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Canadian Housing

Using retirement savings for a down payment is a 'wealth winner'

Transferring some of your tax-sheltered savings into buying a house can pay big dividends in retirement, and still provide the best tax-break in the country.

Canada’s Home Buyers Plan, which allows purchasers to tap into a Registered Retirement Savings Plan (RRSP) for a downpayment on a principal residence, is extremely popular. Since the federal government program started in 1992, it has been used by an average of 114,000 buyers each year, representing one-third of all MLS housing sales in the country.

The program allows people to use RRSP funds up to a $20,000 maximum, or $40,000 for a couple, towards the purchase of a home. The withdrawals are not deemed to be taxable income in the taxation year they are withdrawn. There is a no-penalty payback period for the RRSP money over a maximum of 15 years.

On average, buyers using the program withdraw $9,984 from a RRSP towards a home purchase. And, according to a study done by the Canadian Real Estate Association, more than 90 percent of home buyers who take funds from their RRSP are repaying the money.

Now, a fresh look at the program by the Real Estate Institute of British Columbia, shows that using the Home Buyers’ Plan can return much higher equity than leaving the money in tax-sheltered savings, based on even modest real estate appreciation.

The study compares someone withdrawing the maximum $20,000 from a RRSP for a home purchase, compared to leaving the money inside the RRSP.

If the $20,000 were left in the RRSP for 15 years, given an annual 3 percent rate of return, it would grow into approximately $31,200. Not a bad return.

However, if the home buyer doesn’t tap the RRSP they will incur a larger mortgage and may even need to purchase mortgage insurance for a high-ratio home loan.

(The insurance premium for 95 percent of value financing is 3.75 percent of the mortgage amount. Normally, the mortgage lender adds this fee to the mortgage amount that you pay each month.)

Leaving the issue of the cost of mortgage insurance aside, a $20,000 mortgage with a 25-year amortization period and 6 percent interest rate will cost $128 per month in payments. After 15 years, almost $14,600 will have been paid on a $20,000 loan. There will still be $11, 565 outstanding.

Remember the mortgage payments come from after-tax income. If the buyer is in a 33 percent tax bracket, for instance, the interest payments have cost the gross income equivalent of $21,800, with a further $17,000 still needed to discharge the loan.

Therefore, the Institute notes, if the money were left in the RRSP the cost of the extra mortgage payments needed would mean a negative wealth position after 15 years.

Should the buyer use the Home Buyers Plan and take advantage of the cash-flow savings between the monthly mortgage payments of $127.96 and the RRSP repayment of $111.11 reinvesting the difference of $16.85 back into RRSPS over the 15-year period, the RRSP would grow to $29,000 (assuming a 3 percent rate of return.) Also, there should be an additional $6,600 in house equity for a total wealth position of $35,600.

Of course, the capital appreciation on a principle residence is the only investment in Canada that is tax-free.

The bottom line is that if you have the capability, withdrawing the maximum amount from your RRSP towards a home purchase is a wealth winner. The effect is even more pronounced if a couple can access the maximum $40,000 from RRSPs to further reduce the amount of the mortgage.

Frank O'Brien can be reached at .

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