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Planning ahead with the FHSA to optimize tax benefits 

In part one of this two-part series on the new FHSA, titled Alternative ways to fund and use an FHSA, we used some out-of-the box thinking to show ways this account could be used a bit differently. Now, we’ll look at how to optimize its tax benefits by planning ahead. 

As a Private Wealth Advisor, Aaron has broad and deep experience working with clients across a wide spectrum of wealth management issues. He’s also frequently sought by the media as an expert on wealth management and cross-border financial planning.
Taking a forward-looking approach to any savings vehicle is important, and it’s especially so with the new First Home Savings Account (FHSA) plan. How long you can keep the account open, how long you can wait after buying a home to make a qualifying withdrawal, and when you need to make a contribution to attract a current year tax deduction are all crucial considerations. Here, I’ll focus on two specific timing issues: when you should open your FHSA account and when you should claim your tax deduction.

When to open your FHSA

If you’re even loosely thinking about a home purchase, you should open an FHSA account as soon as possible. Even if you don’t have money to put into it yet, establish the account and get it opened.*

Why open the account if you can’t fund it? The carry-forward of unused contribution room.

With the FHSA, if you don’t contribute the full $8,000 that you’re able to, then the unused portion can be caught up the next year. Note that the maximum possible carryforward from previous years is $8,000, or one full year of normal contribution room.

So, if you open an account in 2023 but don’t put a penny into it, then in 2024 you'll be able to contribute $16,000 ($8,000 for 2024 and $8,000 for the unused portion from 2023). If you contribute $5,000 in 2023, then in 2024 you could contribute $11,000 ($3,000 unused from 2023 + $8,000 for 2024). Note that, if you open an account in 2023 and make zero contributions in both 2023 and 2024, then in 2025 you’d still only be able to make a $16,000 contribution (not $24k), because the maximum carryforward amount is $8,000.

Some people have “lumpy” earnings (e.g., annual bonus plans, stock options/share plans with vesting dates, or commissions). If your lump sum occurs in the spring of 2024, and that’s what you were planning to use to fund your FHSA, don’t wait until then to open the account! Do it in 2023, so when that lump sum payment arrives you won’t be limited to only the $8,000 of room for 2024.

 

When to claim your tax deduction

Once you’ve made a contribution, you have another decision to make. When should you claim the resulting tax deduction? With an FHSA, you don’t have to claim your tax deduction on your tax return in the year in which you made the contribution. Instead, you can carry it forward to any future year, and it can be used to offset any type of income.

A deduction reduces the amount of income that’s exposed to the tax calculation. So, if you earn $100,000 and receive an $8,000 tax deduction, then when you file your taxes you’ll only have to pay tax on $92,000 of that income (i.e., $100,000 would be your total income and $92,000 would be your net income after your $8,000 deduction).

It’s likely that your payroll would have withheld the correct amount of tax on your $100,000, so the additional tax that was withheld on your income (between $100,000 and $92,000) would typically be returned to you as a tax refund when you file your tax return.

However, Canadian tax brackets are progressive, which means the tax rates are lower at lower levels of income and higher at higher levels of income. So, the same $8,000 tax deduction is worth more to someone at a higher income than at a lower income.

There are many government programs which are income tested. The two most commonly discussed income-tested benefits are the Canada Child Benefit (CCB) and Old Age Security (OAS). Both programs are clawed back when your net income exceeds certain levels. OAS is clawed back at a rate of 15 cents for every dollar of income which exceeds the clawback floor (which is $86,912 for 2023). If your net income was $95,000 then your marginal tax rate is 30.5%, but when you factor in OAS clawback, your effective tax rate is much higher and would be getting fairly close to the highest marginal tax rate for Albertans. This is relevant given the FHSA program applies for people up to age 71.

So, if you’re a high-income senior who’s renting and plan to begin your OAS in the next year or two, you might want to consider saving your FHSA deduction for a tax year when you’ll have OAS clawback exposure.

The same planning can apply for younger individuals who are either looking to start a family in the next year or two, or are planning to have an additional child in the upcoming years. Let’s look at the example of a family earning $65,000 net income with three children. Figure 1 outlines the CCB benefit reduction rates.

Figure 1: Canada Child Benefit reduction grid

CCB Benefit Reduction GridSource: Canada Revenue Agency

As you can see, this family is in the 19% clawback zone for their CCB, but they also would be in the 30.5% income tax bracket, making for a whopping effective rate of tax of 49.5% (which exceeds the typical top marginal tax bracket in AB of 48%). So, they need every tax deduction they can get.

As the example shows, if you currently have one child then you’ll have a CCB reduction of 7%, whereas with two children the rate changes to 13.5%, and then goes up to 19% with three children. So, if you plan to have a child next year, consider saving your FHSA tax deduction because it’s going to give you a bigger return if you wait.

The family with three children and a net income of $65,000 has an effective tax rate of 49.5%. If they can manage to contribute even $1,000 into an FHSA, they’ll get an extra $495 next year by way of tax refunds and increased CCB payments. If they then took that $495 and reinvested it back into their FHSA – and did that over and over again – here’s what would happen.

Figure 2: Tax savings over a 5-year FHSA contribution plan
Tax savings over a 5-year FHSA contribution plan

Summary: If a single income family with 3 kids can find a way to save $1,000 into the income earning spouse' FHSA, and they then take their resulting tax savings and extra CBB income and roll that into the FHSA each subsequent year, then after 5 years they will have earned back $586 in tax savings and $365 in additional CCB benefits for a total of $951 – almost doubling their original investment without any market growth.

Source: Canada Revenue Agency

As you can see, the tax savings can be substantial over time. Hopefully, this helps explain how looking ahead is important when using the FHSA as a savings vehicle.

As both pieces on this subject have shown, the opportunities are out there – it’s just a matter of identifying them. Your advisor can work through different scenarios with you to help ensure you’re maximizing the full potential of this strategy in your overall wealth plan.

Sources: Canada Revenue Agency

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