First-time homebuyers have more available savings options than ever

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Understanding your options will allow you to build a home purchase strategy that turns your dream into a reality

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For generations, Canadians have considered home ownership an important milestone following college graduation or starting a family, and buying a home is the most significant investment many will ever make.

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Considering today’s real estate market, however, some may consider this milestone more of a dream than a reality. Incomes are not rising at the same rate as housing prices, so younger generations are choosing to live with their parents longer and are holding off purchasing their first home until later.

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If you are waiting for the right time to start saving for a home, the good news is that there are now more tools available to make the dream come true.

Leveraging savings accounts

There are several options you can leverage when it comes to choosing a savings strategy to help you finance your first home. You can use a tax-free savings account (TFSA), a registered retirement savings plan (RRSP) and the newest savings tool, a first home savings account (FHSA).

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Since each is unique and offers different benefits, it’s advisable to incorporate a few accounts into your house purchase plan rather than relying on one. It may seem overwhelming to keep track of all these acronyms, but it is important to understand the difference between each savings account and in which scenario you should use them.

An RRSP is a well-established retirement savings plan where your contributions are tax deductible. Any income you earn in the RRSP is usually exempt from tax as long as the funds remain in the plan; you generally have to pay the associated tax when withdrawing funds. A TFSA is a tool for individuals 18 or older to set aside money tax free throughout their lifetime. Any income earned in the account is generally tax free, even when withdrawn.

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The newest tool at the disposal of new homeowners is the FHSA, which allows prospective first-time homebuyers to save for their first home tax free (up to certain limits).

Each savings tool has its benefits and shortcomings. For example, while the RRSP is a retirement tool, first-time homebuyers can apply the funds saved on a tax-free basis to purchase a home. The drawbacks of the RRSP are that you can only apply up to $35,000 to a home purchase, and it must be paid back over 15 years. A benefit is that while you are generally limited to depositing 18 per cent of your previous year’s income to the plan, you can contribute unused amounts in future years to significantly ramp up your savings.

A TFSA doesn’t have a limit on how much you can pull from it to apply to your purchase, but the downside is that there are limits to how much you can contribute each year, and these funds are not tax deductible.

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First home savings account

The recent addition of the FHSA to the savings options you can use to purchase your first home serves as a useful tool to use alongside TFSAs and RRSPs. One of the major benefits of a FHSA is that you can contribute a maximum of $8,000 per year to the account. This is tax deductible against your income above and beyond the RRSP limit. In short, the FHSA allows you to allocate a significant amount of money into your account while still receiving tax relief.

The FHSA is an excellent multi-generational tool as well. Many parents and grandparents are anxious about gifting their children money because they can’t stipulate how their children will spend it. Since the FHSA earmarks funds for a specific use, it eases many parents’ concerns about the direction of their children’s spending. What’s more, you can also transfer money from an RRSP to an FHSA, and any unused FHSA funds can be transferred to an RRSP on a tax-free basis.

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There are, however, a few things to keep in mind when using an FHSA. First, there is a maximum holding period of 15 years on the FHSA, so it’s not recommended for daily savings or short-term income needs. The FHSA should ideally be dedicated to purchasing a home, whereas other savings accounts can help you manage external costs.

New homeowners should also remember that they will need a reserve of funds for emergencies. This is where a diverse savings portfolio is beneficial since emergency funds can be placed in a TFSA.

Bottom line

Purchasing a home may seem more complicated than ever, but younger generations have many valuable tools at their disposal to simplify the process. The FHSA is an exciting new addition to the savings programs that homeowners can leverage when purchasing their first home.

You will also want to maintain a diverse savings portfolio to account for emergencies and unexpected costs.

Exploring all the available options, and understanding the benefits and drawbacks of each, will allow you to build a home purchase strategy that turns your dream into a reality.

Diana Orlic is a portfolio manager and wealth adviser at Richardson Wealth.

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