First Home Savings Account – A new best friend for younger investors?
This article looks at the details of this new savings account.
Sun Life Guaranteed Investment Funds (GIFs) - Effective April 24, 2023, the Deferred Sales Charge (DSC) option and Low Load (LL) Sales Charge option will no longer be available for new purchases. Switching from a fund previously purchased under DSC or LL Sales Charge options to other DSC or LL funds, will continue to be permitted.
This article looks at the details of this new savings account.
Residential housing in Canada has significantly risen in value in the last decade. While this has benefited current homeowners, it has been a curse for many young (and not so young) Canadians wanting to buy their first home.
To help fix this, the Federal Government proposed creating a new First Home Savings Account (FHSA) in the 2022 Federal Budget. This plan would allow first-time homebuyers to save for a down payment on a tax-free basis. Like a registered retirement savings plan (RRSP), contributions to an FHSA will be tax-deductible. And like a tax-free saving account (TFSA), withdrawals to purchase a first home will be non-taxable.
This article looks at the details of this new account.
To open an FHSA, an individual would need to confirm to an issuer that they are a “qualifying individual.”
To do this, they would need to establish that they are:
An FHSA has an annual contribution limit of $8,000 and a lifetime limit of $40,000. The full annual limit is available starting April 1, 2023.
Contributions to an FHSA can be made in cash, or through a transfer from an RRSP (see section on Cessation and Transfers below).
The equivalent of one year of unused FHSA contribution room can be carried forward once an individual has started their participation period by opening their first FHSA. The FHSA carry forward amount will be limited to $8,000.
Thus, an individual contributing less than $8,000 in a year could contribute the unused amount (i.e., $8,000 less their contribution in that year) in a subsequent year on top of their annual contribution limit of $8,000 (subject to their lifetime contribution limit).
For example: an individual that contributes $6,000 to an FHSA in 2023 would be allowed to contribute $10,000 in 2024 (i.e., $8,000 plus the remaining $2,000 from 2023).
Individuals can claim an income tax deduction for contributions made up to their annual limit, except for a contribution that is transferred from an RRSP. The deduction would not affect the individual’s RRSP contribution room, nor will a transfer from an RRSP reinstate the individual’s RRSP contribution room. It’s important to note that unlike RRSPs, contributions made within the first 60 days of a given calendar year could not be deducted in the previous year’s tax return.
Individuals are not required to claim a deduction for the tax year in which a contribution is made. Like an RRSP, such contributions (although reported in the tax year) could be carried forward and deducted in a later tax year, subject to certain to restrictions. For example, an individual will be prevented from deducting contributions made after a qualifying withdrawal (see definition below) has been made.
The FHSA holder is the only taxpayer permitted to claim deductions for contributions made to their FHSA. Individuals would not be able to contribute to their spouse or common-law partner's FHSA and claim a deduction.
Like the case for a tax-free savings account (TFSA), a special tax would apply on excess FHSA contribution amounts.
To summarize, an excess FHSA amount is determined by a formula. In principle, this is simply the total of an individual's actual FHSA contributions and transfers (from an RRSP) at a particular time, less the individual's contribution limits at that time.
This tax would be imposed monthly and would equal one per cent of the highest excess FHSA amount during each particular month. The deadline for a person to file the prescribed form and remit the penalties in respect of a calendar year is June 30 of the following year. This special tax will apply until such time as the excess FHSA amount is eliminated.
An individual's excess FHSA amount can be eliminated or reduced by making taxable withdrawals or by designating an amount for withdrawal or transfer using a prescribed form. When an amount is designated, an individual can correct an excess FHSA contribution by essentially reversing a contribution or a transfer from an RRSP.
As well, when a taxpayer's annual contribution limit is reset at the beginning of each calendar year, over-contributions from a previous year may cease to be an over-contribution. A taxpayer would be allowed to deduct an over-contributed amount for a previous year in the tax year in which it ceases to be an over-contribution but not earlier. However, if a qualifying withdrawal is made before an over-contribution is no longer an over-contribution, no deduction can be made for the over-contributed amount.
An FHSA will be able to hold "qualified investments" similar to those that can be held in a TFSA or RRSP, for example. However, should an FHSA hold a property that is not a qualified investment, a penalty equal to 50% of the fair market value of the property would apply.
Similar to the TFSA, the income earned within the FHSA will not be taxed with a few additional stipulations – provided that:
An individual will be able to make a tax-free "qualifying withdrawal" to purchase a first home if all the following conditions are met:
An individual counts as a first-time home buyer for this purpose where, during the four calendar years preceding the particular year in which the withdrawal was made, and in the period in the particular year ending 31 days before the withdrawal was made, the individual did not live in a home that they owned.
A qualifying home is a housing unit located in Canada. A share in a co-operative housing corporation that entitles the holder to own and have an equity interest in a housing unit located in Canada, would also qualify. However, a share that only provides a right to tenancy in the housing unit would not qualify.
Provided the individual meets the qualifying withdrawal conditions, the entire balance in their FHSA may be withdrawn on a tax-free basis in a single withdrawal or a series of withdrawals.
If an individual has made a qualifying withdrawal and a balance remains in the FHSA, they have two options:
The HBP would continue to be available under the existing rules. An individual would be permitted to make both an FHSA withdrawal and an HBP withdrawal in respect of the same qualifying home purchase. Since HBP allows first-time homebuyers to withdraw up to $35,000 from an RRSP to buy a home, a homebuyer maximizing both programs could potentially access $75,000 in capital, plus any growth accumulated in the FHSA, for a down payment.
There is a limit to the period of time that an FHSA can remain open (the "maximum participation period"). An individual's maximum participation period would begin when the individual opens their first FHSA. It would finish at the end of the year following the year in which the earliest of the following events occur:
For example, if a 20-year-old individual opens an FHSA in 2023, their maximum participation period will conclude at the end of 2038 (i.e., the 14th anniversary of the date since the opening of the FHSA is in 2037 and the end of the year following that year is 2038). However, if that individual makes a qualifying withdrawal from their FHSA during 2028, their maximum participation period will conclude at the end of 2029.
Once an FHSA is past that maximum participation period, it is no longer exempt from tax on the income earned within the account.
In that year, the account holder must include in their income for the taxation year an amount equal to the fair market value of all property of the FHSA immediately before the FHSA lost its tax-free status.
Any savings not used to purchase a qualifying home can be transferrable on a tax-free basis into an RRSP or a RRIF in which the individual is the annuitant and provided the transfer is a direct transfer, without requiring RRSP contribution room, or it would have to be withdrawn and is taxable in that year. Such transfer or withdrawal would have to be completed by December 31 of the year following the year of the first qualifying withdrawal.
If an individual has made a qualifying withdrawal, any unwithdrawn amounts still held in the FHSA can also be transferred on a tax-free basis to an RRSP or RRIF until December 31 of the year following the year of their first qualifying withdrawal.
It will be possible for an individual to have more than one FHSA and to transfer funds directly from one FHSA to another FHSA on a tax-free basis.
Note that funds transferred from an FHSA to an RRSP or RRIF will be subject to tax upon withdrawal from the RRSP or RRIF, similar to any other withdrawals from those accounts. Individuals would also be allowed to transfer funds directly from an RRSP to an FHSA on a tax-free basis, subject to the FHSA annual and lifetime contribution limits. Such transfers would not be deductible and would also not reinstate an individual's RRSP contribution room. Finally, transfers from an individual's RRSP to their FHSA will not be possible on a tax-free basis if a spousal contribution has been made to the RRSP in the current year or two preceding years.
In case of the breakdown of a marriage or a common-law partnership, any amount held in the FHSA can be transferrable directly from the FHSA of one party to the relationship (the transferor). This includes an FHSA, RRSP, or RRIF of the other party to the relationship (the transferee), provided it is pursuant to a decree, order, or judgement of a competent tribunal or under a written agreement, relating to a division of property in settlement of rights arising from their marriage or common-law partnership. Such transfers would not re-instate any contribution room of the transferor and would not be counted against any contribution room of the transferee.
An FHSA will cease, at the latest, to be an FHSA at the end of the year following the year of death of the last holder. After that, the FHSA will no longer be exempt from tax on the income earned within the account.
Any individual, including the estate of the FHSA holder, who receives a distribution from the FHSA shall include the amount in computing their income for the year. Under certain circumstances, an election will be available, to shift the tax liability from the holder's estate to a beneficiary of the estate.
If no individual has been named beneficiary to the FHSA, the deceased individual's estate would be considered the beneficiary and the fair value of the FHSA would be included in the deceased estate's income.
If a beneficiary to the FHSA has been named by the holder, the law will require that they include in their income for the year the fair market value of the FHSA. If the surviving spouse or common law partner (CLP) has been named as a beneficiary of the FHSA, they will be able to transfer the fair market value of the deceased FHSA, minus any excess contribution, directly to an FHSA in their own FHSA or to their RRSP or RRIF, without needing contribution room.
Such inherited FHSAs would assume the surviving spouse's maximum participation period.
If, however, the surviving spouse is not eligible to open an FHSA (they are not a qualifying individual), the FHSA can instead be transferred directly to their RRSP or RRIF or withdrawn on a taxable basis.
If the beneficiary of an FHSA is not the deceased's spouse or common-law partner, the funds would be withdrawn and paid to the beneficiary. Amounts paid to the beneficiary would be subject to withholding tax and included in the income of the beneficiary for tax purposes in the year received.
Similar to a Tax-Free Savings Accounts (TFSA), individuals may be permitted to designate their spouse or common-law partner as the successor holder. If named as the successor holder, the surviving spouse would become the new holder of the FHSA immediately upon the death of the original holder provided the surviving spouse meets the eligibility criteria to open an FHSA.
In Québec, naming Successor holder (or a beneficiary) would only be possible if the account is held in a segregated fund contract.
If the surviving spouse or common law partner is not a qualifying individual (see definition in first section), the law would prohibit the surviving spouse/CLP from becoming the owner of the account. They must either transfer the deceased FHSA property directly into their RRSP or RRIF, or receive a taxable distribution from the deceased holder's FHSA.
If the holder of an FHSA has not named their spouse or common-law partner as a beneficiary or Successor holder of the account, but has instead bequeathed the account to a surviving spouse/CLP in their will, the legal representative of a deceased holder's estate and the surviving spouse/CLP can jointly designate, using a prescribed form, to have the FHSA proceeds that were paid to the estate treated as having been transferred from the FHSA of the deceased holder to an FHSA, RRSP or RRIF of the survivor. All subject to meeting certain conditions. As a result, the legal representative does not need to include the amount received in computing the income of the estate. Such a disposition will allow for an indirect tax-free rollover of the deceased FHSA to the surviving spouse/CLP FHSA.
Alternatively, the legal representative of a deceased holder's estate and the surviving spouse/CLP can jointly designate, using a prescribed form, to have the FHSA proceeds that were paid to the estate treated as having been paid directly to the surviving spouse/CLP as a beneficiary. In that case, the amount will be included in the surviving spouse/CLP income for the year in which the survivor received the payment. As a result, the legal representative does not need to include the amount received in computing the income of the estate.
Such options will allow for some tax planning between the deceased and the surviving spouse/CLP.
As is the case for an RRSP, RRIF, and TFSA, an investor would not be allowed to deduct fees for the administration or management of their FHSA or for advice in connection with purchasing or selling securities in respect to an FHSA. Similarly, interest paid on money borrowed by an individual to make a contribution to an FHSA would not be deductible.
Attribution rules will not apply when a person gifts money to a spouse or common-law partner and that spouse or common-law partner uses those funds to contribute to an FHSA opened in their name. And, when a withdrawal is made from the FHSA, no portion of such withdrawal would be attributed back to the spouse who made the gift.
The Income Tax Act will prevent using an FHSA as security for a loan. Should a taxpayer pledge an FHSA as security for a loan, the fair market value of the FHSA at the time of the loan will be included in the account holder’s income in the year.
Taxpayers would be allowed to contribute to an existing FHSA after emigrating from Canada but would not be able to make a qualifying withdrawal -to buy a property- as a non-resident. A taxpayer making a qualifying withdrawal from an FHSA must be a resident of Canada at the time of withdrawal and up to the time a qualifying home is bought or built. Withdrawals by non-residents would be subject to a non-resident withholding tax of 25%.
Finally, contrary to RRSPs and RRIFs, FHSAs would not be afforded creditor protection under the Bankruptcy and Insolvency Act.
Combining the best of both an RRSP (deductibility of contributions) and a TFSA (tax-free withdrawal) when used to buy a first property, the FHSA will probably become the preferential tool for young (and not so young) Canadians to accumulate savings.
Used in conjunction with the HBP, it will allow a prospective first-home buyer to accumulate a sizeable amount for a down payment. Furthermore, even if the sums accumulated in the FHSA are not used to acquire a property, they can eventually be transferred into an RRSP or RRIF, thus indirectly allowing an individual to enhance their retirement savings.
Whether you plan to buy a home or not, what’s not to like?
Bill C-32, which contains the new disposition of the Income Tax Act pertaining to the FHSA has set an effective date for the new account: April 1, 2023.
Information contained in this article is provided for information purposes only. Its not intended to provide or be a substitute for professional, financial, tax, insurance, investment, legal or accounting advice and should not be relied upon in that regard. It also does not constitute a specific offer to buy and/or sell securities. You should always consult your financial advisor or tax specialist before undertaking any of the strategies discussed in this article to ensure that all elements and your personal circumstances are taken into consideration in developing your individual financial plan. Information contained in this article has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy and SLGI Asset Management Inc. disclaims any responsibility for any loss that may arise as a result of the use of the strategies discussed.