrow up to $35,000 from their RRSP, tax free, for a down payment on their first home.
How often you should contribute varies and will be unique to every person. It’s best to start investing as early as you can so your money works for you well into the future.
Unused contribution amounts carry over to the next year so it’s never too late to start investing. But remember, this can be tricky to navigate so always consult a financial professional to discuss your options and create a plan that’s right for you.
If you have any questions regarding the Home Buyers Plan, how to take equity out of your home to contribute to your RRSP, or any other mortgage-related question, we’d love to hear from you. Contact us here.