Understanding the First Home Savings Account (FHSA)

As inflation gradually eases and interest rates remain fixed at 5.0%, Canadians are beginning to feel some economic relief. Despite this, many first-time homebuyers still struggle with the high cost of housing, leading many to give up on the dream of homeownership. To tackle this issue, the federal government unveiled the tax-free First Home Savings Account (FHSA) in their 2022 budget. Effective April 1, 2023, this initiative allows Canadians to open an FHSA and save for their first home without paying taxes on the earnings, with a lifetime contribution cap of $40,000.

What is the First Home Savings Account (FHSA) and How Does it Work?

The FHSA is a registered savings plan designed to help first-time homebuyers save up to $40,000 towards their home purchase without being taxed on the contributions or earnings. Similar to a Registered Retirement Savings Plan (RRSP), contributions to an FHSA are tax-deductible in the year they are made. Additionally, funds withdrawn for the purpose of purchasing or building a first home are tax-free. If the funds are not used, they can be transferred tax-free to an RRSP or a Registered Retirement Income Fund (RRIF).

Key Rules for the FHSA

While the FHSA offers significant benefits, there are strict requirements for account holders:

1. Eligibility: To open an FHSA, you must be a Canadian resident, at least 18 years old, and must not have owned a home (individually or jointly with a spouse/common-law partner) in the last four years. Your spouse or partner also must not own your current primary residence.
2. Contribution Limits: The annual contribution limit is $8,000, with a lifetime limit of $40,000. Unused contribution room can be carried forward, up to a maximum of $8,000 per year. Over-contributions are taxed at 1% per month until they are corrected.
3. Account Duration: The FHSA remains open for up to 15 years, until you turn 71, or until you make a qualifying withdrawal for a first-home purchase, whichever comes first.

Benefits of the FHSA

• Tax-Deductible Contributions: Like an RRSP, contributions to an FHSA reduce your taxable income.
• Tax-Free Withdrawals: Withdraw funds for your home purchase without incurring taxes.
• Flexible Savings: Use the account to save for your home over time, with the option to transfer unused funds to an RRSP or RRIF.

How to Open and Manage an FHSA

To open an FHSA, contact a qualified issuer such as a bank, credit union, or insurance company. Many major financial institutions, including the Big Six Banks, offer FHSAs.

Types of FHSAs

1. Depository Accounts: Hold cash, GICs, or term deposits with financial institutions.
2. Insured FHSAs: Annuity contracts with licensed providers.
3. Trusteed FHSAs: Trust accounts that can hold cash, GICs, bonds, and mutual funds.

When to Close an FHSA

To avoid unintended tax consequences, it’s advisable to close your FHSA before the end of its maximum participation period (15 years, age 71, or after a home purchase).

Withdrawal Rules

• Qualifying Withdrawals: To make a tax-free withdrawal, you need a written agreement to buy or build a home by October 1 of the following year, and you must occupy the home within a year. Complete Form R725 and submit it to your account issuer.
• Taxable Withdrawals: Non-qualifying withdrawals are taxed as income.
• Designated Withdrawals: Remove excess contributions without them being taxed as income.

Investing in an FHSA

FHSAs can hold various investment vehicles similar to RRSPs, including cash, GICs, bonds, mutual funds, and public securities.

What if You Don’t Use Your FHSA to Buy a House?

If you decide not to buy a home, you can transfer the funds to an RRSP or RRIF tax-free, or withdraw the funds as taxable income.

Other Canadian Home Buyer Incentives

1. Home Buyer’s Plan (HBP): Allows first-time homebuyers to withdraw up to $35,000 from their RRSPs tax-free, with a repayment period of 15 years.
2. First-Time Home Buyer Incentive: A shared-equity mortgage with the government, providing 5-10% of the home’s purchase price, to be repaid within 25 years or when the home is sold.

Using FHSA and Other Incentives

You can combine the FHSA with the Home Buyer’s Plan and the First-Time Home Buyer Incentive to maximize your benefits and increase your chances of affording your first home.

By understanding the FHSA and leveraging its benefits, aspiring first-time homebuyers can take significant steps toward achieving their dream of homeownership.