Let's talk about the newest registered account in Canada, the First Home Savings account, or FHSA.
This account was introduced recently to help Canadians save for their first home. As a registered account, it has some similarities to other registered accounts you may know of and be using, but it also has some distinct differences.
What is the First Home Savings Account (FHSA)?
High level, this account provides you with a deduction when you contribute, funds get to grow in the account tax-free and withdrawals are tax-free if used to purchase a qualifying home. Let's take a closer look at who qualifies for this account, how contributions and carry-forward room work, investing within the account and withdrawals or transfers.
How do I qualify for the First Home Savings Account (FHSA)?
First, to qualify for this account, you must be a resident of Canada, be the age of majority in your province or territory, and not have lived in a home as your principal residence that you own or jointly own - or your spouse or partner own or jointly own - in the calendar year you open the account or the previous four calendar years.
How do contributions for the First Home Savings Account (FHSA) work?
If you qualify to open this account. Great. You can contribute a maximum of $8,000 per year to your FHSA, to a lifetime maximum of $40,000.
Now, if you don't contribute to your FHSA in a given year, you may be able to carry the unused contribution room forward. But to start to accumulate room to carry forward you have to open an FHSA. This is different than how contribution room works with other registered accounts. For example, to begin to accumulate contribution room for a Registered Retirement Savings Plans, or RRSP, all you have to do is earn eligible income and file taxes, and for a Tax-Free Savings Account (TFSA) all you have to do is turn 18 – and room begins to accumulate. To start to accumulate contribution room for the FHSA however– you must open an account.
Now, the maximum amount of room you can carry forward after you open the account is $8,000 even if you open an account and don't contribute for two years.
So let's say you opened an FHSA last year, and didn't contribute – that means this year you can contribute $16,000. $8,000 for last year plus $8,000 for this year.
But the same would be true next year – if you opened an account last year and didn't contribute, and you also don't contribute this year. Next year you can contribute $8,000 for next year, plus a total of $8,000 in carry forward. You don’t have $8,000 for last year plus 8,000 for this year because only a maximum of $8,000 carries forward. Unused room does not accumulate beyond a total of $8,000.
If instead you opened an account last year and contributed $4,000 last year, you can contribute $12,000 this year. That is $4,000 carried forward from last year, plus your $8,000 this year.
So as you can see, there is a bit of a "use or lose it" criteria when it comes to contributions.
It's also worth noting that you can have more than one FHSA, but your contribution room is in aggregate, you don't get $8,000 of room per account. So it's important to ensure you don't over-contribute, otherwise you'll be faced with a penalty of 1% per month.
How is First Home Savings Account (FHSA) tax deduction calculated?
Your available FHSA contribution room will reported on the Notice of Assessment you receive from CRA after filing your taxes after opening an FHSA.
When you contribute to your FHSA, you get a tax-deduction. This means you reduce your taxable income by the amount of the contribution, thereby potentially eliminating, or at least deferring, the tax you would pay on that income at your marginal tax rate.
Let's say you make $50,000 this year, and you contribute $8,000 to your FHSA. You save tax on $8,000 of income at your marginal tax rate. That saves you about $1,600 in tax if you live in Ontario, which could be paid out as a tax refund.
But just because you contributed this year, that doesn't mean you have to take the deduction this year. If you think you're going to make more money in the future, you can deduct the contribution later, when it's worth more.
For example, if you think you're going to make $65,000 in the future and you use that deduction then and live in Ontario, that deduction will be worth closer to $2,400. The decision to claim the deduction immediately or carry it forward is yours.
Can you roll over Registered Retirement Savings Plan (RRSP) contributions to the First Home Savings Account (FHSA)?
Now in addition to contributing to the FHSA, you could also transfer funds into it from an RRSP. When you transfer from an RRSP, you don't get a deduction because you already got that deduction when you contributed to the RRSP.
Both contributions (and withdrawals) will be reported on a T4FHSA, which will be sent out by the institution that holds your FHSA by the end of February every year.
Not only do you get a deduction for contributions to the FHSA, you also don't have to pay tax on any of the interest, capital gains or dividends you earn in the account. That means no matter what you invest in, the returns on the investments are not taxed in the account as they are earned.
What are eligible investments in the First Home Savings Account (FHSA) and how do withdrawals work?
Eligible investments typically include equities, fixed income and cash-like investments. Your advisor can help you decide what is most suitable for you.
You can withdraw funds from your account at any time for any reason but you may be subject to income tax on the withdrawals. Because you got a deduction when you contributed, you'll generally pay tax on withdrawal unless the account is used for it's main purpose – to buy your first home.
A qualifying home is defined by the CRA as a housing unit in Canada that you intend to be your principal residence.
If you withdraw the funds with the intent to buy or build a home, you must have a written agreement to do so by October 1 of the year following the first withdrawal and be living in the home as your primary residence within one year of purchasing or building it.
If you're purchasing a home with a spouse or partner, you can both withdraw from your FHSAs toward the home purchase. And if you have funds in an RRSP that you wish to use under the Home Buyers' Plan, you can combine those funds toward the purchase too.
If you don't use the funds in your FHSA within 15 years from opening the account, or by December 31st of the year you turn age 71 you must close the account. When closing the account, you have the option to withdraw the funds as taxable income or transfer the funds to your RRSP or your Registered Retirement Income fund, or RRIF. You can do this even if you don't have contribution room. Transfers to an RRSP/RRIF are not taxable upon direct transfer, but withdrawals from the RRSP and RRIF are taxable as income upon withdrawal.
Summary of the First Home Savings Account (FHSA)
To summarize, the FHSA can be a valuable tool to help you save for your first home. You begin to accumulate room when you open the account. The FHSA can generally stay open for 15 years. Contributions to the account from non-registered sources will get you a deduction at your marginal tax rate. You don't have to claim the deduction the year you make the contribution, you can carry it forward to a year when you're in a higher tax bracket. Funds invested in the account grow tax-free and can be withdrawn tax-free if used to buy or build a qualifying home within one year of withdrawal. After 15 years or December 31st the year you turn age 71, you must close the account by withdrawing the funds or transferring them to your RRSP or RRIF.
The FHSA offers several advantages but it also has restrictions and drawbacks. An FHSA is not a stand-alone plan, but rather it is part of an overall comprehensive home-buying or retirement-savings plan. An advisor can help you determine if this account is good for you, and how this may support your overall financial strategy. Please get in touch.