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When to Pay Back the Home Buyer’s Plan

There is often much discussion about the best way to pay back the RRSP home buyer’s plan, namely the specifics of when, how much, and how soon to pay back the money you borrowed from yourself.

The TFSA Changed the Game…

With the creation of the Tax Free Savings Account, and the tax free gains you receive from your after tax income, weighing the options between contributing to your tax free savings account or to your home buyer’s plan became a bit more difficult.

With the home buyer’s plan, you can borrow up to $25,000 from your RRSP’s without having to pay tax on the withdrawal. Technically, you are withdrawing your pre-tax income.

The year after your withdrawal, you are expected to pay at least 1/15 of the money you borrowed back into your RRSP. This is expected of you for 15 years. You do this by filling out Schedule 7 when you file your taxes (or your accountant files your taxes) and listing how much of your RRSP contribution you are going to use to pay back your Home Buyer’s Plan.

If you don’t pay 1/15 of the money you borrowed from your RRSP, that 1/15 amount will be taxed at your marginal rate for that year.

Sometimes, if you have a low-income year (for example, if you are a student that year or if you were unemployed or on maternity or paternity leave) this may work out advantageously because you will be at a lower marginal rate than when you were working.

In this case, what would be the best options for your home buyers plan payback?

Let’s take a look at a few scenarios:

Scenario A: Allow for 1/15 of the home buyers plan to be declared as income because you are in a lower marginal tax rate.

This is considering the alternatives that you could use for that money- including filling up your tax free savings account or paying off your mortgage faster. The RRSP helps you delay taxes, the TFSA allows for gains that are not taxed at all when you withdraw.

Scenario B: Pay the HBP plan off during your low income year.

When you pay off the HBP plan off in your low income year, you will free up contribution room in the future higher income years. In addition to this you will free up potential cash flow in the future to pay off your mortgage.

This can be accomplished, for example, by either moving non-registered stocks with a neutral or small capital gain, or better yet, by transferring funds or shares in kind from your Tax Free Savings Account to your Registered Retirement Savings Plan account. Of course, another feasible option is to pay off the home buyers plan with savings if you have it available.

Paying back the home buyers plan allows for more possibility of tax sheltered growth in your registered account (time is on your side), in addition to allowing for future tax refunds from bigger RRSP contributions in the future at a higher marginal rate.

I see a benefit to this as it helps you get out of debt to yourself, and out of the annual obligation of 1/15 of the borrowed amount. It helps free up your cash flow, in a sense.

Scenario C: Pay the minimum payment 1/15 annual repayment to the HBP and focus on saving the rest of your annual retirement savings in the Tax Free Savings Account instead.

The TFSA is the clear winner in comparison to the RRSP due to numerous reasons as pointed out in this RRSP vs TFSA article.  This scenario is dependent on how much you think you might be earning in retirement, though pretty much any way you slice, it contributing to your max out your TFSA may be a better idea than your RRSP if you can’t do both.

My Situation:

For example, I borrowed roughly $15,000 from my RRSPs for my down payment on our first home. This is the first year that I’m expected to pay back 1/15 of what I borrowed. This is also a year in which I am at a much lower tax bracket than I usually am. I’m debating between scenario’s A, B, and C, and am leaning towards either scenario A or B. I still have one year where my income will be low. Therefore, I do have one more year to decide whether I want to go all in and do scenario B.

MDJ readers, what is your take? Which scenario would you opt for in this home buyer’s plan repayment dilemma?

About the Author: Clare is a 20-something who lives in beautiful (but expensive) British Columbia and has been working on her frugal living skills and fighting lifestyle inflation. She works to expand her DIY investment knowledge and hopes to enjoy financial independence one day. She enjoys reading personal finance books, freelance writing, but not so much arithmetic.

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 12 comments… add one }
  • FT FrugalTrader September 12, 2012, 9:28 am

    @Clare, if this is an extremely low income year, and you are not too worried about RRSP contribution room (defined benefit pension during retirement), then sure, counting the repayment as income may be a good bet. It’s similar to withdrawing from your RRSP during low income years. Also note though that tax wise, TFSA’s and RRSPs are NET equal as TFSA deposits are with after tax dollars, and RRSP contributions are with pre-tax dollars. TFSA’s can be a better bet in the long term as most people do not reinvest their RRSP tax refund. As well, TFSA withdrawals are not income tested for seniors (not yet anyways), thus reducing the “tax” on clawbacks.

  • Squire September 12, 2012, 11:13 pm

    @Clare, in your scenario I would allow the 1/15 to be included in your income. Like FrigalTrader mentioned it is simply a way to shift income from a year when your top marginal tax rate was higher (assuming it was when you put the 15k in there). If it wasn’t then I would presume you would carry that deduction forward to a future tax year when it is eventually high. In two years when your tax rate will be higher I like option C (or a variation of C, at least), in that you claim the minimum payback but continue to invest in the RRSP to get the deduction from your income. For example, if your top marginal tax rate was 40% and your minimum payback was $1000 I would invest as much as you could, say $2500, and take that 1500 as a deduction from your income. This gives you a 1500*.4=$600 additional refund to which you can reinvest in your RRSP leaving only 400 to pay the next years payment or put it in the TFSA…or buy ice cream, whatever your fancy is.

  • lawgirl September 13, 2012, 2:16 pm

    I guess this wasn’t discussed because it is probably the most common option -but what about paying the minimum 1/15 payment each year and then still contributing to your RRSP (similar to Situation C but without contributing all to the TFSA?). Seems like the best option for those in higher tax brackets (or at least higher ones than when they will be retired). That way you’re paying your minimum HBP payment, but are still getting the tax benefits!

  • The Passive Income Earner September 13, 2012, 3:32 pm

    @Clare
    I like the options presented. I have not been a position to have a lower income and I have juts been doing the 1/15 per year.

    Just paying the taxes can definitely be a lower amount than putting back what you borrowed. Essentially, you are executing the withdrawal.

  • Ed Rempel September 14, 2012, 2:09 am

    Hi Claire,

    You can do both A and B.

    The total that you are allowed to contribute to your RRSP is the sum of your RRSP deduction room plus your Home Buyer’s Plan outstanding amount. Once you contribute, you have the option for any dollar contributed to either:

    1. Claim it as a deduction and get the tax refund.
    2. Apply it to the Home Buyer’s Plan.
    3. Carry it forward.

    This means you can contribute the total of your entire Home Buyer’s withdrawal, but then decide to carry it forward and neither deduct it or apply it to your Home Buyer’s Plan balance.

    This means you get your money invested and compounding tax-free and can make a separate decision about how much and when to claim a tax deduction.

    Remember, the Home Buyer’s Plan is not a fee withdrawal. Your cost of borrowing is the amount that the investments would have earned if you had them invested. If you would have invested for a normal stock market return (say 10%), then borrowing from the Home Buyer’s Plan is really a 10% loan. Very expensive!

    The best solution for you depends on your situation and your financial plan. RRSPs are best if you can deduct it when you are in a higher tax bracket than you will be when you retire.

    If you are in the same tax bracket today that you will retire in, then there is still a tax-free compounding benefit, so RRSPs are still okay, but a TFSA is probably a better choice.

    In your case, if you have a very low income, you are probably in a 0% (income $0-$10,822) or 20% bracket (income $10,823-$37,013) in BC for 2012. The lowest tax bracket for seniors is 20% in BC, so you will retire in the same or a higher bracket than you are today.

    Therefore:

    A. If you expect to retire in the 20% bracket (income of $37,013 or lower in today’s dollars but above the GIS clawback income up to about $23,000), then claiming the 1/15 is probably the best because it preserves your RRSP room and gives you years of tax-free compounding.

    However you should probably contribute just enough to the RRSP to pay back the 1/15 of your HBP withdrawal and contribute the rest to a TFSA (unless you do not expect to have the money to contribute to your RRSP in future years.)

    B. If you expect to retire in a higher tax bracket (retirement income below $23,000 in today’s dollars or above $37,013), then it is best to not apply your contribution and tax the 1/15 of your withdrawal into income for this year.

    C. If you are in a 30% or higher tax bracket today (income of $42,707 or higher in BC) and you expect to retire in the 20z5 bracket, then you should contribute as much as you can to your RRSP (within your limits) and make the HBP repayment.

    This is a bit technical, but knowing your tax bracket today and what you expect it to be in retirement is important to your choice now.

    Ed

  • cash_man September 14, 2012, 12:32 pm

    I am in a payback plan for 10k over 15 years. My household income is 120,000 of which I make half. I am in a group RRSP plan, investing pre-tax. currently I am not paying it back and just taking the tax hit. Is this the best solution for me?

  • Andrew Spencer September 14, 2012, 3:31 pm

    Clare,

    1) Your first HBP repayment (1/15 of the amount taken out) isn’t due until two years after you took the money out.

    Ex, I take out $10,000 from my RRSP to fund the down payment of my new house in 2011. I don’t have to make my first HBP repayment until the 2013 tax year…so I technically have until the first 60 days of 2014. Any amount I repay in 2012 will be counted against the 2013 tax return, up to 1/15 of the original amount, with the remaining divided equally over the remaining 14 years.

    2) Also note that HBP repayments do not affect your RRSP contributions for subsequent years.

    In the above example, if I racked up $5000 RRSP contribution room for the 2013 tax year, then I can put $5000 + 1/15*$10,000 in that year. I would then deduct the $5000 from my employment income and use the $667 (1/15*10,000) to repay the HBP amount due. I could also pay off the entire HBP amount if I wanted to.

    I don’t believe that either of the above two points were very clear in your explanation.

  • Clare September 15, 2012, 2:09 am

    @FT- Thanks for the tip! Unfortunately this is not an extremely low income year. I figure I might be in the same tax bracket but on the lower end :( Yes, I love my TFSA, and I do have a defined benefit pension, but am considering not working full time so might have to beef that up a bit.

  • Clare September 15, 2012, 2:20 am

    @Squire- I like the idea of ice cream lol. My question is, why not get rid of the HBP loan now, and then I will have more money in the future have deduction room for tax benefits? (e.g. instead of the 1500 as deduction income, why not 2500?)

    @lawgirl- Thanks lawgirl :) Yes, that’s definitely the most common option. I know that the TFSA and RRSP are basically mirror opposites of each other and I intend to max both out, but I do tend to favour the RRSP because of its tax refund :)

    @PIE- Sounds like 1/15 per year is the way to go… I think I might just defer it this year (though it pains me to have to do that this year) and build up the RRSP room so that when I do have higher income/ higher tax bracket, I will just use my RRSP deduction then for a big tax return.

  • Clare September 15, 2012, 2:27 am

    @Ed- Thanks- I liked the play by play- very helpful. :) The technical aspect is helpful and is something I often struggle with :)

    @Andrew- yes, sorry should have clarified. Bought my first home in 2010- yes, technically I do have until the first 60 days of 2013 to repay. Thanks for the clarification.

  • AndyWakeee September 18, 2012, 9:52 am

    I am holding off repayments because US is going to keep interests very low until 2015 and Canada usually follows. My TFSA returns might not be great, but they are better than my 2.25% mortgage rate

  • Phala January 5, 2013, 10:15 am

    I used my RRSP to buy a house and also expected to pay 1/15 this year. Im planning to use all my taxes return to pay it off, is it a good strategy?
    Is there any impact to pay more than 1/15 the first year?
    Thanks

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