Why Using Your RRSP For A Home Down Payment Is A Bad Idea

DCIM100SPORT

The Home Buyers’ Plan was introduced in 1992 by the Conservative government with big fan fare. It was during a time when housing prices weren’t budging, interest rates were sky high and there was very little growth in home building and construction. Fast forward 23 years later and we’re seeing one of the largest housing booms that have ever existed in Canada, maybe the world.

The impact of the Home Buyers’ Plan was significant. A report issued by Statistics Canada 6 years after the introduction of the plan showed that over $6.2 billion dollars was removed from RRSPs as Canadian plowed their money into bricks and mortar. If housing prices didn’t move before it did after.

The Home Buyers’ Plan was designed to allow people to use their retirement savings in order to buy a house. It would seem somewhat contradictory to use a retirement plan to buy something you wanted now, but nonetheless, during the period when the plan was introduced the housing market was in dire straits. Something was needed to give it a kick start, and all that idling cash that was sitting in RRSPs was untapped potential for construction magnates and developers.

If there was any reason why we have celebrities like Brad Lamb, Mike Holmes and the “Do It Yourself” Bryans, it’s probably because of the Home Buyers’ Plan.

The Plan

The Home Buyers’ Plan allows first time home buyers to withdraw up to $25 000 from their RRSP towards the down payment of their first home. The house that is bought must be used as a primary residence. This means the person using the plan must have the intention of occupying the house within a year of purchasing.

If there is a couple who wish to purchase a home together, then it’s possible to pool $25 000 from each individual and put $50 000 for a down payment on a home.

What was even more intriguing was that the plan allowed individuals to use before tax money for the down payment for their home. Remember that upon contributing to the RRSP, individuals receive a “refund” for the taxes they would have paid on the amount of their contribution. This meant that money received back from contributing to an RRSP could also be used to put towards a down payment. The only caveat to this rule was that money used for the Home Buyers’ Plan needed to be sitting in the RRSP for at least 90 days. This circumvented any abuse that people might plan to do when purchasing a home on a whim.

The Catch

handsreachingoutIt seems too good to be true. Save up, invest tax free and then pull out money when you buy a home using before tax money. Why wouldn’t anyone do that?

Despite the fact that one can raid their retirement savings to buy a home, the government does require the individual or couple to pay back what was taken out of their RRSP. This starts 2 years after the withdrawal from the RRSP and the full amount must be paid back over the next subsequent 15 years.

In general 1/15 of the amount taken out from the RRSP must be paid back within the calendar year or within 60 days of the next year. This is the standard RRSP contribution period for any given year. Money that is contributed to an RRSP plan that repays the amount borrowed from the Home Buyers’ Plan does not count towards any tax credits. This means that individuals will not get any “refund” for their contributions. The government won’t let you double dip.

If for any reason 1/15 of the total amount withdrawn cannot be paid back during the calendar year, the amount not met will be considered as income for the year, and taxed at the marginal rate. This is the equivalent of withdrawing money from your RRSP and getting taxed as regular earned income. Remember I mentioned in my previous post that RRSPs are just a way to defer tax.

The Worry

The rules of the Home Buyers’ Plan seems pretty straight forward. Borrow from the RRSP and pay it back in 15 years and nary have a problem. It seems all too simple, but in reality home buyers don’t pay back their withdrawals from their RRSP.

In the first report issued by Statistics Canada, it stated that roughly 25% of people taking advantage of the Home Buyers’ Plan didn’t repay the amount. In a more recent study done in 2011 that number rose to nearly 50%. This is certainly an alarming trend. More and more people are shying away from saving and investing in their RRSPs and moving to a one asset strategy for retirement. Their home.

One of the few things individuals and couples don’t realize is that home ownership incurs additional costs that actually make cash flow worse on a month to month basis. This makes it hard for people to repay back the money that was withdrawn from their RRSP to buy a home.

Imagine a scenario where a $300 000 mortgage is taken out at a rate of only 3% over 5 years and amortized over 25 years.

hbp

For the 15 years that the repayment needs to happen, it has the equivalent of raising interest rates by a significant margin. These are costs that many home buyers don’t factor in when they use their RRSPs to buy a home. The monthly payment is actually significantly more than what’s anticipated. On top of that, the mortgage broker or banker won’t include this extra amount when you apply for your mortgage.

It’s even harder to come up with that kind of money for a single lump sum payment at the end of the year. This is why many people decide not to pay back their RRSP, but would rather pay the taxes that come from withdrawing from their RRSP.

Repaying the taxes for the money that you take out to buy a house is actually one of the worse financial decisions that a home buyer can make. Remember I wrote that RRSPs are a way to defer taxes, not avoid them. It’s pretty much a given that during the 15 year time span, salaries will be increasing and most likely taxes will be paid at a higher tax bracket than when the contribution was made.

What this all equates to is that one would end up paying more taxes to the government using their RRSP for a down payment versus saving for a down payment outside of their RRSP. Of course, some people like paying the government more taxes, but certainly I don’t.

The Nasty

shocked_senior_computer_userThe Home Buyers’ Plan has been in place for the last 20 years now. In retrospective, the buyers of those homes back in the 1990’s should be close to paying off their homes and moving onto their retirements years. That, however, is not the case. A recent study released by Sun Life found that individuals starting to reach their retirement years plan to continue working well past 66.

These are individuals that should have been able to take advantage of historically low interest rates in the past few years to pay off debt and invest in rising stock markets to save for retirement, but somehow their retirement strategy didn’t work. Having a single asset and relying on it retire may not have been the most ideal solution.

The greatest fear these people have is where to live if they sold their homes? How long would their equity last if they were forced to rent? How would one pay off their regular maintenance bills and cost of living if they downsized? Would they even be able to maintain their current standard of living? Owning a home is great, but the past generation forgot that houses solve one problem: Shelter. It didn’t solve the other problem of generating monthly cash flow to pay for everyday necessities.

Fewer and fewer people are saving for their retirement. With the number of home owners growing, the value in RRSP accounts keep getting smaller and smaller. I’ve already written that only a quarter of the population even contribute to their RRSPs. Even more staggering is that many of those people are using it as a means of saving for a home down payment not even retirement.

The Future

The use of RRSPs for houses has gone on for more than a couple of decades. No doubt with house prices so high, the trend will continue where people raid their retirement funds to buy houses they desire. Where this might lead is anyone’s guess.

History might not predict the future, but those that have relied solely on large increases in home prices for retirement may have gotten it wrong. One thing that never got factored into the requirement equation is just how emotional it can be to sell one’s home just to raise funds for retirement. It is something that families don’t want to have to do, but it might become a necessity.

The question to ask is: “Should you really be raiding your retirement funds to buy a house?” If past history is anything to be considered then the answer is no. Too many people don’t repay their RRSPs back. They incur larger tax bills in the process. They miss out saving for retirement. When it comes time to actually retire, they can’t. It all sums up why we should be protecting our RRSP like endangered species, not raiding them like savage hunters.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s