Alison Griffiths

Saving for a new home is about to get $500 easier. On Jan. 1, just as you’re wondering why you thought eggnog and tequila was a good combination, the contribution limit for Tax Free Savings Accounts (TFSA) rises to $5,500 annually. (Note: the government site hadn’t updated the limit information as of writing.)

As far as I’m concerned, TFSAs are the best way to save for a home, especially if you are young and/or a first-time homebuyer. Until 2009, when TFSAs were introduced, many people put together the down payment for their first home by withdrawing money from their RRSPs under the Home Buyers Plan (HBP.)

I’ve never liked that strategy. In fact, I believe the HBP is a huge drag on retirement savings. Today, you can withdraw up to $25,000 from your RRSP to buy a first home, and then return it to your account over 15 years. The problem lies with the payback.

Though you get a tax deduction for the original contribution and can repay the withdrawn money interest-free to the RRSP, the HBP still amounts to a loan. Added to a mortgage plus insurance and taxes, it can create a considerable burden. And if you don’t manage the required minimum annual payments — 1/15 of the balance starting the second year after withdrawal — the sum is added to your income.

Worse, the HBP repayments have a dampening effect on retirement savings. First-time buyers tend to be younger with new families, careers and also new debt such as student loans, cars and so on. Fifteen years of paying back an RRSP loan is often all the “savings” this demographic can afford. It’s also not unusual to find individuals who think the HBP repayments qualify as RRSP contributions. That, of course, would be double dipping.

The $500 contribution increase to TFSAs starting in 2013 isn’t a huge amount in the scheme of things. However, the announcement serves to highlight the utility of TFSAs as a superior down payment savings tool.

1. Tax impact. Even though contributions to a TFSA are not tax deductible, the tax rate is generally lower for young homebuyers, who are usually at the beginning of their earning years. Also, there are often offsetting credits for children and tuition or education amounts carried forward from post-secondary education, which reduce the amount of tax payable.

Also, the self-employed often have little or no taxable income and a low earned income. They can’t make significant RRSP contributions to build up a home purchase fund. In contrast, anyone can contribute the maximum annually to a TFSA.

2. Flexibility. Because you’ve already paid tax on TFSA deposits, there’s no payback requirement. Additionally, there’s no limit on how much can be withdrawn.

For example, as of 2013, anyone who was 18 when TFSAs were introduced has built up $25,500 in contribution room, slightly more than the $25,000 maximum HBP withdrawal. If you choose the TFSA route and save for two more years, there could be $11,000 additional available in that account, for a total of $36,500. All of it can be withdrawn with no tax or payback requirement.

3. Purchase options. Right now the HBP applies only to first-time purchasers. If both individuals in a relationship use the HBP for a home purchase, that’s it. You can’t go back a second time, even after a divorce or separation. But TFSA savings can be used for buying any home or even a rental property.

4. Specificity. One of the reasons why I’ve never liked the HBP is that it uses money that should be conserved for retirement. Losing 15 years of growth on $25,000 can have an enormous impact down the road.

Let’s say the investment return on that money is a conservative four per cent. After 15 years, $25,000 will have grown into just over $45,000. That a lot of growth to give up and it is very hard for many families to compensate by boosting RRSP contributions after the HBP withdrawal is paid back. Try your own savings calculation.

Granted, many will find it difficult to save for retirement and a home through TFSA deposits. An alternative strategy, though one which requires considerable discipline, is to max out RRSP contributions, then deposit the tax refund into a TFSA.

There’s no question this is a slower approach but it does allow the pursuit of both goals — retirement savings and a home purchase. A further strategy for those in a hurry is to max out the TFSA contributions, devote remaining savings to an RRSP and then use the tax refund for the following year’s TFSA deposit.

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