RRSP Loans Can Get You Thousands of Dollars For Your Home Purchase: Home Buyers Plan
Are you thinking about buying a home within the next year,
but can’t seem to save the down payment and closing costs fast enough? Here is a trick to get you there much faster by using the Home Buyers Plan which smartly leverages RRSP loans and gets you a tax refund in the thousands. In the case study below, a young couple made $21,000 appear overnight by smartly using RRSP loans and then applying for a mortgage.
Case Study: John and Katie’s Savings Plan
Daniel Machado, a local Toronto Financial Advisor, has been working with John & Katie for the last four years on their financial plan and specifically on their savings goals. The couple works hard at their stable jobs and would like to do everything possible to save money and buy a home as soon as possible.
John and Katie want to own a home in the city and are budgeting that the cost will be approximately $1,100,000. Their combined gross salaries are $170,000 and are expected to remain unchanged for the next few years.
They are already committed to saving a total of $4,000 per month to their non-registered savings accounts. The main reason for this is to build an emergency cash reserve. So far, from consistently contributing the last four years, and earning an average of 5% annual return, the total investment is now worth $213,000. This savings amount is their current savings for down payment which they do not want to touch until absolutely necessary so they don't miss out on the 5% growth for as much money as possible.
John and Katie do not have employer sponsored group savings plans with either of their current employers. Their previous year’s earned income creates new RRSP contribution room each year and that opens the door to a new planning opportunity. The couple usually are very close to breaking even with taxes each year, which means no large amounts of tax owing.
How they increased their wealth by $21,000 via borrowing $70,000 in RRSP loans
In this case, John and Katie had not maxed out their RRSPs throughout the year, so to get a tax refund when they file their income tax returns, they need to contribute and max out the $70,000 RRSP limit quickly and this can be done via a loan.
John and Katie met with Daniel in January of this year and stated that they would like to be ready with their 20% down payment ($220,000) before the summer. As they are currently short on funds to meet their goals, Daniel suggested that they get ahead by applying for two individual RRSP loans of $35,000 (for a total of $70,000) and to complete this in the first 60 days of 2021 to count for a refund sometime in 2020. The loan will cost around 2.45% which is generally the prime rate - remember that paying 2.45% on $70,000 to not lose 5% growth on another $70,000 is a prudent investor move.
After John & Katie file their 2020 tax returns, the CRA will issue the couple a refund of ~$21,000 total. The reason why they will get $21,000 is because each of them earns $85,000 individually. By contributing $35,000 reduces their overall yearly income to $50,000. This means that John and Katie have overpaid their share of income taxes for 2020 by $10,500 each.
Executing The Plan
John and Katie must pay back the RRSP loan before they are eligible to make a qualifying withdrawal under the Home Buyer’s Plan (which does not tax you for withdrawing $35,000 per person in the year of withdrawal).
All in all, the young couple have $213,000 of investments and $70,000 in RRSP loans that must be repaid before buying their home and getting a mortgage. The RRSP funds must remain in their accounts for at least 90 days. During this time, it is likely that the CRA will issue the aforementioned $21,000 tax refund.
Assuming that savings of $4,000 have continued for the last three months, and their investments continue to grow at the same pace, they are now worth $228,000. After paying back the loan balance, their non-registered account will have $179,000 and with $70,000 in RRSPs, their mortgage funds are now equal to $249,000 which is $21,000 more than they would normally have. Since they need to pay closing costs very close to $21,000, this is very important cash to have besides what is going for down payment directly.
THE BOTTOM LINE
If John & Katie did not follow our advice, it would take approximately nine more months to reach that same level of savings for at least a 20% down payment plus closing costs of $21,000. They got $21,000 quickly through the RRSP Loan and didn't have to dip into their investment pool of money which was making a strong return.
Guest Writer: Daniel Machado from IG Wealth Management