The First Home Savings Account (FHSA) is one of the least-known but most powerful tax-free accounts in Canada. Offering a tax break on contributions, as well as tax-free withdrawals, the FHSA is like the best of a TFSA and an RRSP rolled into one – with a catch:
The FHSA can only be used – with its full tax benefits – to save up money for purchasing your first home. If you withdraw funds from an FHSA without buying a home you intend to live in, you pay taxes on the withdrawal as if it were employment income. The FHSA is also subject to strict $8,000 annual/$40,000 lifetime contribution limits. These limits aren’t increasing over time like TFSA annual contribution limits are.
So, the FHSA has some very intriguing tax benefits. However, you waive many of the benefits if you do not use the account for its intended purpose. In this article, I’ll explore how the FHSA works, so you can decide whether it is the account for you.
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Saving for a home
The FHSA has three main tax benefits:
- A tax break (a deduction) on contributions.
- Tax-free growth and compounding while funds are in the account.
- Tax-free withdrawals.
The FHSA has all of these benefits for someone who uses the account to save up for a home. If you withdraw funds without buying a home – specifically, your first home, and one that you will live in – then you forfeit the tax-free withdrawals. In this scenario, the FHSA functions much like an RRSP that you make an early withdrawal from.
Speaking of RRSPs: apart from taking the early withdrawal penalty, another way to exit an FHSA without buying a home is to roll the funds into an RRSP. If you do so, there is no tax penalty until you start making RRSP withdrawals.
Investing
One of the main benefits of the FHSA is the ability to hold investments in the account tax-free. Your options are technically the same as those for an RRSP or TFSA: if you open a self-directed account, you have the full buffet of stocks, bonds and ETFs available to you. However, because the FHSA is used for savings with a deadline, it is perhaps best suited for holding fixed income investments rather than stocks.
Take the BMO Money Market Fund (TSX: ZMMK), for example. It’s a Canadian money market ETF that holds a combination of Canadian treasuries and short-term corporate bonds. It owns thousands of bonds, which is an adequate amount of diversification. It is sponsored by a reputable financial services company, the Bank of Montreal. Finally, as a Canadian bond fund, ZMMK can be held in a self-directed FHSA tax-free. If you use the account as intended – to save for a home – you can even withdraw any principal and profits earned on ZMMK from an FHSA tax-free!
How to open an FHSA
Having explored the basic rules, use cases and investment cases for a TFSA, it’s time to explore how to open one.
This is pretty simple: walk into a bank branch to set up a meeting with a financial advisor, then attend the meeting and say you want to open an FHSA. Most likely, if you’re older than 18 and younger than 71, you’ll be approved for the account. The advisor might push you into an FHSA that comes pre-invested in specific funds; if you want the ability to trade ETFs in your FHSA, just request a self-directed account. Your advisor will most likely be able to accommodate you.
