Two Investment Accounts to Consider in 2024

This will be my last blog post until the new year. I wish all readers a sense of joy in this season of celebration. Merry Christmas and Happy New Year!

 

There are two accounts that I think are worth considering for 2024 if you have not yet done so, the Tax-Free Savings Account (TFSA) and the First Home Savings Account (FHSA).

 

Tax-Free Savings Account (TFSA)

The TFSA is not a new account type, having been available to eligible Canadian residents aged 18 and older since 2009. The big news, if I dare put it that way, is that for two consecutive years, the contribution limit has risen. From 2019 to 2022, the limit was $6,000. In 2023, it rose to $6,500, and in 2024 it will rise again, this time to $7,000. If you have never contributed to a TFSA and have been eligible since 2009, you will have $95,000 in contribution room come January 1, 2024. For a couple, that equals $190,000.

 

Why the consecutive increases? When the TFSA was established, the limit for each of the first four years was $5,000. The rule that was established at the time was that the TFSA contribution limit would increase by the rate of inflation, rounded to the nearest $500 increment. When inflation was low, the increases were infrequent. Now that we have had a period of higher inflation, we have had two increases.

 

It should be noted, too, that as the annual contribution limit increases, the impact of even a low inflation rate can become more significant. To illustrate, when the initial contribution limit was set at $5,000, a 2% inflation rate would mean moving $100 closer to the $5,500 limit. However, that same 2% inflation rate on a $7,000 limit results in a $140 step closer to $7,500. Fifteen years of 2% annual inflation would lead to an increase from $5,000 to $6,500, a $1,500 difference. When you start at a $7,000 base, 2% per year means a $2,500 increase in the limit, to $9,500.

 

I only bring up this subject because the TFSA limit is becoming steadily more substantial. Although it is usually only the wealthier among Canadians who can take advantage of the TFSA and RRSP contribution room, if you are in a lower tax bracket during your working years, approximately $50,000 or less in taxable income, depending on your province of residence, you may find that you will do better to favour retirement savings in a TFSA. This is so for two reasons. First, the impact of the RRSP contribution on your tax deduction is not as substantial as it is for someone in a higher tax bracket. Second, because withdrawals from a TFSA are tax-free, they do not have an impact on your eligibility for certain means-tested benefits, such as the Guaranteed Income Supplement (GIS).

 

First Home Savings Account (FHSA)

Depending on how you end up using this account, the FHSA can have the tax characteristics of both an RRSP and a TFSA.

 

But first, how does one qualify to open an FHSA?

 

1. You need to be between ages 18 and 71 (a minimum age of 19 in provinces where 19 is the legal age).
2. You are a resident of Canada.
3. You did not live in a qualifying home as your principal place of residence that you owned or jointly owned in the current calendar year or the previous four calendar years.
4. You did not live in a qualifying home as your principal place of residence that your spouse or common-law partner (CLP) owned or jointly owned in the current calendar year or the previous four calendar years, OR you do not have a spouse or CLP at the time you open the account.

 

How is the FHSA like an RRSP?

Contributions to a FHSA are tax-deductible, just like they are for an RRSP. If you live in the kind of household where you tend to maximize your RRSP contributions every year, this is like getting extra contribution room regardless of your income.

 

An FHSA is not like an RRSP, however, in that you cannot contribute to the FHSA in the first 60 days of the new year and apply it against the previous year’s income. If you want, though, you can choose not to claim the deduction to carry it forward.

 

How is the FHSA like a TFSA?

If you make a qualifying withdrawal to buy a home, the amount withdrawn is tax-free.

 

How much can a qualifying individual contribute to an FHSA?

The annual contribution limit is $8,000 per year. If you cannot maximize your contribution room in a given year, you are permitted to “carry forward up to a maximum of $8,000 of unused FHSA participation room at the end of the year to use in the following year.”

 

The lifetime FHSA limit is $40,000. That means you can potentially “max out” your FHSA contributions in five years. If you cannot maximize your FHSA contributions using uninvested cash, you can make a direct transfer from your RRSP to your FHSA without any tax consequences. To be clear, a direct transfer means you cannot withdraw from your RRSP and then turn around and contribute to your FHSA. Rather, you must complete the transfer paperwork of your financial institution that holds your FHSA to initiate this movement of assets “directly” from the RRSP to the FHSA. Note that a contribution via a transfer from an RRSP does NOT qualify for a tax deduction since you already received a deduction when you contributed to your RRSP.

 

What can you invest in inside an FHSA?

You can invest in the same types of securities that qualify for investment in an RRSP or TFSA. A classic example of an investment that would NOT qualify is a stock traded on the US Over-the-Counter (OTC) markets. There are also certain investments that are prohibited. This is typically a security over which you may have a significant or controlling interest.

 

As long as the security you hold is a qualified investment, you can also contribute to your FHSA in-kind, assuming your financial institution permits the transaction. The position being transferred will have to stay within the contribution limits. Furthermore, if you are transferring from a non-registered account, the transfer may trigger a capital gain, which is the difference between the Adjusted Cost Base (ACB) and the Fair Market Value (FMV) at the time of the transfer. For example, if you transfer shares of ABC bank stock with an FMV of $8,000 from your non-registered account to your FHSA, and those shares have an ACB $3,000, you will have to pay capital gains tax on the $5,000 capital gain. Fortunately, only half the gain is taxable, but it is effectively the same as disposing of the stock in your non-registered account and immediately rebuying it in your FHSA.

 

What should you invest in inside an FHSA?

This depends on your risk tolerance and time horizon. If you think you will buy a home within five years, I will tend to discourage the purchase of risky assets like stocks, bonds, or funds (mutual funds or ETFs) that hold the same sorts of investments. To my mind, that is too tight a timeline to take even a modest amount of risk. Stick with High-Interest Savings Accounts or GICs. If, on the other hand, you don’t intend to buy a house and are instead using the FHSA to effectively add up to $40,000 to your RRSP contribution room, you can use the same asset allocation that you would within your RRSP.

 

When do you have to close your FHSA?

As I mentioned earlier, if you maximize your contributions each year, you can reach your $40,000 lifetime contribution limit in five years. However, from the year of opening, you have 15 years before your FHSA must be closed, which, on average, works out to annual contributions of $2,666.67 per year, if you want to reach your lifetime contribution limit over the maximum 15-year life of the account.

 

Two other flags signal the mandatory closing of the FHSA. Either of these could arrive before 15 years have elapsed. First, there is the age limit of 71. By December 31 of the year that you turn 71, you must close the FHSA, most probably by transferring it into a Registered Retirement Income Fund (RRIF), as age 71 is the last year you are permitted to own an RRSP before its assets, too, must go into a RRIF.

 

The final trigger obliging the FHSA owner to close the account is when a qualifying withdrawal is made. Presumably, you would withdraw the entire value of the account when you are making the house purchase, but you must close the account by December 31 of the year following the qualifying withdrawal.

 

How much money could you have for a home purchase?

Let’s assume a young couple in their early 30s, married or CLPs, neither of whom has owned a home within the current year or the previous four years, but who are diligent savers. Their RRSPs and TFSAs are maxed out. With the addition of the FHSA, they have another vehicle for their savings. Because they hope to buy a house within five years, they each contribute the maximum of $8,000 per year. At the end of five years, each of their accounts has grown to $45,000. They have found a home that they want to buy. They withdraw their FHSA balances, which equals $90,000 ($45,000 x 2), and in addition, they each pull $35,000 from their RRSPs under the Home Buyers Plan (HBP) which means they have an additional $70,000, for a total of $160,000. If TFSAs were withdrawn as well, there would be even more money available.

 

Of course, not everybody will be able to maximize RRSPs, TFSAs, and FHSAs, but the flexibility of the FHSA makes it a valuable account for accumulating assets. If you qualify but have not yet opened an account, you may want to take advantage of the opportunity presented.

 

Where can you open an FHSA?

Surprisingly, not all online brokers currently provide the ability to open FHSAs. According to a MoneySense article dated December 15, 2023, the online brokers that do not yet offer an FHSA are:

 

• BMO InvestorLine
• Scotiabank iTrade
• TD Direct Investing

 

If you wanted to stay with one of these banks, you would need to open an FHSA available through their retail bank channel.

 

Those online brokers that offer FHSAs are:

 

• CIBC Investor’s Edge
• National Bank Direct Brokerage
• Qtrade Direct Investing
• Questrade (the first to make the FHSA available)
• RBC Direct Investing
• Wealthsimple

 

Let me close by reiterating a point I had made earlier. Even if you are unsure about buying a home, if you qualify to open an FHSA, it can still be to your advantage to do so. The worst-case scenario is that you have effectively been able to add to your RRSP. In the best case, you have a tax-free lump sum to buy a home.

 

All the best in 2024.

 

This is the 229th blog post for Russ Writes, first published on 2023-12-22

 

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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.

 

Photo by Sandy Millar on Unsplash