You have savings to buy your first house and you are short but not by much? Here is a strategy that allows to convert a bank loan in a RRSP and then to use the associated tax refund as a downpayment for the purchase of your first residence
The trick is to use the Home Buyers’ Plan (HBP). Many people know about the HBP. It allows to withdraw contributed sums to your RRSP to buy or to build a property, but without any fiscal impact (without the HBP, the sums that are withdrawn from RRSP are taxable). The strategy described here is different. As explained by Richard-Eric Nantais: “First, you borrow a sum from a bank to deposit it in your RRSP. “
$ 25,000 is a good sum as it is the maximal amount that the government allows to withdraw from the RRSP for the HPB. For a couple, we are talking about $ 50,000. Naturally, it is necessary to have enough untouched RRSP contribution room and a good credit score in order to get this loan from a financial institution.
This contribution to your RRSP allows you to reduce your taxable income by up to $ 25,000. In English it means “that if you have gained $ 80,000 this year, only $ 55,000 will be taxable”, explains Richard-Eric Nantais.
In order to comply with the HBP rules, you will need to leave the sums in your RRSP for at least 90 days. You can then withdraw the sums to use them for the HBP without any fiscal impact, by presenting a purchase offer that has been accepted. This $ 25,000 withdrawn thanks to the HBP will be used to refund the $ 25 000 bank loan.
It is the tax refund given by the $ 25,000 deposited in your RRSP that will become your downpayment to purchase a property. In this case, the refund would be somewhere around $ 10,000. It is the taxable amount avoided on the $ 25,000 at an approximative rate of 40 %. For couples, this amount is doubled. Naturally, the amount of the refund will vary depending of your fiscal situation.
“This approach is attractive to young professionals who don’t already have a RRSP but still need a downpayment in order to purchase a property”, says Richard-Eric Nantais, investment adviser at National Bank Financial.
Conditions that must be met
One can benefit from the HBP multiple times during his lifetime at the condition of not have been an owner for the past 5 years. The house needs to become your main residence no more than a year after it was purchased or built. These are the main conditions, but there are others. To know all the details, please see the form of the Canada Revenue Agency.
In order to use the HBP, you must be well prepared.
One of the main reason is that the plan rules require to take possession of the property before October 1st of the year following the RRSP withdraw. It is important that you make sure that the transaction is notarized before that date, otherwise you risk to be taxed on the amount withdrawn from your saving plan. A potentially very costly mistake.
This point is particularly important in case of projects under development where construction delays can postpone the whole process.
Another reason to be well prepare is the income tax refund that could be used as a downpayment. It is usually received from 4 to 6 weeks after filing a tax return.
” If you wish to move during summer, then you must remember to transfer the money in your RRSP well before the contribution limit date, which is Mars 2nd of every year, in order to benefit from the tax refund next Summer”, advises Julie Beauregard, accredited mortgage broker at Multi-Prêts.
Another reason to plan ahead regards the loan that will be borrowed from the bank. “It can sometime take a few weeks and sometime even require to have an accepted purchase offer, adds Ms Beauregards.
Ideally, it is important to start shopping for houses during Summer or Fall, to contact your financial institution to get more information about the terms and conditions of the loan, and to contribute to your REER around December or January.
Saving for retirement
The time frame to refund your RRSP, for the sums withdrawn during the HBP, is set to 15 years. It means that you need to annually refund one fifteenth of the sum you have withdrawn from your RRSP starting from the year following the withdrawal Adhering to a HBP forces you to save for retirement.
If you are unable to refund one fifteenth of the amount withdrawn during one year or more, you will be taxed on this amount.
On a finale note, this strategy is usually very profitable. However, experts warn potential buyers of one thing: to avoid purchasing a house that one wouldn’t have the mean to be pay otherwise. The best would be to study a strategy with your financial advisor.
How to use the HBP without a RRSP in 5 steps
- Borrowing a loan at your bank for an amount corresponding to your needs (max: $ 25,000) while respecting the maximal contribution allowed by your RRSP.
- Depositing the sum in your RRSP for at least 90 days.
- Withdrawing this tax-free amount from your RRSP and refunding your bank loan with it.
- Using the tax refund as a downpayment to purchase a property.
- Refunding your RRSP over 15 years (the maximum allowed timeframe).