As RRSP season runs into high gear, it's time for a reminder that the federal
government's Home Buyer's Plan, or HBP, is not the only way to use RRSP money to
pay down a home or condominium mortgage.
Under the HBP, taxpayers are allowed to withdraw up to $20,000 from their
Registered Retirement Savings Plan without paying tax on the money, if they buy
or build a qualifying home with the money.
The main requirement is that the money has to be repaid to the plan
within no more than 15 years.
Payments have to be made to the RRSP each year until the HBP balance is
zero. If a taxpayer does not repay the amount due for any year, it will be
treated as a taxable withdrawal in that year, and will have to be included in
income for that year.
These were the rules Stephanie and I were discussing when she recently
visited my office to review the builder's purchase agreement for a new downtown
Toronto condominium.
After we went over the offer in some detail, she told me that she had to
get high-ratio financing for the purchase because she had only a 20 per cent
down payment after taking full advantage of the $20,000 HBP contribution.
With a purchase price of about $253,000, and a healthy down payment of
$51,000, she was going to be about $12,000 short in order to get a 75 per cent
mortgage without paying CMHC insurance fees. In other words, if Stephanie had an
extra $12,000, she would avoid paying the CMHC high ratio premium of 1 per cent
(plus 8 per cent provincial sales tax on the 1 per cent) on her $202,000
mortgage.
For lack of an extra $12,000, Stephanie would have to borrow and repay
about $2,350 in mortgage insurance charges — a premium of almost 20 per cent on
the $12,000.
It was then that I told Stephanie about a neat way of avoiding the CMHC
fees and reducing her borrowing from 80 per cent to 75 per cent of the cost of
the condominium.
First, I asked her the magic question: Do you have any money besides the
first $20,000 in your RRSP?
Yes, she said, I have another $20,000 after I take out the initial
$20,000.
Is it liquid? I asked.
Yes, she replied, but why?
Then I explained to her that although she had that extra $20,000 in her
RRSP, about $8,000 of that money really belonged to Ottawa. It was the tax money
she didn't have to pay when she put the money into the savings plan. Eventually,
she would have to pay the taxes back to the government — sometime before the
year 2043 when she turns 69.
Or, I said, she could pay the tax now and collapse the plan. If you pull
the second $20,000 out of the RRSP now, you'll have about $12,000 left after
taxes — depending on your tax bracket. You can add it to your down payment, and
avoid paying any CMHC fees at all.
In addition, I pointed out that her mortgage would be $12,000 smaller,
resulting in lower payments and an interest savings of $576 a year in after-tax
dollars for the next 25 years. If she put that money into the mortgage along the
way, and invested all her after-tax RRSP money into the mortgage instead of the
plan for the next 15 or so years, the mortgage would be paid off much sooner
than the original 25-year amortization.
Then Stephanie noted that aside from repaying the $20,000 to her RRSP for
the Home Buyers Plan loan, she wouldn't have the additional $20,000 in her plan
because she would spend it on the condo. This bothered her until I explained why
I thought it was a good idea.
Over the years, I have usually advised young clients to forget the RRSPs
and instead pay down the mortgage on their homes as fast as possible.
Most of the conventional advice to the contrary is given by financial
institutions and advisers who are promoting investments in their own RRSPs.
Institutions typically advise RRSP clients to use excess cash to invest
in an RRSP and then pay down the mortgage with the tax refund. The flaw in that
argument is that if it makes sense to use just the tax refund to reduce the
mortgage, why not take all the excess cash, pay tax on it, and use all of what's
left over to pay down the mortgage.
This way, the mortgage will be paid down much faster.
There is no simple answer to the mortgage vs. RRSP debate. Among the
factors to be taken into account are the homeowner's age, lifestyle, tax rate,
mortgage interest rate, investment return inside the RRSP, general financial
health, pension plan and the target age for paying off the mortgage.
I always tell clients to obtain independent financial advice from someone
who is not selling RRSPs.
Surplus after-tax cash invested in a home mortgage rather than an RRSP
could result in having a debt-free home five or 10 years earlier than the
typical 25-year payout period.
See also Smart investors skip RRSPs to pay down mortgage now - Title Page, Feb. 1, 2003 .
-------------------------------------------------------------------------------- Bob Aaron is a Toronto real estate lawyer. He can be reached by email
at bob@aaron.ca, phone 416-364-9366 or fax
416-364-3818. Visit the column archives at
http://www.aaron.ca.
