Your FHSA contribution limit: avoid these 5 common mistakes

Anyone looking to buy their first abode knows that homes are not cheap, which means you’ll need to save up a decent down payment if you want to own a place of your own.

While there are a few programs to help first-time homeowners save for a down payment, most aren’t as attractive as the new Tax-Free First Home Savings Account (FHSA). This new account, launched in April 2023, combines the more attractive features of a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA), creating a powerful tool to help your down payment dollars grow.

As with any registered account, though, there are some rules you’ll want to be aware of before you open one up to help you save.

FHSA qualifications

Before you can use an FHSA, you must be qualified to open one. First, you have to be a Canadian resident who is at least 18 years old (or 19 in the Territories), and also under age 71, and you must be considered a first-time homebuyer. The government considers you to be a first-time homebuyer as long as you haven’t owned your principal residence over the past four years and you are not living with a spouse who owns a home at the time when you open the account. That said, if you or your spouse owns a home that hasn’t been your primary residence, like a rental property or a seasonal cottage, you could possibly still qualify.

What is the contribution limit for an FHSA?

The FHSA allows you to contribute up to $8,000 in your first year, up to a lifetime limit of $40,000. You don’t have to max out your contributions every year, but if you do, you’ll hit the lifetime limit after five years. (And the more you save now, the more time those dollars will have to grow.) No matter what you put into the account, once you’ve opened up your FHSA you’ll have up to 15 years (or until you turn 71 years old) before you must withdraw your savings.

Common mistakes

The rules sound simple enough, but there are some common mistakes that can trip up even the savviest saver.

Mistake #1: Overcontribution

One of the benefits of using an FHSA is that, as with an RRSP, your contributions can potentially earn you a tax refund. It’s a nice perk, but don’t exceed your contribution room. If you do, your FHSA will be subject to a 1% penalty per month on the excess amount. For example, if you contributed $10,000 in the first year of opening your FHSA – $2,000 more than you’re allowed to do in a year – you’ll get dinged $20 each month until you either remove the excess amount or your participation room increases on January 1 of the next year.

If you do overcontribute, you can withdraw the excess amount without paying income tax. You can also transfer those extra dollars to your Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF), as long as you have unused contribution room in those accounts.

Mistake #2: Not maximizing your contribution room

You also don’t want to underutilize your contribution room. Why? First, FHSA contributions are tax-deductible, meaning any contributions you make lower your taxable earnings – so you could be eligible for a refund on your income tax, which you could then put back into the FHSA for even more savings. Second, anything you earn within the account grows tax-free, which helps your money compound faster. Finally, you don’t pay any tax on your withdrawals if the funds are used for a qualifying home purchase. By not maxing out your FHSA contribution limit, you’ll be missing out on these money-saving perks.

Mistake #3: Worrying about the 15-year duration

When you open an FHSA ,you start the 15-year countdown to when you need to use the funds. Deadlines can be stressful, but don’t get too worked up about this one. Ideally, after a decade and a half of saving, you’ll be ready to withdraw your funds to make a qualifying home purchase. But if you do decide that you’re not ready to buy a home after that time, or it’s not your priority any more, you can transfer it tax-free to an RRSP or a RRIF, even if you don’t have any unused contribution room in those accounts.

But don’t ignore the deadline entirely. As important as it is to start saving early, opening an FHSA as soon as you’re eligible means that you’ll increase the likelihood of being financially ready to buy your first home in your early 30s. That’s great if you’re financially ready to buy a home then; the FHSA could be an excellent tool to help you get there.

Mistake #4: Not understanding the FHSA carry forward

If you can’t use up your full contribution room in a year, don’t worry. You can carry forward the unused portion and add it to the next year. For example, if in year 1 you open your FHSA and contribute $6,000, in year 2 the available contribution room will be $10,000, which comprises the unused $2,000 contribution room from year 1 and $8,000 of new contribution room from year 2.

However, there are some nuances to the carry-forward. Unused contribution room from a particular year can only be used in the following year. Continuing our example: if you contribute $1,000 in year 2, it is first “applied” against the unused $2,000 contribution room from year 1, and the remaining $1,000 of room is effectively lost; it can not be carried forward to year 3. However, you still have $8,000 of carry-forward, because the $1,000 contribution counts against the previous year’s carry-forward amount, and therefore none of the year 2 $8,000 room is considered to have been used. In year 3, the available contribution room will be $16,000, which comprises the unused $8,000 contribution room from year 2 and $8,000 of new contribution room from year 3.

Further, it should be noted that you can not open an account, contribute nothing for five years, and then make a lump sum contribution of $40,000. The maximum contribution in a single year is $16,000 (the annual $8,000 + a maximum $8,000 carry-forward from the previous year, if no contributions were made).

And a word of caution: the longer you delay contributing to the account, the less time your investments have to grow. Remember, contribution room only accumulates once the account has been opened.

Mistake #5: Confusing FHSA benefits with those of RRSPs

With an RRSP, you have the option of contributing to your spouse or common-law partner’s plan, but this isn’t the case with FHSAs. Contributions to an FHSA can only be made and deducted by the FHSA holder. The good news: you and your spouse can both open an FHSA and combine the savings on a first home, provided you are both considered to be first-time homebuyers. There is also nothing stopping a spouse from giving the money to their partner to contribute to an FHSA.

Now that you’re aware of common mistakes investors make with FHSAs, you can stay clear of any missteps and unlock the full potential of your FHSA contribution limit. The FHSA can be an essential tool for making your homeownership dreams a reality.