Like thousands of young couples starting out, E.J. Bugayong and his wife Jessica dreamed of owning their own home. Lucky for them, many relatives and friends gave them money as wedding gifts.
Two years ago, the newlyweds purchased their first home using the $14,000 they had accumulated in their RRSPs.
"Right after our wedding, we took the money we received in gifts and put it into an RRSP," says the 29-year-old teacher. "When we deposited into our RRSPs, we received a substantial amount back from our taxes and used that money as well, which allowed us to put a good down payment on our condo." (The higher your tax bracket, the bigger the refund you will get.)
But now they have to pay that money back to their RRSPs in 15 years, while they're paying their mortgage. Wouldn't a Tax-free Savings Account (TSFA) have been a better choice?
There is no right or wrong answer, according to Diane McCurdy, a well-respected financial planner and author of How Much is Enough?(Wiley, 2013)
TFSA or RRSP?
Canadians have two programs that protect their savings from the tax man: Registered Retirement Savings Plan (RRSP) and Tax-free Savings Account (TFSA).
TFSAs allow your after-tax savings to grow 100 per cent tax free.
RRSPs reduce the amount of tax you'll have to pay, often resulting in a refund. Your investments grow tax free and then are taxed when you take them out, presumably when you're retired and making less money.
Under the federal government's Home Buyers' Plan(HBP), first-time home buyers are allowed to withdraw up to $25,000 from their RRSP plan to help with a down payment. (That's $50,000 per couple).
"In the past, I didn't advocate that people use their RRSP to buy a home. However, because homes are so expensive in BC it's more difficult to avoid using your RRSP," she says.
Rules to remember
First, contributions must remain in the RRSP for at least 90 days before you can withdraw them under the HBP. Once you do, you have to replace them.
"Young couples must be really mindful of the fact that they must pay back the full amount to their RRSP within 15 years or pay a hefty penalty," she says.
On the upside, you can use your tax refund from your RRSP contribution toward your down payment as well, as Bugayong did. McCurdy suggests taking the tax refund and contributing it to your TFSA, since it allows money to grow into a bigger down payment, with no payback penalty.
One step better is to top up your TFSA to the maximum. That's now $5,500 per year. The program began in 2009, and all contribution room is carried forward, so if you've never contributed to a TFSA, you can now put in up to $31,000.
"If you withdraw from a TFSA, you must wait until the next calendar date to re-contribute into the plan, but you may still make the following year's contribution. It is a wonderful saving tool designed to help you save money for emergencies and large-ticket items," says McCurdy.
However, she cautions that you have to track your contributions and be careful because any over-contributions will be hit with a one per cent penalty per month. There is currently no method to track your eligible TFSA room.
Which is better for you?
McCurdy has this rule of thumb for deciding which plan will work best for you.
If you're in a higher tax bracket when you put the money in than when you take it out, then it's better to use an RRSP. When you contribute to your RRSP you receive a tax rebate now, and CRA takes less tax on withdrawal.
However, if you'll be in a higher tax bracket when you take the money out, it's better to go with a TFSA.
"If your tax rates are the same when the money goes in and out, then your options are the same," adds McCurdy.
"Navigating through the differences and complexities of TFSAs and RRSPs can be difficult, so it's important for first-time buyers to educate themselves on what is the best savings plan for them," adds McCurdy.
If you don't already have a financial planner, your bank or credit union can usually make one available, or you can search for someone near you via the Institute of Advanced Financial Planners.