What Is the Tax-Free First Home Savings Account (FHSA)?

What is the Tax-Free First Home Savings Account?

You may have seen headlines and financial wizards gushing about this new savings account—but what’s all the hype about anyway? In a nutshell, the FHSA is a new type of savings plan for first-time homeowners in Canada. Starting in 2023, you can use it to save up to $40,000 to buy your first home.

The new account blends the best of the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA). It comes with some sweet tax breaks on contributions (just like an RRSP), and you don’t pay taxes on investment income and withdrawals (just like a TFSA). It also has some similarities to the Home Buyers’ Plan(HBP), but more on that later.

TLDR: if you aspire to own a home someday, this is a great savings vehicle to help you get there.

How does the Tax-Free First Home Savings Account (FHSA) work?

As far as adding money to your account goes, the rules are simple:

• Your contributions max out at $8,000 per year.
• If you don’t save the full $8,000 one year, your contribution room will roll over to the following year. 
• Over your lifetime, you can save up to $40,000 in your FHSA. 

The FHSA helps you to save money towards the purchase of your first home, partly by giving you a tax break on your contributions. When you contribute money to the FHSA, you lower your taxable income. As your investments grow within the account, you also skip the tax bill on those gains.

When it comes time to buy that dream home, you tap into those funds in the account. And here’s the other big benefit: you won’t pay taxes on the money you withdraw for that purpose.

Not everyone has more than $600 a month to set aside for home savings, but don’t forget these are pre-tax dollars you’ll be saving (you get a tax deduction similar to the RRSP). Plus, you get up to 15 years from the time you open the FHSA account to use it to buy your first home. So saving, $40,000 over 15 years may be a more attainable goal for some people. 

However, if you have unused funds left over in the account and you want to use them for anything else, the Canada Revenue Agency (CRA) will come knocking at your door.

How to open the Tax-Free First Home Savings Account (FHSA)?

Now that the FHSA is (finally) available, contact your financial institution. Confirm your eligibility, provide some personal information, and follow their instructions to open your account. It will be like opening an RRSP or TFSA.

Who’s eligible for the Tax-Free First Home Savings Account?

To open an FHSA, you must be:

• Between 18 and 71 years old
• A Canadian resident
• A first-time homebuyer. (Translation: That’s you if you haven’t lived in a home you or your spouse/common-law partner owned in the last four years.)

If you fit these criteria, keep reading.

How is the FHSA different from the Home Buyers’ Plan (HBP), RRSP, and TFSA?

While the four sound similar, some key differences make them suited for different purposes.

FHSA vs Home Buyers’ Plan:

At first glance, the HBP and FHSA may seem like twin siblings, but they’re actually more like distant cousins. Both accounts allow you to take out the money tax-free to pay for the purchase of your first home. However, there’s one big difference: when you withdraw funds from the FHSA, you don’t have to pay it back later.

Yep, that’s right: with the HBP, you’re basically taking money from your RRSP and giving yourself a loan that must be repaid later (otherwise, expect the CRA to come calling). 

How it works: the HBP lets you withdraw up to $35,000 (or $70,000 for first-time homebuyer couples) from your RRSP to purchase a home, but you need to pay it back over the next 15 years. Otherwise, the unpaid amounts will count as a withdrawal from your RRSP—aka taxable income that must be claimed on your tax return. Yikes!

FHSA vs RRSP:

The FHSA also has some similarities with an RRSP—mainly that both contributions are tax-deductible.

But there’s one huge difference: you don’t pay taxes when you withdraw funds from your FHSA to purchase a home. Whereas anything you pull from an RRSP is taxed as income (unless it’s under the Lifelong Learning Plan or Home Buyers’ Plan).

This is why waiting until retirement (when you’re in a lower tax bracket) to start drawing from your RRSP is a smart strategy.

FHSA vs TFSA:

Think of the FHSA as a TFSA that’s laser-focused on homeownership. They both have the same setup: you choose the investments (such as ETFs, mutual funds, bonds, and more) and any money you make from those holdings is (mostly) non-taxable.

However, unlike the TFSA, you’ll pay tax on withdrawals if you use the FHSA for anything other than purchasing your first home. Whereas with a TFSA, you can pull out the funds anytime without paying a dime in taxes and spend it on anything you want.

What are the contribution limits and rules for the Tax-Free First Home Savings Account (FHSA)?

Here’s the lowdown on how you can add your hard-earned cash to your account:

• If you meet all the eligibility requirements, you can contribute up to $8,000 each year to a maximum of $40,000.
• You must contribute within a single calendar year. No sliding in last-minute contributions in January and February of the new year, like you can with an RRSP. 
• If you don’t contribute one year, you can carry over up to $8,000 of contribution room to the following year.
• If you want to open more than one FHSA, go for it! But just know that your total lifetime contributions can only go up to $40,000. 
• Finally, if you contribute after withdrawing money for your first home, that money will not be tax deductible.

What are the advantages and disadvantages of a Tax-Free First Home Savings Account?

It sounds good on paper, but before you go all in on the FHSA, consider these pros and cons.

Advantages:

• Tax-deductible contributions mean you might get a nice little break on your taxes (and in this economy, every bit helps, right?).
• When you withdraw money for your first home (hooray!) or your investments within the account make money, you don’t pay taxes.
• You don’t have to pay the money back into your account after you withdraw to buy your first home. So now you’re free to start saving money for fun homeowner things, like property taxes and your energy bill.

Disadvantages:

• If you’re already in a lower income tax bracket, this account might not do you any extra favours in the tax savings department.
• You can only use your FHSA savings to purchase your first home; otherwise, expect a tax bill from the CRA. If you’re looking for a tax-sheltered account that lets you withdraw money to buy a new EV or score front-row Taylor Swift tickets, consider a TFSA.

What happens if I don’t use the tax-free home savings?

Since you have 15 years to contribute, maybe you start saving but decide to bail on buying a home down the road. What then? Don’t worry, there’s a solution.

If you don’t end up using all (or any!) of the savings in your account, you can transfer it to an RRSP or RRIF without paying additional taxes.

However, if you ultimately decide to cash out from the FHSA, you will be taxed on the money as if it were income.

The last word

If you’re saving for a home, you need TurboTax in your corner to help you keep track of your FHSA contributions. TurboTax can help save you money (and headaches!) by helping you figure out the best way to maximize your return and lower your tax bill. Connect with a tax expert who can answer your questions.