So, you’re saving for your first home. Odds are your current savings account isn’t quite cutting it as far as growth goes, so what should you do? You may have heard of a TFSA or RRSP, and don’t worry, if you’re confused about what they are, you’re not alone. These are both savings/investment vehicles that can help you realize your dream of homeownership.
What is a tax-free savings account?
A TFSA allows you to make low-, medium-, and high-risk investments for short or long term goals. The beauty is, taxes aren’t applied to interest earned or capital gains, even upon withdrawal.
There is a contribution limit of $5,500 a year, but the maximum carries forward; meaning the maximum is the same for everyone, so you can contribute up to that point at any time. If you’re more than $10,000 below the maximum, then you don’t have to worry about only contributing up to $5,500. Be wary though and ask your financial advisor at the bank what the maximum is because there is a monthly 1% penalty for over-contributing.
A TFSA is good for saving for your home purchase because the interest gained is stronger than your typical savings account. Also, you can withdraw the money at any time, tax-free. When you look at your TFSA account, the total number you see is all your money.
If you and your financial advisor decide to make medium- or high-risk investments, don’t get too nervous if you see the dollar amount drop. The market value fluctuates. If you have long-term saving goals, a medium-risk approach is a safer bet.
What is a registered retirement savings plan?
An RRSP is also an investment plan, but it is different from a TFSA in many ways. For one, you need an income to make contributions and these contributions lower your annual income. So, when it comes to your income tax, an RRSP contribution defers the tax you would pay on that money, so it would be taxed on withdrawal.
You can contribute up to 18% of your annual income for the prior year, and yes there is an over-contribution penalty of 1% like a TFSA. An RRSP is technically savings for your retirement, but you can make withdrawals at any time. Just remember it will be taxed.
But, a withdrawal won’t be taxed if its part of the Home Buyers Plan. This allows you to take out up to $25,000 from your RRSP to buy or build a qualifying home. This money will be tax-free, but the Canada Revenue Agency will put you on a plan to pay back the amount you withdrew; the plans can be up to 15 years long. Yes, it’s your own money, but it’s supposed to be for your retirement, so you should put it back!
Which savings plan is right for you?
When you really look at the TFSA and RRSP investment plans side by side, they are quite different. In order for you to take advantage of the HBP, you need to already have money in your RRSP. If you’re not making RRSP contributions, then it doesn’t make sense to make contributions for the purpose of withdrawing with the HBP. If you do have $25,000 or more in your RRSP, the HBP is definitely something to consider.
You may also want to consider RRSP contributions if you happen to have high income and an 18% contribution may put you in a lower tax bracket.
A TFSA won’t allow you to defer any taxes, but all your withdrawals are tax-free. This is basically a stronger version of your current savings account. You don’t need to know how to invest because your financial advisor at the bank can make recommendations and manage it for you.
Depending on your homeownership goals, either a TFSA or RRSP may be right for you. For more information, book a consultation with a financial advisor at your bank!