As a first-time home buyer, I expect Canada’s First Home Savings Account (FHSA) to save me $12,000 in taxes over the next four years.
The new FHSA opened April 1st. If you are a first-time buyer, you may be wondering, “What are the benefits of the FHSA?”
To answer this question, I must invoke taxes. Unfortunately, I can’t make taxes fun, no matter how hard I try.
Perhaps a different approach, “Are a few minutes spent learning about taxes worth a few thousand in tax savings?”
Understanding the FHSA will also help you understand the TFSA and RRSP. This gives you a leg up, as I’ve noticed that most people don’t understand tax-sheltered accounts.
FHSA Overview
The FHSA can combines the tax benefits of the TFSA and RRSP, as per the infographic below. You can contribute up to $8,000/year with the FHSA, with a maximum lifetime contribution limit of $40,000.
Finally, the FHSA can only be used for first-time home buyers. For more details, check out the CRA’s FHSA page.
Let’s dig into the three primary benefits of making these contributions to the FHSA.
1: Tax Deductible Contributions
When you contribute money to the FSHA, you reduce your taxable income. This is the primary benefit of the FHSA.
If you earn $100,000/year and put $8,000 in the FHSA. You would only be taxed on $92,000.
Typically, I pay a ~30% tax rate on earned income. Therefore, I will pay $2,400 in tax on $8,000 of extra earned income.
But when I contribute $8,000 to the FHSA in 2023, I pay zero tax on the $8,000 of income. Therefore, each year the FHSA will save me $2,800 that otherwise would have gone to tax.
Higher earners have higher tax rates, going up to $53.5% in Ontario. Therefore, higher earners see more tax benefits from an FHSA.
How To Receive Your FHSA Tax Savings
There are two ways that you can receive tax savings from your FHSA contributions:
- (1) Pay tax on the income like usual, and have the tax returned on your 2023 tax return (in March 2024).
- (2) Fill out the T1213 form and gain CRA approval for your employer to reduce tax deductions on your 2023 pay. Your take-home pay will increase.
2. Tax-Free Investment Income
Income earned from investments in the FHSA is not taxed.
First, a 100% stock portfolio is best for 10+ year time horizons, even for a diversified stock index fund that minimizes risk. Since I plan to buy a home in 2-4 years, I will not hold stocks in my FHSA.
Instead, I will buy a short-term bond index ETF, yielding about 4%. Based on my $8,000 contribution in year one, I expect to earn $320 in investment income in the first year. .
Typically, $320 of interest income is taxed at my marginal rate of 30%. That’s $96 in tax.
But the interest income is not taxed when the bond ETF is held inside the FHSA.
Over a four-year horizon, I expect to earn $3,331 of total interest. In a regular investing account, I would pay $999.30 in tax.
The FHSA shelters me from tax on investment income, saving $999.30.
You do not pay tax on income generated from investments in the FHSA. Income from investments includes:
- Interest Income (bonds, GICs, money market funds)
- Capital Gains Income (stock sale)
- Dividend Income (stocks)
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3. Tax-Free Withdrawal
You can remove money from the FHSA tax-free.
The FHSA’s tax-free withdrawal benefit is similar to the TFSA. But it is very different from the RRSP since money removed from the RRSP is taxed as regular income.
Unlike the RRSP Home Buyers Plan, there is no need to return money to the FHSA!
There is one catch with FHSA withdrawals that I’m sure you are aware of: the money removed must be used to buy your first home. For more, see the detailed CRA rules for FHSA withdrawals.
FHSA vs Home Buyers Plan
FHSA is better than RRSP Home Buyers Plan (HBP). With the FHSA, you do not have to pay back the money when you use the FHSA.
The HBP is like a loan from yourself. You must pay back the loan over the next 15 years by making RRSP contributions that do not provide tax benefits.
You must use after-tax money to repay your HBP amount. Paying back your RRSP in future years can reduce your tax savings from RRSP contributions.
Total FHSA Benefits
The chart below shows combined benefits for someone who maxes the FHSA over five years, with a marginal tax rate of 35%.
The primary FHSA benefit are the tax savings you receive through contributions to the FHSA.
Your exact FHSA benefit will be unique to you. It depends on your marginal tax rate, which depends on your income and province of residence.
You can find your marginal tax rate by plugging your income into a tax calculator like this one.
Conclusion
The First Home Savings Account combines the benefits of the TFSA and RRSP. By using the FHSA, you see the three primary benefits:
- Contributions reduce your taxable income
- Investment income is tax sheltered
- You can withdraw money tax-free (unlike the RRSP)
The FHSA is a great tool to help Canadians save for a first home. But before pulling the trigger on a home purchase, I recommend you read the Rent vs Buy Assessment to understand the full costs of home ownership.
Jake out.
