The government has two popular tax free programs that can help you save up for your down payment. Simply ask your local bank or investment advisor about the Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP). Both are great for savings but if your purpose is to use the funds for a down payment, there are advantages and disadvantages.
Here are the advantages for a Tax-Free Savings Account (or TFSA)
If you earn any interest, dividend, or capital gain, it’ll be all be tax free!
There’s a wide range of investment options available. You can invest in something safe like a term deposit or if you’re looking for something with a higher return, you can invest in stocks. Because this account is so flexible, you can withdraw the funds without much restrictions.
Lastly, all Canadians, regardless of your income, Investment in this account does not affect your income taxes. Currently, all Canadians can contribute up to $6,000. The limit can change so double check before you contribute.
And now the disadvantages for TFSA . There’s actually only one I can think of and that’s contributions do not help lower your taxable income. All funds are after tax money so don’t expect any tax refunds from the government.
Now we move on to the advantages for a Registered Retirement Savings Plan (RRSP)
Same as the TFSA, all growth or returns in the account are all tax free
And here’s the most attractive advantage. The amount put into RRSP will decrease the same amount of your taxable income. So for example, if you make $50,000.00 working in British Columbia, you’ll need to pay $7,228 in taxes. But if you contribute say $5,000 into your RRSP account, the government no longer sees your taxable income as $50,000 anymore. Your taxable income is now $50,000 - $5,000 contribution which equals $45.000. Because your income is lower, your tax will also decrease. The new tax due is now $5,966! A savings of $1,262.00!
And Lastly, if you’re a first time home buyer, you can withdraw your RRSP, tax free, of up to $35,000. This amount may change so double check before you withdraw. The catch is that you’ll need to repay it back in instalments within 15 years.
There are a few more disadvantages of a RRSP compared to TFSA
Putting money into RRSP is simply to postpone paying your taxes. Eventually you must withdraw it and pay taxes on it when you retire. The assumption is that when you retire, your income is much lower so you’ll be taxed at a lower tax bracket. This may or may not be true for everyone though.
Another disadvantage is that there’s a penalty when you take out the funds which makes this plan very restrictive. Unless if you are a first time home buyer, withdrawing from RRSP can be very complicated. It will result in penalties and increased taxable income.
So what’s my take on whether you should contribute into RRSP or TFSA for your down payment? It comes down to whether or not you are a first time home buyer. If you are, contribute into your RRSP up to $35,000 as that’s the maximum you can withdraw to go towards your down payment. Any additional funds beyond $35,000 should be contributed into your TFSA.
If you’re not a first time home buyer, then maximize your TFSA contribution limit. If you still have funds remaining, I would still keep it out of RRSP if your main purpose is to use it for a down payment for a future investment property. The restrictions of withdrawing from a RRSP will limit your access to the funds until many years later when you retire. I understand that the tax rebate cheque from the CRA can be quite enticing, but the access to your cash from the tax rebate is much lower than if you were to keep the cash in your account and not contribute.
And there you go! Now you know if you should put your down payment in a TFSA or RRSP. Contact me and we can discuss the right solution for you.