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Buying a house

RRSP or TFSA for a down payment on a house?

By 21 April 2023No Comments
REER ou CELI pour achat maison

Buying a home is often considered one of the most important investments you can make in your life. However, before embarking on this adventure, it is important to plan for the down payment needed to obtain a mortgage.  Many people wonder if it is better to use their Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA) for their down payment. 

Both types of accounts have their advantages and disadvantages. In this article, we’ll take a closer look at how RRSPs and TFSAs work when it comes to buying a home and the difference between the two. We’ll also explain how to choose the best account for your long-term financial goals.

 

What is an RRSP?

A Registered Retirement Savings Plan (RRSP) is a financial tool created by the federal government to help people save for their retirement. RRSPs allow individuals to deduct contributions from their taxable income, which can reduce their tax liability and allow them to save more for their future.

In addition to serving as a savings vehicle for retirement, an RRSP can also be used to finance other important projects such as buying a home or returning to school. Under the Home Buyers’ Plan (HBP), contributors can use up to $35,000 of their RRSP to purchase a first home without paying tax on the amount withdrawn. Similarly, the Lifelong Learning Plan (LLP) allows contributors to withdraw funds from their RRSPs to finance full or part-time education without paying tax on the amount withdrawn. 

Both of these programs offer additional flexibility for contributors who are looking to undertake major projects while enjoying the tax benefits offered by an RRSP. This may seem like a great advantage, however, it is important to understand the limitations and rules associated with using an RRSP to maximize its benefits.

 

How does an RRSP work?

The operation of an RRSP is relatively simple. First, an individual must establish an RRSP account with a financial institution such as a bank, credit union or insurance company. Once the account is established, the individual can begin making contributions, which can be deducted from their taxable income.

Annual contributions to an RRSP are limited to 18% of the previous year’s earned income, up to an annual maximum determined by the government. Funds invested in an RRSP can be used to purchase a variety of financial instruments such as stocks, bonds, mutual funds and guaranteed investment certificates. The returns earned on these investments are tax-free as long as they remain in the RRSP. However, withdrawals from the RRSP are taxable as income.

There are, however, exceptions to this rule. Under the Home Buyers’ Plan (HBP) or Lifelong Learning Plan (LLP), an individual can withdraw funds from his or her RRSP without having to pay tax on the amount withdrawn. The HBP allows individuals to withdraw up to $35,000 from their RRSPs for the purchase of a home without paying tax. However, the funds withdrawn must be repaid within 15 years, or they will be taxed. 

Similarly, the LLP allows contributors to withdraw funds from their RRSPs to finance full-time or part-time education without taxation, but these funds must be repaid within 10 years. Finally, it should be noted that the RRSP has limits on withdrawals. If a contributor decides to withdraw funds before age 71, they will be required to pay a 10% early withdrawal penalty. 

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What is a Tax-Free Savings Account?

A Tax-Free Savings Account (TFSA) is a tax-advantaged savings plan in which a person can accumulate income tax-free. Even when money is withdrawn, no tax is payable. Therefore, any money deposited in the TFSA is generally considered tax-free.

This account is ideal for short-term or long-term projects, or for building an emergency fund for the unexpected. It is an effective tool for achieving financial goals such as buying a home, purchasing a car, financing a return to school or any other investment planned for the future. 

The TFSA is therefore a flexible savings account that allows individuals to prepare for the future while maintaining the freedom to use their money as they wish. However, contributors should be aware of the annual and lifetime contribution limits, as well as the rules and regulations that govern the use of the TFSA.

 

How does a TFSA work?

The TFSA offers investors great flexibility in terms of contributions and withdrawals. Any Canadian resident 18 years of age or older can open a TFSA and contribute up to a certain amount each year, set by the federal government. Unused contributions are carried forward from year to year, so missed contributions from previous years can be made up. Unlike RRSPs, there is no age limit for contributions, allowing people to continue saving in their TFSAs even after age 71.

Funds held in a TFSA can be invested in a variety of financial products, such as stocks, bonds, mutual funds, guaranteed investment certificates, etc. The income generated by these investments, such as dividends, interest and capital gains, is not taxed, allowing investors to grow their savings faster.

The TFSA also offers great flexibility in terms of withdrawals. Unlike RRSPs, there are no penalties for early withdrawals. In addition, withdrawals can be reinvested in the TFSA in subsequent years, allowing you to continue to enjoy the tax benefits of the plan. 

However, the TFSA also has some limitations. The maximum annual contribution amount allowed must be respected, as any excess will be subject to a 1% per month penalty tax until it is withdrawn from the account. Also, TFSA contributions are not tax-deductible, which can be a disadvantage for those looking to maximize their savings.

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What is the difference between an RRSP and a TFSA?

Choosing between an RRSP and a TFSA for savings depends on a number of factors, including your financial goals, your age and your income. While both plans are designed for savings, they have important differences.

Eligibility 

To contribute to an RRSP, you must have income from employment or other sources. You can contribute until December 31 of the year you turn 71. To open a TFSA, you must be 18 years of age or older in your province or territory of residence with a valid Social Insurance Number. There is no maximum age for contributions. 

Primary use 

An RRSP is generally used to save for retirement, while a TFSA can be used for any savings goal, such as a home, car, education, etc. 

Taxation 

Contributions to an RRSP are tax-deductible, while contributions to a TFSA are not. 

Withdrawals

Withdrawals from the funds are also treated differently. With an RRSP, withdrawals are taxable, while with a TFSA, you can withdraw funds at any time without paying taxes or early withdrawal fees. 

Contribution limits 

The maximum annual contribution limit for a TFSA in 2021 is $6,000, while for an RRSP it is 18% of your reported earned income for the 2020 tax year or $27,830, whichever is less, subject to certain adjustments.

Excess Contributions 

For an RRSP, you can contribute more than the maximum allowable amount of $2,000 per year without penalty. However, if you exceed this limit, you will be subject to a 1% monthly penalty. For a TFSA, the first dollar over the annual contribution limit will result in a 1% per month penalty. 

Spousal Plan 

With a spousal plan, an RRSP allows you to contribute directly to your spouse’s plan. With a TFSA, however, there is no spousal account, and you can only transfer funds to your spouse so that he or she can contribute to their own TFSA.

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Down payment on a property: RRSP or TFSA?

First, it is important to note that the use of RRSPs for a down payment is subject to certain rules. In fact, it is possible to use up to $35,000 of your RRSP for the purchase of a property, provided that you are a first-time home buyer or that you have not owned a principal residence in the last four years. Amounts withdrawn from the RRSP must be repaid within 15 years to avoid penalties. The RRSP contributions can then be used for retirement savings.

On the other hand, a TFSA can also be an interesting option for saving for a down payment. Unlike an RRSP, there are no specific rules for using the funds to purchase a property. In addition, withdrawals from a TFSA are not taxable, which can be advantageous if you are withdrawing a large amount. However, the annual contribution limit for a TFSA is $6,000 (as of 2022), which may not be enough if you want to save a large amount for your down payment quickly.

Ultimately, whether you choose an RRSP or a TFSA for your down payment depends on your particular situation. An RRSP may be attractive if you want to maximize your contributions for retirement savings while taking advantage of a temporary use for the down payment. A TFSA may be an attractive option if you want to have more flexibility in using the funds and avoid penalties for missed repayments. 

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Mortgage services

If you are looking for a mortgage loan for the purchase of your home, the services offered by Refinancing Mortgage are the ideal solution. Our professional advisors are there to guide you and help you find a solution that suits your financial situation. 

We understand that the calculations can be complex, and the process can seem daunting, so we are committed to making it easy for you. Our experts are available to discuss your options and find the right lenders to meet your needs. 

Contact us