Blessed by the Potato

The RRSP is the most misunderstood tax shelter in Canada. It holds pre-tax money, which is not intuitive to think about at all. So when it comes to the Home Buyer’s Plan (HBP), there’s similarly a lot of conflicting articles out there that don’t quite analyze the options right.

First off, what is it? The Home Buyer’s Plan is a relief valve for RRSP investments, and an incentive for first-time home buyers: a first-time buyer can take up to $60,000 out of their RRSP when buying a house (presumably for the down payment but the funds can be used for anything — moving costs, furniture, renovations, just sticking in your savings account, the key test is that you bought a home, not specifically which dollar did which job). That relief valve means that people who aren’t sure if they should be saving for retirement or for a first house can utilize their RRSP for saving/investing, and still get a decent chunk of the money back out later if they end up buying a place. Then if you do take the money out of the RRSP, you have to put it back in over the course of 15 years, with a little delay (2 years) before you have to start. If you fail to make the repayments, the amount gets added to your income and you lose the RRSP room, just as though you had made an RRSP withdrawal in the year you skipped the repayment.

The FHSA is hands-down better in every way, but has limited contribution room, so a new buyer will likely have both a FHSA as well as some RRSP contributions made. And fortunately, you can use both.

Now if you’re cutting it close on having the funds for a downpayment, the HBP is a nice little incentive: because it’s pre-tax money, with a bit of planning ahead (you have to have had the funds in your RRSP for at least 90 days), you can take your downpayment savings, throw it in an RRSP, get your tax refund, then use both the original after-tax amount and the refund for a downpayment.

What if you don’t need that tax refund/pre-tax aspect to get more scraped together for your downpayment? That’s where it gets tricky: you’ll find articles describing the HBP as “an interest-free loan to yourself” (ignoring the opportunity cost of investing in your RRSP), or “like earning your mortgage rate in your RRSP”, which actually sounds worse than leaving it in and investing in equities. You may also see some comments saying if you don’t need it, don’t bother: if you’re going to have investments left over, wouldn’t you rather have investments in your tax shelter than out of it? And it’s never clear if these are the correct framings, or if someone is forgetting about the pre-tax nature of RRSPs, or just saying things to fill the silence.

So, let’s set up the analysis: you’ve been renting and investing the difference for over a decade, so have plenty saved up to put down on the house. If you don’t need that pre-tax boost to meet your desired down payment, does it make sense to use the HBP anyway? You need to figure out where to source the last $60,000 of downpayment (or land transfer tax, or pre-move-in-renos, whatever): from your non-registered, TFSA, or RRSP? Let’s put $60,000 (nominal) in each, and see how things work out for a simple model.

From our asset location breakthrough we should recall: the RRSP holds pre-tax money, so $60,000 coming from there is equivalent to less being taken from a non-registered or TFSA account. We should see this fall out when we calculate out the impacts. So this should work out best by taking advantage of the HBP. But that HBP also comes with a pesky repayment requirement and up-front paperwork and sitting on hold with your brokerage. Will it be worth the hassle and brainsweat?

Here are our three scenarios: take from the non-registered account; take from the TFSA; take from the RRSP-HBP. In each case, we’ll have 1/15th of the withdrawn amount ($4000) each year as cashflow to put into the account that was used (ignoring the grace period). In our tax shelters, our investments will increase at 6%. In our non-registered account, the tax rate will be 15% (i.e., a 30% tax bracket but with investments taxed at half the rate), for a 5.1% after-tax growth rate. In our RRSP, at the end of 15 years we’ll withdraw it and pay tax at 30% to get everything in after-tax dollars. I put everything in a Google sheet so you can follow along (no it’s not publicly editable — download a copy for yourself if you want to play with your own numbers).

1: Use the RRSP HBP

We pull the $60,000 out of the RRSP. The $60k in each of the non-registered and TFSAs keep growing. After 15 years, we have: The TFSA amount grew to $143,793. The non-reg, thanks to tax drag, grew to a just $126,530. The RRSP growth and slow rebuild over 15 years led to $93,104 pre-tax, but melting that down to make everything in after-tax dollars leaves us with $65,173. In total, the net worth at the end was $335,496.

2: Use the non-registered account

We use $60,000 of non-registered funds, leaving our tax shelters alone. The RRSP and TFSA each grow to $143,793 nominal (as the TFSA did before, good sanity check), but after melting down the RRSP was $100,655 after tax. Meanwhile the non-registered grew to $86,967. That leaves the total net worth for this case at $331,416.

3: Use the TFSA

Come on, you knew this was going to be the worst option — that logic of “if you have investments left over, wouldn’t you want them to be sheltered” is much more straightforward here. The re-built TFSA is worth just $93,104 at the end, with the other accounts that’s a final net worth of just $320,289.

Conclusion:

The HBP is useful for people who don’t have enough funds available for their downpayment: they can use pre-tax money for a little boost. Even if you do have enough, using pre-tax money and letting your after-tax non-registered investments grow does have an advantage: with fairly reasonable assumptions, about $4080 of future (i.e. 16 years from now) value — at that same rate of return, about $1850 of present day value. Now that is nothing to sneeze at, but for someone in the harried stress of buying a house, is that worth the headache of all the HBP paperwork and then repayment schedule? (Actually, yeah, it’s not that much work and not often you can get almost two grand just from tax optimization).

The (future) value of the HBP changes a bit as the assumed rate of return and tax rate change.
Rate of return 4%: $2885 and Tax rate 50%: $5101
Rate of return 5%: $3525 and Tax rate 50%: $6392
Rate of return 6%: $4080 and Tax rate 50%: $7636
Rate of return 7%: $4511 and Tax rate 50%: $8796
Rate of return 8%: $4774 and Tax rate 50%: $9829

But it’s always enough that the headache is likely worth it.

Not modelled: what happens if your tax rate changes over time.

Bonus:

What if you don’t invest in equities, and instead your non-registered is in bonds/GICs at your full tax rate? Then the HBP actually works against you: the tax drag on your non-registered account is too much for the pre-tax bonus of pulling the RRSP funds out to overcome, and you’re better off not using the HBP. So if you’re not going to invest the money (or use it on the house), don’t do it!