Using Your RRSP- "Home Buyers Plan"
The Federal Home Buyers Plan allows first time home buyers to withdraw up to $20,000 from their RRSP for the purpose of buying or building a qualifying home. The primary benefits are that the RRSP issuer will not withhold tax on the amount nor will you have to claim the amount as income. The amount must be repaid to the RRSP within 15 years with a minimum annual payment of 1/15th of the amount withdrawn. If a repayment is not made for a given year the minimum repayment is included as taxable income for that year.
The 1998 budget now allows Canadians to use the homebuyers plan again. The applicant must have no outstanding balance on any previous Home Buyer Plan loans and must re-qualify for the program again. This means the home owner must re-qualify as a first time home buyer by not owning for the prescribed period. The effective date of the changes is 1999.
Withdrawing $20,000 from your RRSP under the "Home Buyers Plan" can be viewed as a loan from your RRSP to yourself. Some call this a zero interest loan but of course the actual cost of the loan is exactly what the funds would have earned if they had remained in your RRSP. You will forego these earning if you take the funds out and use them for a down payment. On the other hand if you don't withdraw these funds you will be forced to borrow the required down payment.
Lets assume you have $20,000 in your RRSP at an average annual rate of return over the next 15 years of, say 8%. In 15 years your $20,000 will have grown to $63,443, an increase of $43,443. As such if you withdraw these funds under The Home Buyers Plan, while you won't suffer taxes, you will forego these earnings.
Most financial advisors will counsel you to borrow to invest in your RRSP because the "overall" rate of return from your RRSP is greater than the cost of borrowing the money. The cost of borrowing $20,000 in a catch up loan over 15 years is usually in the neighborhood of Prime, plus or minus a percentage point, depending on the risk of the RRSP investment. Assume a cost of 7.5% over the 15 year amortization of the loan. The interest paid to borrow $20,000 would be $13,372. If we also assume a 35% tax rate, you would have to earn $20,572 of gross income in order to net out these interest costs.
We can now compare the before tax cost of borrowing - around $20,572 - with the before tax return this $20,000 would earn in your RRSP - around $43,443. Clearly it makes sense to borrow to invest in your RRSP. Conversely, it should also make sense to leave the money in your RRSP and borrow your down payment, one being the same as the other.
In reality, no mortgage lender will finance 100% of your purchase price. In addition, your lender will qualify you for a larger mortgage, based on gross income, if your debts are lower and don't include a large personal loan for the down payment. A personal loan or second mortgage is a debt that squeezes the maximum mortgage amount you will qualify for if it puts you above the lenders target debt service ratios.
In addition withdrawal under the Home Buyers Plan may be more cost effective than borrowing if this borrowing cost also includes a CMHC fee. This fee can dramatically push up your effective interest rate. If you're just shy of a conventional down payment of 25% it may be wise to withdraw the remainder from your RRSP to avoid paying mortgage insurance fees.
The best approach is to withdraw from your RRSP under the Home Buyers Plan, get all the financing you qualify for, and then once the mortgage is funded borrow to replenish the RRSP if you can afford the payments. Remember you'll also have to pay back your RRSP 1/15th each year.
Always invest as much as you can in your RRSP, even if you have to borrow, but be sure you can afford to carry the loan.
Withdraw the money from your RRSP only if you have no other source of non RRSP savings.
Saving Your Down Payment Using your RRSP
To accumulate $20,000 in a non RRSP savings plan, assuming an 8% return and a marginal tax rate of 35%, you would have to invest $3,605 each year for the next five years. This would mean earning $5,546 in gross income each year in order to net out this $3,600 in after tax savings.
Rather than spending this $5,546 in gross income each year on a non RRSP investment, you could invest this same amount into your RRSP. With yearly RRSP contributions of $5,546, you will accumulate about $32,536 in five years. You will also receive tax savings each year in the amount of $1,941. Another way to look at it is that you could accumulate the required $20,000 down payment in about 3 1/3 years by choosing the RRSP savings approach. IT ALWAYS MAKES SENSE to save through an RRSP, whether the savings will be for a house or retirement.
Tax-Free RRSP Withdrawals for Lifelong Learning
Canadians will be eligible to make tax-free withdrawals from their RRSPs to support lifelong learning. Individuals will be able to withdraw tax free up to $10,000 per year from their RRSPs, with a maximum of $20,000 over a four-year period. To preserve retirement incomes, these withdrawals will be repayable over 10 years.
What if I want to sell my home before I have paid off the RRSP loan?
In some situations, outstanding repayment installments have to be reported as income by the borrower:
When you leave the country. If a taxpayer ceases to be a resident of Canada, "the balance of withdrawals made under the plan and not yet repaid must be repaid within 60 days of ceasing residency, or must be included in the individual's income for that year."
If you die. When an individual dies with an outstanding Home Buyer's Plan repayment balance, "the outstanding amount must be included in the deceased's income for the year. There is an election that may be made in certain circumstances to allow a spouse of the deceased to effectively take over the deceased's obligations with respect to repayment installments."
When your RRSP matures. If you have an outstanding Home Buyer's Plan repayment balance at the end of the year in which you turn 69 - the deadline for collapsing an RRSP - this outstanding amount must be repaid before year end or be reported as income on your tax return.
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