After a decade of rising property prices, Canada’s housing market has reached a point where buying a home has become unaffordable. To help Canadians buy homes, the Canadian government introduced another tax-free savings account to help first-home buyers save for their down payment. The First Home Savings Account (FHSA) will be effective from April 1, 2023.
What is Tax-Free in First Home Savings Account (FHSA)?
The FHSA is one of its kind because its tax benefits are unmatched.
- Like the Registered Retirement Savings Plan (RRSP), your FHSA contributions of up to $40,000 ($8,000 per year) are tax-free.
- Like the Tax-Free Savings Account (TFSA), your FHSA withdrawals are tax-free, provided they are used to buy the first home.
If you do not buy a home, you can transfer the FHSA money into your RRSP without affecting your RRSP contribution. By now, you know that the key attraction of FHSA is tax-free contributions and withdrawals. But these contributions and withdrawals become taxable in certain scenarios.
This article will discuss four such scenarios where tax is levied on the tax-free FHSA.
Scenario 1: Over-contribution to The First Home Savings Account (FHSA) is taxable
All tax benefits have a maximum limit; anyone who exceeds this limit loses the tax benefit on the surplus. Similar is the case with TFSA and now with FHSA.
The proposed FHSA will allow you to contribute a maximum of $8,000 in a calendar year with a lifetime limit of $40,000. You can carry forward the annual limit to next year, which means if you contribute $3,000 in the first year, you can contribute $13,000 ($8,000+$5,000 carry forward) next year. But if you exceed the limit, the excess contribution will be added to your taxable income and attract an additional 1% tax. You can avoid this 1% tax by transferring the excess FHSA contribution to RRSP or withdrawing the surplus before the end of the calendar year.
If you neither withdraw nor transfer the over-contribution, a 1% tax will apply to the surplus, and the over-contribution will be reduced from next year’s FHSA contribution. For instance, Mary contributes $9,000 to FHSA in the first year resulting in an over-contribution of $1,000. If she doesn’t transfer this amount to RRSP or withdraw it, she will face a tax liability of $10 (1% of $1,000), and her 2024 FHSA limit will reduce to $7,000.
Scenario 2: Non-Qualifying Withdrawal of First Home Savings Account (FHSA)
In FHSA, only qualifying withdrawals are tax-free. A qualifying withdrawal is when the owner withdraws FHSA to buy their first home in Canada with the intention to occupy it as their principal residency within a year. You can withdraw money from FHSA otherwise, but the withdrawal would be added to your taxable income. Moreover, your FHSA provider will withhold some tax and pay you the amount after tax. Remember, FHSA withdrawals do not replenish your contribution. If you invested $35,000 but withdrew $10,000 (qualifying or not) from your FHSA, your contribution room will still be $5,000 ($40,000 – $5,000).
Scenario 3: Your First Home Savings Account (FHSA) Ceases To Exist
Other than contributions and withdrawals, there are scenarios where the FHSA will lose its status. The FHSA has a 15-year life, after which it ceases to exist. It also ceases when the owner turns 71. If you did not use the FHSA funds before the cessation date, the FHSA amount would be added to your taxable income.
But you can avoid this deemed taxable income by acting on the FHSA fund before it loses its tax-free status. You can either make a qualifying withdrawal by buying a home or transfer the funds tax-free to your RRSP before the cessation date. Please note that the amount transferred from FHSA to RRSP does not affect your contribution room.
Scenario 4: Transfer of First Home Savings Account (FHSA) Funds after the Death of the Accountholder
You can pass on your FHSA to your spouse and other beneficiaries after your death. But whether it can be transferred tax-free or not is the question.
- If the beneficiary is the surviving spouse who is eligible for an FHSA, the deceased’s FHSA funds can be transferred to the surviving spouse’s FHSA or RRSP.
- If the surviving spouse is not eligible for the FHSA, the deceased’s FHSA amount could be transferred to an RRSP or RRIF or withdrawn on a taxable basis.
- If the FHSA beneficiary is not the surviving spouse, they must withdraw the funds from the deceased’s FHSA and add the proceeds to their taxable income. This withdrawal also attracts a withholding tax.
Even a tax-free account attracts tax. Discuss with a professional estate planner and determine a tax-efficient way to transfer wealth.
Contact KSSP Partners LLP in Markham and across the GTA to Help You With Your Tax Needs
A skilled tax advisor can help you plan your estate transfer most tax-efficiently. At KSSP Partners LLP, our tax experts can provide services to support your tax and estate planning function, whether you need partial or complete support. In addition, we can recommend storing wealth in structures best suited for your business. To learn more about how KSSP Partners LLP can provide you with estate planning expertise, contact us online or by telephone at 289-554-5997.