How to use RRSP season strategically when purchasing a first home

Question from a Globe and Mail reader: I’m 36, married and expecting my first baby soon. After saving up for over a decade, my partner and I would like to purchase a home this year before the baby comes and are wondering about the best strategy. We have the following in assets: $30,000 each in a tax-free savings account (both of us have $39,500 in TFSA contribution room). I have $5,000 in a registered retirement savings plan (contribution room is $120,477) and my partner has $10,000 in an RRSP (contribution room $162,800). We also have around $60,000 in cash sitting in a high interest savings account. We haven’t done anything with it because we don’t know how to best use it given that we want to buy something. We are aiming to purchase a $650,000 condo. I make $65,000 a year and my partner makes $80,000 a year. What the best use of our money?

Answer from Shannon Lee Simmons, financial planner and founder of The New School of Finance: First off, congrats. You’ve done a great job of saving. It’s RRSP season until March 2, so there’s a neat trick that you may want to take advantage of if you’re buying a home this year and you’re a first-time homebuyer.

The RRSP season and the RRSP

A quick refresher on RRSP season and the registered retirement savings plan. During the first 60 days of the calendar year, any money you deposit into an RRSP account can be used as a tax deduction against last year’s income. A tax deduction will lower your taxes owing and likely create a refund for you. Allow me to explain using approximations.

Let’s assume you’re an employee and that you earn $65,000 a year. Your employer has been deducting your Canada Pension Plan, Employment Insurance and income taxes all year long on each paycheque. So, by the end of the calendar year, you’re paid up with the taxman. At that income level, you would have paid approximately $12,000 in income taxes. If you deposited $10,000 into an RRSP during the first 60 days of this year, you can use it to lower your taxes owing for the previous year that you earned $65,000. With a $10,000 RRSP contribution, your taxes owing would decrease from $12,000 to approximately $9,000 since you’re now only being taxed like you made $55,000 ($65,000 minus $10,000). Since you’ve already paid $12,000 through your payroll deductions, you get back that $3,000 as a tax refund. Fun, right?

The Home Buyers’ Plan (HBP)

A quick refresher on a government program for first-time homebuyers. If you qualify to participate in the Home Buyers’ Plan, you can each withdraw up to $35,000 (as of March 19, 2019) from your RRSP to put toward a down payment. Between the two of you, this would be $70,000. When you take the money out of your RRSP as part of the HBP, your financial institution won’t withhold any taxes.

Essentially, you loan yourself the money, interest-free. You pay back the money you took out over 15 years. So, if you took out $35,000 from your RRSP, you’d owe back $2,333 each year ($35,000/15 years). If you weren’t able to make those payments, the $2,333 would be added to your income and you’d pay tax on it at your marginal tax rate.

Yes, you are taking money from your long-term savings pot, but you’re doing so to purchase an asset that, one hopes, increases your net worth over time. More importantly, the goal is that the bigger your down payment, the less your mortgage will be and the more likely you’ll be able to afford your home. That means that you can actually afford to keep saving for retirement and repay this loan.

How to use RRSP season strategically when purchasing a home

Imagine you contributed enough this season to bring the total in each of your RRSPs to $35,000. You would take $30,000 from the $60,000 in your high interest rate savings account ($5,000 existing + $30,000 new) and your partner would take $25,000 from the high interest savings account ($10,000 existing + $25,000 new). That would mean each of you now has the maximum amount that you can withdraw in your RRSP under the Home Buyers’ Plan.

For you, the $30,000 RRSP contribution would likely net you a tax refund of approximately $8,151. The $25,000 new contribution by your partner would likely give him a tax refund of $7,562 since he earns $75,000 a year.

Between you both, that’s an extra $15,713 ($8,151 + $7,562) that will come into your bank accounts four to six weeks after you file your taxes! Who doesn’t need an extra $15,000 when purchasing a home? This could be used to help with closing costs, land transfer tax, moving expenses and any minor upgrades or decorating you need to make without eating into your initial down payment.

If you don’t use this strategy, your total savings add up to $135,000. I would suggest putting aside $15,000 for all the closing and moving costs mentioned above. So, your down payment would be $120,000 on the $650,000 condo. That’s great. It’s almost 20 per cent, but you’d still be considered a high ratio mortgage and have to have mortgage loan insurance premiums rolled into your mortgage. With these numbers, it would be approximately $14,840 that would be added onto your mortgage according to Canada Mortgage and Housing Corp.

By using the RRSP season strategy, however, you’d have close to $150,000 at your disposal because of the refunds. Therefore, you can use the entire $135,000 as your down payment. This is more than 20 per cent and therefore you don’t have to have mortgage loan insurance premiums.

The catch? The money needs to be in your RRSPs for at least 90 days before you can withdraw them under the HBP. So, if you put them on March 2, you cannot close your housing deal within 90 days.

The other catch? You need to pay it back over 15 years and it’s important to remember this. Too often I see people withdraw all their assets for their down payment and I totally get it, homes are so expensive. The problem comes when long-term retirement portfolios never get filled back up. The HBP can perpetuate this because it’s a reason to take such a large amount from your retirement portfolio nest egg.

TL;DR: Put $30,000 into your RRSP and $25,000 into your partner’s RRSP before the end of RRSP season. Use the money in the high interest savings account to do this. Split the remaining $5,000 in the high interest savings account between your tax-free savings accounts.