Saving for a downpayment? First of all — congrats. With rising interest rates and tougher lending rules, scraping together the cash is a big accomplishment — especially in markets like Toronto and Vancouver. So where should you keep this hard-earned money while it’s adding up?

Of course, there are chequing and savings accounts where you can park your cash, but these offer little-to-no advantages when it comes to tax breaks and compounding returns. There are two savings vehicles that will serve you much better: a tax-free savings account (TFSA) and a registered retirement savings plan (RRSP). You probably know what these are, and you may be contributing to one, or both, right now. They are both powerful tools when it comes to buying a house and we have the goods to help you understand which is best, how they differ and how to use them in tandem to hit your homebuying goals.

Photo: LendingMemo.com

Let’s start with the basics. What are the key differences between an RRSP and a TFSA?

When you make an RRSP contribution, you get to deduct that amount from your taxable income. Say you make $60,000 and contribute $9,000 to your RRSP. The government taxes you as if you made $51,000 (resulting in major tax-breaks). That $9,000 (and any other future contributions) can be invested in your RRSP — in bonds, stocks, mutual funds, ETFs, GICs and the like. Any capital growth will accumulate free of tax while it remains in the plan. Down the road, however, when money is withdrawn from the RRSP, you will have to pay taxes on all of it.

Your RRSP is designed to help you save for retirement, although there are two exceptions that let you take the money out penalty-free — to continue education or for a first-time home purchase.

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Despite the slightly misleading name, your TFSA is much more than a savings tool. TFSAs can hold almost any investment your RRSP can. And similar to an RRSP, once the money is in the plan, it grows free of tax. The key differences are that unlike your RRSP, you don’t have to pay tax on it when it comes out and you can withdraw the money at any time (including for your downpayment, or say — that vacation to Hawaii).

If you have to pick just one, you will want to consider a few factors: your current and future income levels, your short-term and long-term goals, and the flexibility you will need to access those funds.

Do you make more or less than $50,000 a year?

“The traditional idea behind an RRSP is that you put your money in now, it comes off your net income and you get a tax break. When you take the money out, you will be taxed on it but you’ll be in a lower tax bracket,” says Kevin Klein, Vice President and Investment Counsellor at T.E. Wealth in Alberta. “But what we’re finding with the younger generation is that if you’re just starting out, you might not be in a higher tax bracket.”

Klein says TFSAs are generally the better choice for people with modest or low annual incomes. If you’re making less than $50,000 and anticipate earning more in your later years, your RRSP can turn into a future tax burden instead of a benefit.

With a TFSA, you contribute after-tax dollars. Meaning, unlike an RRSP, the money you contribute is not deducted from your net income and you won’t get a tax break. But you also won’t be taxed on it when you pull it out later — a blessing in disguise if you anticipate your income will go up in your later years.

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Will you need convenient, flexible access to your savings?

Unlike an RRSP, a TFSA can be used for any type of savings goal — whether it’s a rainy-day fund, vacation, first-time home purchase, wedding, retirement or anything else you feel like saving for. This is because you can withdraw your funds at any time — with no tax implications. “There’s a whole debate between TFSAs and RRSPs — which is better. TFSAs are a lot more flexible,” explains Klein.

How much do you want to contribute to your downpayment and your retirement?

You can contribute 18 percent of your income or $26,230 a year to your RRSP (whichever figure is higher). The Home Buyers’ Plan allows eligible first-time homebuyers to withdraw up to $25,000 tax-free out of their RRSPs. It’s technically a loan to yourself because homeowners will have to start paying the amount back to their RRSP over a 15-year period beginning two years after the initial withdrawal (we explain how it all works in this article).

The federal government grew the TFSA contribution limit from $5,500 in 2018 a year to $6,000 in 2019 and it could change again. That sum increases significantly if you are opening an account for the first time. If you were 18 when the program started in 2009, you can put up to $63,500 in a lump sum they get this number by adding up the yearly contribution limit from the past ten years). Whenever you take money out, you also get that room back in your TFSA for more contributions, and if you don’t contribute one year, the allotted funds will carry over to the next. You can pull out as much as you want, and unlike the RRSP — you don’t have to pay it back.

This is both a blessing and a curse. On the one hand, the flexibility helps you put a real chunk of change towards your downpayment. On the other hand, if your TFSA is your only retirement savings vehicle, there are no immediate penalties for not paying it back. And remember, when you take money out — you sacrifice the compounded growth of your investments had they been left inside to grow.

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What should your investment plan be in your TFSA or RRSP? Well, that depends on when you plan to buy a house.

“It really comes down to time horizons,” explains Klein. “If you’re looking to buy a house in the next six months, year, or even a couple years, you will want to be cautious with where you put your money and how you invest it. If you aren’t planning to buy for 10 or 15 years, you can take more risk.”

In the short term, markets are volatile and subject to wild up-and-down swings. If the market is down when you want to pull the trigger to buy a house, you could end up at a loss. When you are saving for a long-term goal, you can ride out the waves of the market.

If you’re looking to purchase a home in the short- or medium-term, it’s best to go with a risk-free strategy that allows you to withdraw it at any time. “Even though interest rates may be low — between 1.5 to 2 percent — that money will still be sheltered from taxes in a TFSA and an RRSP,” explains Klein.

Wilkie Kam, a Vancouver-based investment advisor for BMO Nesbitt Burns reiterates this: “I would recommend a minimum time horizon of three years or above if investing in anything that can fluctuate in value for the purpose of a home purchase. A balanced portfolio usually carries lower risks than a growth portfolio and return higher than a straight-term deposit which suits the purpose.” However, the advisor still cautions doing your homework on the selection of the investment products. “If poorly chosen, a balanced portfolio can even have larger volatility than a growth portfolio,” Kam explains.

If you currently have higher risk investments in your TFSA or RRSP, Klein suggests bringing the risk down as you get closer to homeownership: “There are many strategies out there when your time horizons are changing. What people should look for is something that is liquid over time, with no penalties to get in or out of. When it comes to a downpayment, you want to make sure you stay on top of your money and that it’s appropriate given your changing situation.”

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