Home Buying Series: Registered Retirement Savings Plan (RRSP)

A Registered Retirement Savings Plan better known as an RRSP is a tax deferred account that is registered with the Government of Canada. Unlike the tax-free saving account (TFSA), monies put into an RRSP are taxed when they are withdrawn because they are not taxed when contributions are made into the account.

The RRSP account was introduced to help employees and the self-employed save money for retirement. Unlike a TFSA which can be used for retirement or other financial goals, an RRSP account was originally intended for retirement savings. Some additional differences between an RRSP and TFSA include:

 

RRSP TFSA
Contribution room based on earned income Yes. Contribution room based on 18% of qualifying income. No. Contribution room is based on the age of resident since the TFSA was introduced.
Contributions are tax deductible Yes. Amount contributed in RRSP can be deducted against income at tax time. No. Amount contributed in TFSA cannot be deducted against income at tax time.
Withdrawals can be made tax- free No. Withdrawals are taxed at retirement based on income level. Penalties & fees are charged if withdrawn before retirement age.

Exceptions include taking money out through:

Home Buyers Plan: taking money out of your RRSP to buy a home

Life Long Learning Plan: Taking money out of your RRSP to go back to school full time.

Yes. There are no taxes charged on withdrawals from TFSA, including on any gains/growth from investments
Age limit to start contributions No. There is no age limit to start contributing into an RRSP as long as you had qualifying income to grow your RRSP room. Yes. You must be 18 years old or older and a resident of Canada to open a TFSA account.
Age limit to stop contributions Yes.  There is a maximum age in which you can no longer contribute into your RRSP account (age 71) and must start withdrawing money from your RRSP No. There is no maximum age in which you must stop contributing into your TFSA account.

 

Most Canadians will use monies in their RRSP account to fund the down payment of their home through the Home Buyers Plan. Some Canadians may use a combination of monies in their RRSP and TFSA accounts to put towards a down payment.

Which option is better, an RRSP or a TFSA account to fund a down payment for a home?

It depends. There are many factors to consider when deciding whether or not to use monies in a TFSA or RRSP to put towards your down payment. I think there 2 major considerations to address, if not more:

  1. Your budget and expenses after home-ownership. If you withdraw money from your RRSP to put towards your down payment, that money must repaid back in equal payments over 15 years. The key word is MUST. Any amount not repaid back each year will be considered income for that year and you will be taxed on this amount.

Here is a hypothetical example. John and Mindy want to buy a home and each take out $25,000 (the maximum allowed) from their RRSP to fund their down payment. This comes to a total of $50,000. The year after they withdraw the money, they must pay this money back into their RRSP individually over 15 years. So each year for the next 15 years both John and Mindy will need to put $1,667/year each ($3,334/year for both) back into their RRSP or pay tax on this amount.

Some things they will need to consider:

  • Can we afford to pay back this amount based on our budget after buying a home?
  • Have we accounted for the contingencies like loss of work, pregnancy etc.? Do we have an emergency fund?
  • What percentage of our take home pay will go towards house costs? Note: Repayment of an RRSP through the homebuyers plan should be considered a housing cost because this money does not grow your retirement savings.
  • Will this repayment expense adversely affect the things we want to do based on our budget?
  • If we can’t repay, are we willing to pay the tax and lose the contribution room forever?

If the amount to repay will not have a significant impact on your budget after home-ownership, then using your RRSP through the home buyers plan may be a good option. If however, you will find it difficult to repay and do the things you want to do, then the RRSP account may not be the best option due to its rigid repayment requirements. It is also important to mention that if one fails to make the repayment amount back into their RRSP in any given year they are not only taxed on this amount, but they lose the contribution room for the amount in question indefinitely.

  1. Other investments, time and compound interest. It is important to balance home ownership with liquidity and retirement savings. If you hold a majority of your retirement savings in an RRSP account, withdrawing this money to buy a home may significantly reduce your liquidity (availability of money that is not in the form of debt) and long term financial gains from investments.

Financial investments grow based on risk, contributions and time. By taking 15 years to repay your RRSP, you are losing 15 years of substantial investment growth.

However, if you have monies invested in a TFSA and/or unregistered accounts in which you plan to not withdraw, then this is a more balanced approach as you will have liquidity and continue to benefit from the growth of your investments through time while owning your home.

Other considerations when saving money. This last point deals with the contribution of money in your RRSP or TFSA, the withdrawal of these monies for a down payment. In addition to the differences mentioned on the chart above it is important to note that monies contributed in a TFSA are not reported on your tax return. So, they are not used to determine whether or not you qualify for senior benefits like Old Age Security (OAS) and other senior benefits that are income tested. These benefits have income cut-offs where you no longer qualify for the benefit. A TFSA may be a good way to maximum senior’s benefits and monies for retirement. In contrast, monies in an RRSP must be converted into a RRIF (Registered Retirement Investment Fund) at retirement age and withdrawals are considered taxable income. These withdrawal amounts may affect your ability to qualify for some senior benefits.

 

In conclusion, whether the RRSP or TFSA is a better option to use for a down payment depends on each family’s unique situation.

Categories: Budgeting, Debt, Savings

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