Q&A: Answering your tax questions on RRSPs, TFSAs, and the new First-Home Savings Account (FHSA)

As we approach the Registered Retirement Savings Plan (RRSP) contribution deadline of February 29, 2024, you may have questions on how much and whether to contribute to your RRSP, the Tax-Free Savings Account (TFSA) or the new FHSA. In this article, we will address some of the most common questions. We have also provided a summary of the deadlines and contribution limits for each of these registered accounts in Appendix A.

What are the key benefits of an RRSP and a TFSA?

RRSPs are an effective retirement savings vehicle that offers three key benefits:

• a tax deduction for amounts you contributed (up to certain limits);
• earnings on assets in your RRSP accumulate tax-free; and
• funds are only taxed upon withdrawal.

However, RRSPs offer limited flexibility in that the annual contribution limit is based on the prior year’s earned income and withdrawing funds from an RRSP does not affect the overall contribution limit as the contribution limit is not adjusted for withdrawals.

TFSAs, on the other hand, do not provide you with a tax deduction on amounts contributed and contributions are also subject to an annual limit, but one set by the statute and not dependent on earned income. However, amounts withdrawn—including both income earned and your accumulated contributions—will not be taxable. TFSAs also offer more flexibility regarding withdrawing funds since the amount withdrawn can be re-contributed in a future year.

Is an FHSA similar to an RRSP or a TFSA?

The new FHSA is a registered account that offers prospective first-time home buyers the ability to save funds on a tax-free basis to purchase a home within 15 years. To be eligible to open an account, the individual must be at least 18 years old, a resident of Canada, and be a first-time home buyer—which generally means that they did not live in a home that they, or their spouse or common-law partner, owned at any time in the year the account is opened or in any of the preceding four calendar years.

FHSAs are similar to RRSPs in that contributions are tax deductible and any contributions not deducted can be carried forward and deducted in a later tax year. The annual contribution limit is $8,000, and the lifetime contribution limit is $40,000. However, for the contributions to be deductible, they have to be made within the calendar year—unlike RRSPs where the contribution can be made within the first 60 days of the following calendar year.

On the other hand, FHSAs are similar to TFSAs in that withdrawals to purchase a qualifying home, including any income and gains earned within the account, are not taxable. However, unlike TFSAs, the maximum unused contribution room that can be carried forward is $8,000 and when withdrawals are made, your contribution room is not restored.

Similar to both RRSPs and TFSAs, interest expense on money borrowed to invest in the FHSA are not deductible for tax purposes and the type of investments that FHSAs can hold are generally the same as for an RRSP or TFSA. Note that there are consequences for all of these plans if a contribution is made over the contribution limits or if non-qualified investments are made. Unlike both the RRSP and a TFSA, the FHSA can only exist for 15 years.

Appendix B presents a table that summarizes and compares the main features of the FHSA, RRSP, and TFSA. For further details on the FHSA, please read our article Q&A: The new tax-free First Home Savings Account (FHSA). 

Should I contribute to a TFSA, FHSA, or RRSP?

Whether it’s best to invest in your TFSA, FHSA, or RRSP will depend on various considerations and individual factors and circumstances. If you do not have the financial capacity to maximize all of your registered plans each year, some of the factors that need to be considered include the amount of funds you have available, your marginal tax rate (now and in the future), and your savings goals, such as whether you are saving for retirement, to purchase your first home, or to make a large purchase.

Purchase of a first home

If you qualify as a first-time home buyer, contributing to the FHSA is a very attractive option as a tax deduction is available on your contribution and a qualifying withdrawal to purchase a qualifying home is tax-free. You can get the best of both worlds with limited risk from a tax perspective because even if you do not end up buying a home, you have the option of transferring the funds to an RRSP with no immediate tax consequences—as long as it is a direct transfer—and this transfer will not reduce your unused RRSP deduction room.

If you have insufficient funds to maximize the FHSA and you anticipate that you will be able to use the FHSA funds to buy a home within the life of the FHSA, you may want to consider transferring funds from your RRSP to the FHSA—taking into consideration the annual limit of $8,000. As the contributions were previously deducted for tax purposes, you will not get a tax deduction on this transfer but a subsequent withdrawal to purchase a qualifying home will be tax-free. However, this transfer from your RRSP to an FHSA will not restore your RRSP contribution room.

On the other hand, if you have excess funds after contributing to the FHSA, you should consider contributing to your RRSP to participate in the Home Buyers’ Plan (HBP). The HBP allows an individual to withdraw up to $35,000 from their RRSP to purchase a qualifying home with no immediate tax consequences. Keep in mind that amounts withdrawn under the HBP must be repaid to an RRSP over a period of 15 years.

If you have already maximized your contributions to the FHSA and considered the HBP under the RRSP, although the TFSA is not specifically geared towards savings for the purchase of a first home, it can also be used to save for this major purchase. This option would be more advantageous than investing in a non-registered account as your TFSA allows for growth and withdrawals to be tax-free.

Retirement

When saving for retirement and financial resources preclude you from maximizing contributions to both the TFSA and RRSP, deciding which account to contribute to in any given year will largely depend on your current marginal tax rate compared to what it will be in retirement.

RRSPs are especially attractive if you’re currently in a high tax bracket and expect to be in a lower tax bracket when you retire. This is because RRSP withdrawals are taxable and if you can withdraw in a year when your income is lower, the withdrawal will be subject to a lower marginal tax rate. In essence, your RRSP contributions effectively move income that would be taxed at a high rate now into a lower tax bracket later, producing both a tax deferral and a tax saving.

In contrast, TFSAs can be particularly beneficial if you’re currently in a lower tax bracket and expect to be in the same or higher tax bracket in your retirement years as withdrawals from TFSAs are tax-free. Keeping a lower rate of income in retirement may be beneficial in terms of income-tested government benefits, such as Old Age Security and Guaranteed Income Supplements.

Purchase of a high-value item

While RRSPs are mostly tailored for long-term retirement savings, TFSAs are much more suitable for short-term savings goals, such as the purchase of a car or vacation of a lifetime. When you withdraw from a TFSA, your contribution room is restored at the start of the following calendar year, which allows you to contribute and save for another purchase or your retirement.

If I’m already a homeowner, can I contribute to my adult child’s FHSA?

If you already own a home but would like to help your adult child or grandchild save for a first home, you could consider gifting the funds for them to contribute to their FHSA. It should be noted that you will not be able to contribute directly to your child or grandchild’s FHSA. Your child or grandchild can claim the tax deduction on their contributions or carry it forward to a later year when they are in a higher tax bracket.

If I decide to emigrate from Canada, what happens to my FHSA, RRSP and TFSA?

If you emigrate from Canada, you are allowed to continue contributing to your FHSA. However, you will not be able to make a qualifying withdrawal and as such, the withdrawal becomes taxable and would be subject to withholding tax of 25%, unless it is transferred to your RRSP.

Similarly, for an RRSP, you will be allowed to keep your account and any income or gains that are earned or realized within your RRSP will not be taxed in Canada. However, if you were to make an RRSP withdrawal as a non-resident, the payment will be subject to a withholding tax of 25%. Contributions to an RRSP are allowed after emigrating from Canada, as long as you still have RRSP contribution room. If you have a HPB at the time of emigration, you must generally repay it within 60 days of leaving Canada, or the outstanding loan balance will be taxable in the year you leave Canada.

Maintaining your TFSA account as a non-resident is also allowed and any income or gains that are earned or realized within your TFSA will not be taxed in Canada. Unlike FHSA and RRSP, however, the withdrawals from your TFSA will generally not be taxable in Canada. However, contribution room will not accrue for the years that you are a non-resident and any contributions made as a non-resident will be subject to a monthly penalty tax until amounts contributed as a non-resident are withdrawn.

If you emigrate from Canada and continue to hold your FHSA, RRSP and TFSA, you will also need to consider the tax consequences under the tax laws of the country you immigrate to. In addition, the 25% rate of withholding tax may be reduced based on a tax treaty between your country of residence and Canada.

Final thoughts

RRSP, TFSA and FHSA are all important and effective ways to save, whether for your retirement, for a down payment on a first home or other savings goals. Keep in mind your personal circumstances and your eligibility for each plan when prioritizing your options.

Contact your BDO advisor to help you to determine which option is best for you.