What is the Home Buyers’ Plan? Should You Pay Down Sooner?

As most readers know my revulsion of Guest Posts, however, Sean Cooper is a friend of the site and has posted before.

Disclosure: This site (and I) have not been compensated for publishing this post. The opinions expressed are those of Mr. Cooper.


Buying a home is a major financial decision. If done right, it can be the single best investment of your lifetime. But the desire to purchase a home and actually buying one are two different things. Many of us would like to be homeowners, but what stops us is the down payment. Thankfully, the government will give you a little help. The RRSP Home Buyers’ Plan assists first-time homebuyers afford a home sooner.

Let’s take a look at what the Home Buyers’ Plan is and if it makes sense to pay it down sooner.

What is the Home Buyers’ Plan?

The Home Buyers’ Plan (HBP) is plan made by the government to make it easier for first-time homebuyers. Under the HBP, you can withdraw up to $35,000 from your RRSP to use for your down payment. (That’s $70,000 combined when you’re buying with another first-time homebuyer.)

The RRSP helps save up your down payment sooner because of the tax refund that you receive. Let’s go through an example to illustrate this. Let’s say your tax rate is 30% and you made a $10,000 RRSP contribution. In this instance you’d be eligible for a tax refund of $3,000 (30% X $10,000 = $3,000). That’s the equivalent of a 30% no risk return on your money. Not bad!

Also by borrowing under the HBP, you may be able to avoid paying CMHC fees thanks to your heftier down payment.

The HBP is a great program as long as you follow the rules. When you withdraw money from the HBP, you’re required to pay it back over 15 years starting in the second years since you borrowed the money. Any money you don’t pay back is included as taxable income and you lose the RRSP room forever. Ouch!

Some financial gurus are against using the HBP. They claim that you’re borrowing from your future self. While that may be true, if you’re buying in a city with high home prices like Toronto or Vancouver, the HBP may be the helping hand you need to get into the real estate market sooner rather than later. In these markets, it’s tough to turn down the guaranteed return you get with the HBP. Provided you use the HBP is a smart way and repay the money you borrow according the repayment schedule, it can be a wonderful program.

Should you Pay Down the Home Buyers’ Plan Sooner?

If you get a cash windfall, should you pay off the HBP sooner? It some cases it can make a lot of sense. As previously stated, you need to pay back any money borrowed from your RRSP from the HBP within 15 years. Using the example above, if you borrowed $10,000, you’d have to pay back $666.67 annually ($10,000 / 15 years = $666.67). But if you have the money, why not increase it to $750 annually? When you do this, you’d pay it back in only 13.33 years, almost 2 years sooner. After the HBP is fully repaid, any further money you contribute to your RRSP goes towards saving for retirement. This lets you take full advantage of the power of compound interest.

About the Author

Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedInTwitterFacebook and Instagram.

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Pay Taxes or Your RRSP ?

Given my love for the RRSP (or the Tax Deferral Savings Plan), I was wondering whether folks use it to defer owed taxes? The simple question is Pay Taxes or Your RRSP ?

If you received my T4 early enough that you could estimate my taxes, what would you do if you estimated you owed $500 taxes?

You have two options:

  1. Give the CRA their $500 and forget about it
  2. Put enough money into your RRSP (before March 1st) to counteract the owed taxes. This means you would then owe $0 in taxes.

The argument I keep hearing is that if I put money away in an RRSP now, I’ll just end up paying a higher tax rate on it when I take the money out. There is a school of thought that you might be in a higher tax bracket when you retire. To me, it seems an odd statement given the money will grow (hopefully) in your RRSP. This mean you’ll have more money to be taxed, albeit at a higher rate ?

I tried very hard to find what your nominal tax rate might be in Ontario, but let’s just assume it’s 50% for you.

This means you need to put about $750 into your RRSP to not pay $500 in taxes to the CRA. To do this exercise, if you have Quicktax or something similar, you can simply plug numbers into their RRSP estimator. This might be a better way to estimate, how much to pay.

Now you have $750 in your RRSP, and say you are 32. You have about 30 years until you want to take your $750 out. Assuming a simple growth 4.5% year over year, it will be about $3100.

Why not Put It in an RRSP ?

You now take $3100 out at a higher tax rate (say 60% again hopefully taxes in 32 years are not that brutally high), but it is still about $1300 dollars net. The bonus is you didn’t have to pay the CRA $500 32 years ago (an added bonus).

A net investment of $250 (you were going to have to spend $500 no matter what) you end up with $800 ? Seems like a winner to me.

Why wouldn’t you do this? If you didn’t have $750 dollars I suppose that might stop you, but are there other reasons?

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Rrsps: The Definitive Book on Registered Retirement Savings Plans

No, I haven’t started working on my stack of books I promised to review. I did, however, find Preet’s book in the Ottawa Public Library and had a quick read through it. This is a great book for folks who want to learn about RRSPs.

Rrsps: The Definitive Book on Registered Retirement Savings Plans
Link to Amazon for Rrsps: The Definitive Book on Registered Retirement Savings Plans

The book has short punchy chapters, which is great for folks like me with short attention spans. Many are simple recaps of previous articles Preet has written. Many of the later chapters capture the more intricate topics of RRSPs like:

  • RRIFs and how they fit into the RRSP solution.
  • Locked in Retirement accounts, and their possible uses (including ways to unlock them).
  • Spousal RRSPs, a topic near and dear to my heart.
  • Life Long Learning Plans and The Home Buyer’s Plan the two ways to get money out of an RRSP “early”.
  • Holding your mortgage in your RRSP.
  • RRSP meltdowns, or using your RRSP the wrong way

I also like that Preet’s introduction mentions the now infamous doubling penny saving plan. A fun arithmetic trick, that will surprise some folk.

Recommendation

I would recommend this book, however, I took it out of the library. It is a quick read, and also a good reference book to have. You need to understand the power of an RRSP, although this book doesn’t really touch on TFSAs and how they have changed the retirement game. The book misses the TFSA because it was published in 2008.

I am also a friend of the author (for full disclosure).

ISBN 978-1-4357-0758-0
Title: Rrsps: The Definitive Book on Registered Retirement Savings Plans
Author: Preet Banerjee

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5 Things to Remember about RRSPs

things to remember about rrsps

Almost time to have your RRSP story closed off (although, you should be doing this all year around). You know my love for top 10 lists, (and evidently the correct cardinality of a financial list is 7) but, here are 5 things to remember about RRSPs.

Things to Remember about RRSPs

  1. Your RRSP balance is not how much money you have to withdraw. The RRSP program is a tax deferral savings system, you will have to pay taxes on your balance.
    • If you take it all out at once, you will end up paying the highest tax rate on the withdrawal.
  2. Are you sure your tax rate when you withdraw the money is going to be lower than your current rate? You may not withdraw at retirement, what if you get laid-off? If you are not sure about the tax rate, is the RRSP is the right place to put your money?
  3. When you take money out of your RRSP, that RRSP “room” is lost (except for a few specific programs (e.g. 1st home purchases). Every year you are allocated RRSP room, but if you cash out before retirement, that room is lost.
  4. The Spousal RRSP is one of the few ways to income share. I have written countless posts about this, but if your spouse will have less retirement income, this is an important tax evasion tactic for Canadians.
  5. Always name a beneficiary for your RRSP (or any registered savings plan), to ensure a smooth and easy transferral should you die before you can spend it.

There are really not only 5 things to remember for RRSPs, there are many more, but here are five to start with.

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RRSP: Tax Deferral Savings Plan

I think if the RRSP was named the Tax Deferral Savings Plan it would clarify to folks how it all works. Most folks simply think of it as a Tax Avoidance program, but like death, there is no hiding from taxes.

The government rarely wants you to get something Tax Free (with the exception of the Tax Free Savings Account (TFSA), and a few other programs). When you get a refund for your RRSP deposit, all you are doing is deferring paying tax on your deposit. You will pay tax on the money in your RRSP, when you withdraw it. This is why I am calling it the Tax Deferral Savings Plan. Remember there are tax deferral advantages possible, but you must realize that is what the RRSP does.

Tax Deferral savings plan
The Tax Ramifications of a Tax Deferral Savings Plan

Some of the underlying assumptions for your RRSP are simple. When you withdraw money from your RRSP you will:

  • Be in the same or lower tax bracket, thus your tax deferral is a net positive (if you have kept your refund from when you deposited into your RRSP).
  • You have money saved to pay the taxes on the withdrawal.

This is where folks tend to get tripped up. They look at their RRSP balance and see the entire value ($X) , when in fact the actual value is  ($X – Income Tax). How much income tax? Depends on when you take the money out, and how much you withdraw. Take it all out at once and you pay the most tax on that withdrawal.

Retirement Withdrawal

Assuming you are making less when you are retired you are withdrawing at a lower tax rate (hopefully). If you have a higher tax rate when you are retired, you will pay more in tax than you got as a refund.

Emergency Withdrawal

A dangerous idea is using your RRSP as an emergency fund. While it might work if you are unemployed (and have no income), using it to pay for a large purchase might give you a much bigger tax bill.

What to do with Refund?

If you put money into your RRSP (or tax deferral savings plan) and you receive a refund, what should you do with it?

  • If you spend the refund, you need a plan to recover it in some fashion. You must be able to pay the taxes on your deposit.
  • Keep in mind the actual value of your RRSP deposit
    • $X deposit gives $N refund, thus you will need approximately $N in tax payment money to withdraw all of $X again.
  • Put the refund into the RRSP, problem solved, and you get another refund next year (repeat).
  • Refund into TFSA, let it grow there, thus you have the Tax Money. An added bonus is you are using it to grow you nest egg (tax free).
  • Hope your RRSP investments grow enough to cover $N worth of taxes due on the initial deposit.

Your RRSP Balance is Before Tax Money

Remember this, you must pay tax on your RRSP withdrawal (with a few exceptions), plan accordingly!

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