Happy Friday morning my friends!
We’ve roared through the fourth full week of the 2021 tax season and things are crazier than ever. In general, I’d say I haven’t seen as many refunds as in years past. Which isn’t to say everyone owes money this year — there are still sizeable refunds to go around — but the average person seems to be seeing a little smaller refund so far.
This has been for a few reasons.
One, CERB payments throughout the 2020 year saw little to no tax deducted at source, resulting in large amounts of income on tax returns with no offsetting tax.
Second, depending on the province you live in, there may be extra COVID front-line worker benefits or compensation, which also had little to no tax deducted at source.
And third, any COVID monies paid to small business owners are taxable in the year received, resulting in semi-large sums of grant revenue with (again) little to no tax deducted.
It’ll be interesting to see how the Prime Minister shapes the upcoming budget on April 19th. I’m sure there will be many Canadian families tuned in to the television (is that a thing anymore? Or should it be tuned into the live stream?) to see if the boosted Canada Child Benefit will see the light of day.
Last week, I promised I’d discuss the RRSP Home Buyers’ Plan. Here we are.
In general, I think the plan is a ripoff.
What is the RRSP Home Buyers’ Plan?
The RRSP Home Buyers’ Plan is a program that allows you to withdraw up to $35,000 from your RRSP to purchase your first home. Once you have withdrawn the funds, you must repay your RRSP over a 15-year period or take the withdrawal as income over that 15-year period.
There was a time and place when RRSP contributions were pretty popular — where I come from, RRSP contributions are a de facto saving element that everyone should be utilizing.
But RRSPs aren’t the smartest retirement saving tool for everyone. If you’re a pensioned worker that contributes to a defined contribution or defined benefit pension plan, RRSPs may not be the most wise retirement savings tool. You can have too much deferred income. In many instances, the TFSA is a wiser retirement savings tool for these types of workers.
Nevertheless, the RRSP Home Buyers’ Plan allows you to access previously contributed funds for your first home.
The entire issue with Home Buyers’ Plan is centred around that 15-year payback period.
The RRSP Home Buyers’ Plan Gotcha Moment
If I speak in generalities, most folks purchase their first home in their 20s or 30s. These same folks also likely see their lowest levels of annual income in their 20s and 30s — most folks grow into the top of their careers in their late 40s and early 50s.
The timing of your highest level of earnings and the timing of your first home purchase are at pure odds with one another.
Flying around at 5,000 feet, the RRSP Home Buyers’ Plan seems to be there to ensure you pay the highest level of tax possible.
Let me explain.
In Canada, we have a graduated tax system. In essence, the more you make, the higher your marginal tax rate. Federal income tax brackets range from:
- 0% on your first $13,000 (the Basic Personal Amount cancels all federal tax on income up to $13,000)
- 15% on income between $13,000 and $49,000
- 20.5% on income between $49,000 and $98,000
- And so on.
Say you earn income at or below the $49,000 mark for your first 5 years in the work force and you dutifully put some of that money into an RRSP. You contribute a healthy $20,000 to your RRSP in that time and you feel you’re ready to purchase your first home. Each RRSP contribution you made in the first 5 years was contributed at the second lowest tax bracket of 15% — each contribution dollar you made while earning under $49,000 deferred 15% of income tax to a future year.
Now, say you withdraw the RRSP under the Home Buyers’ Plan and you purchase your first home. After the 1-year grace period before having to repay your RRSP for the withdrawal, you begin paying back (or taking as income) 1/15th of the required repayment.
But, in that grace period, you receive a raise. You now make $52,500 a year, just above the second tax bracket. You find yourself dipping your toe into the 20.5% income tax range.
Can you see the problem already?
You have to take 1/15th of that RRSP withdrawal (if you withdrew $20,000, 1/15th would be $1,333) and add it to your income. Despite making $52,500 in the year, you are now taxed on $53,833 ($52,500 + $1,333), a chunk of which is at the 20.5% level of income tax.
Said another way, you contributed that RRSP and saved 15% income tax only to turn around and pay 20.5% income tax in your repayment.
You lost 5.5% on that RRSP withdrawal. Sure, you could use the amount to purchase a home. But 5.5% of $20,000 is an extra $1,100 of income tax.
And it’ll only get worse with each and every raise you receive over the next 15 years.
That’s a ripoff if I’ve ever seen a ripoff.
You Should Just Pay the Tax Upfront
I’m personally caught in the middle of this dreaded little RRSP Home Buyers’ Plan “gotcha moment”. I contributed to my RRSP in my early 20s and had a chance to purchase a 20-year home 5 years ago. I had to use my RRSP to purchase our home. At the time, I was making about half of what I make now and now I have to take those amounts as income at a much higher tax rate.
In hindsight, I should have just paid the tax in the year we purchased our home.
The math gets pretty variable at this point, as it greatly depends on your annual income increases in the 15 years after your RRSP Home Buyers’ Plan withdrawal.
But let’s say you paid the tax in the year you withdrew the money rather than over the course of the 15-year payback period. You take $20,000 of RRSP income plus your $49,000 of earnings and pay tax on $69,000 of income in the year you withdrew the cash to purchase your home. You pay the 20.5% tax on the $20,000 of RRSP income and come away with about $15,000 or so available to purchase your home. You’ve locked in that higher tax rate of 20.5% and you’re done with the purchase.
Now, if your earnings jump another tax bracket at any point in time (say, anything that causes you to jump a provincial tax bracket — there’s another bracket increase at $70,000 of income in Manitoba, for instance), your tax losses are locked in at $1,100 of extra tax.
If you’re paying the RRSP back over the 15-year period and jump another tax bracket, your tax losses increase beyond that $1,100 mark.
That’s an even bigger ripoff.
When to Use the RRSP Home Buyers’ Plan
This advice probably boils down to general RRSP contribution advice: If you’re earning income in a high tax bracket and envision your earnings dropping in the future, contribute to the RRSP and withdraw the money to purchase your first home. The math works exactly the same, only backwards — if you contribute at a bracket above $49,000 and pay back the RRSP over 15 years as you earn income below $49,000, you can save that 5.5% instead.
In theory, you may not lose anything if you contribute to the RRSP in one tax bracket and pay back the RRSP in the same tax bracket. Current tax brackets increase by inflation each year and the tax rates applied to each of those brackets hasn’t changed on a percentage basis in 5 or 6 years. However, given the government’s current spending prowess, it seems likely tax rates will have to increase across all brackets at some point in the future. And this may result in a tax loss on your RRSP Home Buyers’ Plan withdrawal.
The other time to potentially use the RRSP HBP is if the withdrawal allows you to avoid CMHC insurance costs. If paying the extra $1,100 of tax over 15 years of repayment helps you avoid a $4,000+ CMHC insurance fee, then you’re going to come out ahead by using your RRSP.
(I’m aware paying a little CMHC may allow you to lock in insured mortgage rates, which may be 0.25% to 0.35% less than interest rates available to non-insured mortgages. But let’s imagine that rule doesn’t apply — it’s only been around for a few years as it is.)
I’m in the accounting profession and clearly have some heavy bias towards professional advice. However, I do think it’s wise to consult a tax accountant about the wisdom of using the RRSP Home Buyers’ Plan to purchase your first home.
If you’re lucky enough to be earning high levels of income early in your life and you foresee the ability to dial back your work in the future, then sure, use the RRSP Home Buyers’ Plan.
But if you’re able to purchase your first home while earning at the lowest levels of income in your life, the RRSP Home Buyers’ Plan is an enticing program that has a poison pill at the end.
I’ve wanted to talk about the two-facedness of the RRSP Home Buyers’ Plan for years at this point. I could go on and on about this program for days on end, so I’ll cut it off here.
Thank you again for your precious time this week. I hope everyone has a swell weekend and a healthy and prosperous week ahead.
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