It is an age-old debate in personal finance whether it is more cost-effective to rent or buy a home — then add in the emotional element. Assuming the ultimate decision is to buy, attention then turns to assembling the downpayment.
Looking past the bank of mom and dad, traditionally that meant building up a reserve in a non-registered account beginning years ahead of the intended purchase. As such deposits are after-tax savings subject to annual taxation on earnings, that could make for a slow exercise.
Since 1992, accumulation in a registered retirement savings plan has been available for this purpose through the Home Buyers’ Plan (the HBP). And since 2009, the multi-purpose tax-free savings account has provided another avenue.
While RRSP and TFSA both offer tax-free accumulation, the pre-tax RRSP allows greater gross accumulation, which would seem to favour usage of the HBP. On closer look however, the choice is neutral at best, and in my opinion instead leans toward employing the TFSA.
The simplicity of TFSAs
The TFSA became available for deposits in 2009. The initial $5,000 annual contribution limit increased through indexing to $5,500 in 2013, and earlier this year was moved up to $10,000 (though it will no longer be indexed). Depending on the outcome of the current federal election, TFSA room may be further adjusted, but there is no suggestion that either the program itself or its tax functioning are at risk.
The TFSA is funded out of after-tax money, so less money is available to go into a TFSA compared to an RRSP deposit. To illustrate, a person at a 35% marginal tax rate who had a dollar to put into an RRSP (assuming available room), would have only 65 cents to go into a TFSA. This is a double-edged sword for the RRSP though, as all deposits and all growth will eventually be taxable.
On the other hand, TFSA withdrawals are not taxed. Thus the amount available for a downpayment is simply the value of the TFSA at any given time. Once a withdrawal is made, there is no service cost or repayment obligation, and the taxpayer is entitled to a dollar-for-dollar credit for re-contribution the year following withdrawal.
HBP accessing RRSPs
At its core (without getting into all the minutia), the HBP allows a first time home buyer to make a withdrawal from an RRSP without facing current taxation. The original withdrawal limit of $20,000 per person (or as much as $40,000 for a couple) was increased to $25,000 in 2009, and there is now an election proposal to further increase it to $35,000.
The quid pro quo is that the withdrawn amount must be returned to the RRSP over the 15 years following the home purchase (or sooner if the person is able, and wishes to do so). Those future replenishing payments are not deductible.
For a renter anxious to enter into home ownership, the HBP opens the door to a larger pot of money to achieve a desired downpayment. This could be particularly helpful in getting past the threshold below which an insurance premium would be payable for the mortgage to be covered by the Canadian Mortgage and Housing Corporation. And obviously a larger downpayment means a smaller amount being financed.
This last point is critical, as larger annual interest charges eat into a household budget for years, and often decades. But what is the trade-off cost of using the HBP for that downpayment?
Just as mortgage payments are non-deductible, again so too HBP repayments. Put another way using our 35% taxpayer once more, roughly $1.50 of the person’s pre-tax income would be required to fund each repayment dollar. To derive a truer cost of financing, an aspiring homeowner would be advised to budget based on the combined cost of mortgage and HBP.
Still, whereas mortgage payments are mandatory (in a practical sense), couldn’t a person simply forego one or more HBP repayments if things get tight? The answer is yes, but then the un-repaid amount is taken into taxable income – And remember, no cash comes available at that time, as it was spent years earlier to buy the home. The tax payment itself is not deductible, costing our erstwhile 35% homeowner almost 75 cents of pre-tax income to pay the roughly 50 cents of tax. And unlike TFSA room, spent RRSP room is non-recoverable.
It is also bears mentioning that likely our homeowner will have higher income in future. While plainly positive on its own, as household costs ascend that could have an impact on the cost of HBP repayment or tax on un-paid instalments. The net effect is ambiguous at best.
Transparency trumps
Perhaps the picture offered here is a bit cynical. Well-informed, well-disciplined purchasers may very well be able to navigate the HBP rules without harm, and possible to their advantage. Indeed, a couple planning a family could strategically manage the program so some future income is recognized by a low-bracket stay-at-home parent.
Even so, the true cost of the HBP remains opaque and uncertain – an uncomfortable position to be in for the largest financial transaction of a person’s life. For my money, the nod should go to the greater transparency and certainty of the TFSA, maybe with the HBP playing a minor supporting role.
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SIDEBAR/CALLOUT
According to Statistics Canada, 180,750 taxpayers did not pay their HBP instalment in 2012 (the last year for which data is available), collectively taking $812 million into income that year.