In this year’s budget, the federal government announced a number of measures to help Canadians who are trying to put together a down payment for the purchase of a first home. The most significant of those measures was the Tax-Free First Home Savings Account (FHSA) which, as the name implies, allows first time home buyers to save on a tax-assisted basis (within prescribed limits) toward such a purchase.
Finance Canada has now released further details of the FHSA and, while the general structure of the FHSA program remains the same as that outlined in the 2022 federal Budget, the most recent announcement includes some changes which increase the flexibility of plan terms, to the benefit of taxpayers.
As part of its announcement, Finance Canada confirmed that, while the FHSA program may not be available until part way through 2023, eligible participants will still be entitled to make a full contribution for the 2023 tax year.
Contributing to an FHSA
Under the program terms, any resident of Canada who is at least 18 years of age and who has not lived in a home which he or she owns in any of the current or four previous years can open an FHSA and contribute to that plan annually. Planholders will be able to contribute up to $8,000 per year to their plan, regardless of their income for that year. The $8,000 per year contribution must be made by the end of the calendar year and planholders will be permitted to carry forward unused portions of their annual contribution limit, to a maximum of $8,000. For example, an individual who contributes $4,000 to an FHSA in 2023 would be allowed to contribute $12,000 in 2024 (representing $8,000 in contribution for 2024 plus $4,000 remaining from 2023). Regardless of the schedule on which contributions are made, there is a lifetime limit of $40,000 in contributions for each individual. It should be noted that the ability to carry forward contribution room to a future year is a change from the original budget announcement, which indicated that no such carryforward would be allowed.
The real benefit of the FHSA program lies in the tax treatment of contributions. Individuals who contribute any amount in a year can deduct that amount from income, in the same manner as a registered retirement savings plan (RRSP) contribution. And, as with an RRSP, an individual is not required to claim a deduction for a contribution made during the year – he or she can make that contribution to an FHSA during a particular year, but wait to deduct that amount from income in a future year. When the planholder withdraws funds from the FHSA to purchase a first home, those withdrawal amounts – representing both original contributions and investment income earned by those contributions – are not taxed.
While funds are held within the FHSA, they can be held in cash, or can be invested in a broad range of investment vehicles. Specifically, such funds can be invested in mutual funds, publicly traded securities, government and corporate bonds, and guaranteed investment certificates (GICs). Regardless of the investment vehicle chosen, interest, dividends, or any other type of investment income earned by those funds grows on a tax-free basis – that is, such investment income is not taxed as it is earned.
Withdrawing funds from an FHSA
Given the generous tax treatment accorded contributions to an FHSA, there are inevitably some qualifications and restrictions placed on the use the plans. First, amounts withdrawn from an FHSA are received tax free only if such withdrawals are “qualifying withdrawals”, meaning that the funds are used to make a qualifying home purchase. In order for a withdrawal to be a “qualifying withdrawal”, the planholder must have a written agreement to buy or build a home (which must be located in Canada) before October 1 of the next year. In addition, the planholder must intend to occupy that home within a year after buying or building it.
Amounts withdrawn from an FHSA and used for any other purpose are not qualifying withdrawals and the funds withdrawn are fully taxable in the year the withdrawal is made.
While Canadians who open an FHSA and make contributions to it are certainly hoping to be able to purchase a home, there are any number of reasons why their plans could change. Fortunately, the rules governing FHSAs provide planholders with a great deal of flexibility when it comes to the disposition of funds saved within a FHSA, in that planholders can transfer all funds held within their FHSA to an RRSP or to a registered retirement income fund (RRIF) on a tax-free basis. Significantly, the amount which is transferred from an FHSA to an RRSP isn’t reduced or limited in any way by the individual’s RRSP contribution room. However, transfers made to an RRSP in these circumstances do not replenish FHSA contribution room – in other words, each eligible individual gets only one opportunity to save for the purchase of a first home using an FHSA. And, of course, any amounts transferred from an FHSA to an RRSP or RRIF will be taxable on withdrawal, in the same way as any other RRSP or RRIF withdrawal.
The ability to transfer funds between plans also works in the other direction. Individuals who have managed to accumulate funds within an RRSP will be allowed to transfer such funds to an FHSA (subject to the $8,000 annual and $40,000 lifetime contribution limits). While no deduction is permitted for funds transferred from an RRSP to an FHSA, that transfer does take place on a tax-free basis. Transfers made from an RRSP in these circumstances do not, however, replenish RRSP contribution room..
Closing an FHSA
Individuals who open an FHSA have 15 years from the date the plan is opened to use the funds for a qualifying home purchase. (Taxpayers must also close their FHSA by the end of the year in which they turn 71.) While these rules do place some pressure on planholders with respect to the timing of their home purchase, there is some flexibility. Specifically, planholders who have not made a qualifying home purchase within the required 15-year time frame must then close the FHSA plan, but can still transfer funds held in the FHSA to their RRSP on a tax-free basis, and without being limited by the amount of any available RRSP contribution room.
Finally, the FHSA program is complementary to the existing Home Buyers’ Plan (HBP). Under that Plan, an individual can withdraw up to $35,000 from his or her RRSP and use those funds for the purchase of a first home. Any such funds withdrawn must then be repaid to the RRSP over the next 15 years. The Home Buyers’ Plan will continue to be available to Canadians – however, an individual will not be permitted to make both an FHSA withdrawal and an HBP withdrawal in respect of the same qualifying home purchase.
The recent announcement made by Finance Canada with respect to the FHSA program included the announcement of a consultation process with respect to the rules governing such plans. That consultation process, which is now open, will continue until September 30, 2022. Details of the consultation process, as well as a backgrounder outlining the design of the FHSA program, can be found on the Finance Canada website at https://www.canada.ca/en/department-finance/news/2022/08/government-delivering-on-budget-2022-commitments-to-canadians.html and at https://www.canada.ca/en/department-finance/news/2022/08/design-of-the-tax-free-first-home-savings-account.html.