Playing With House Money: Ways To Save For That First Home Part 2

As I discussed in Part 1 of this series, saving enough money to buy a first home in Canada these days may seem like deciding to run a marathon without ever owning a pair of running shoes– a long daunting process that may sometimes seem impossible. On the other hand, just like having a training plan to help you complete 26 miles of running hell, having a savings strategy for how to put away enough money buy a place to call your own similarly increases your chances of home-owning success. The first part of this series discussed and compared the three registered savings plans that can help maximize your eventual downpayment, particularly the new First Homebuyers Savings Account that combines the best features of a TFSA and the RRSP Homebuyers’ Plan. Today, I talk about a few additional options other family members can explore if they want to assist the next generation buy into the housing market.

Before diving in, I want to reiterate the key messages from my last article so you read today’s effort with those points in mind. Those are:

One size doesn’t fit all. You’ll have to strategize based on the specifics of your situation rather than assuming what is right for someone else is the most efficient way forward for you.
Any plan may involve using a combination of savings strategies rather than one stop shopping, particularly since there are caps on the government savings plans. Determining the best mix and which options to fund in which order is vital.
If other family members are willing to help (or if you’re one of those generous souls), creating an integrated plan that maximizes everyone’s contributions can make a world of difference. Consider planning as a family and getting professional input.
Plan ahead. Make the most out of the magic of compounding by setting aside funds early and in the right savings vehicles. Older family members can start assisting as soon as youngsters are old enough to open registered savings accounts.
Ensure that your investment mix matches your goals and time horizon. Reduce risk and volatility the closer you get to attending open houses so a change in the stock market doesn’t decimate your down payment.

Family Trusts – Are The Hassles Worth The Tax Savings?

Key Benefits:

Potential massive tax savings if the contributor is in a high tax bracket.
Can allow purchase funding to start far earlier than most other options.
Can be used to augment a youngster’s other savings vehicles or to provide the money to fund those plans.
Loan rates are locked in for life, which is a huge advantage for families who lent money to their trusts before the recent rate hikes.

Key Drawbacks:

Setup and annual costs, plus the headache factor, make this option only really attractive in Wills or when there is perhaps $500,000 plus to contribute at once or over a few years.
The current minimum trust loan rates (May of 2023) are five per cent, which is far less attractive than the one per cent loans offered until July of 2022, which drastically reducing the amount of money left for income splitting after the lender is paid this sum.
May require faith that money allocated to youngsters will ultimately be used responsibly when they are adults.

Trusts either created in a Will or funded during life by gifts or interest-bearing loans at the minimum government rate then in effect are an incredibly valuable tool for families with enough non-registered money to make the costs and effort worthwhile. If set up correctly, they can transfer income that would have been taxed at far higher rates in the hands of older generations to their spouses as well as younger and poorer family members, including minors in some cases. The benefits of a decade or two of extra money left to compound these yearly tax savings can almost seem magical and can make massive difference to junior’s later housing prospect.

As an added benefit, although there might be a sizeable chunk of change in the trust that is used to create taxable income and capital gains, trusts can be drafted so that the original capital loaned or gifted to the trust doesn’t necessarily have to pass to the child. Perhaps just as importantly, how much of the income or gains get allocated to the various family members can be discretionary, so that no funds get distributed to a child or grandchild who hasn’t yet got their act together. The trust can also lend the youngster funds on an interest-free basis so that the family has some control over at least that amount if the child goes off the rails or perhaps as a way of providing a bit of protection in the event of a divorce or creditor concerns.

On the other hand, trusts can allocate money to youngsters but keep the funds invested inside the trust, issuing the child an interest-free promissory note. Over time, if the value of the note continues growing, this can eventually be the down payment. Once that child is an adult, however, they can call in the note to use any way that they like. Accordingly, each family would need to determine their own comfort level. Rather than issuing these promissory notes, the family can simply use each child’s annual allocations to pay that child’s expenses or reimburse their parents. This still leaves the family with far more money than it would have otherwise had if the investments perform as expected but reduces the risk that junior might spend two decades worth of Promissory Notes on a really big truck as soon as (s)he officially becomes an adult.

Obviously, a trust funded by a living relative is not something that every family can afford and the dramatic increase in the minimum interest that must be paid on borrowed funds also eats into some of the profits. Moreover, for trusts created in Wills, it is usually impossible to know exactly when they will be funded. In many cases, although they may still be an invaluable tax saving vehicle for future generations, the money going into the trust may only arrive after a child or grandchild is already many years into home ownership.

Life Insurance – Living Benefits From An Asset Meant To Pay Out At Death

Key Benefits:

Provides later protection for the child’s family while also creating a side savings account that will grow tax efficiently which can be used as needed later in life.
Money can be accessed in a variety of ways.
Ensures insurance for the child even if their health later changes.
Provides protection to the family if a child passes away, particularly after incurring significant medical costs. Allows parents time to grieve.

Key Drawbacks:

Requires funding many years in advance and a parent / grandparent who is willing to assist.
Annual payments are required for at least 10 years in most cases.
Some withdrawals in the child’s hands may be partially taxable.
May not direct as much money towards a down payment as some of the other options, as some of the premiums go towards the life insurance benefit.

Permanent life insurance with a cash value is another all-purpose savings tool that can lend a hand when junior wants to get his own pad. The purchaser of the policy is usually a parent or grandparent who gets things going before the toddler has started to crawl. They purchase the policy for typically a combination of reasons:

Ensuring that the child will have protection for their own children one day even if their health later makes insurance extremely expensive or impossible;
An intergenerational wealth building strategy that allows excess allowable contributions to the policy to compound essentially tax-free until it eventually produces a tax-free death benefit; and
Most importantly for the current discussion, a savings strategy to accumulate a pot of money the child can use during life in various ways, such as purchasing a home.

Interestingly enough, even though the death of a child, particularly after a long and expensive illness, can have a profound effect on family finances, most people don’t purchase policies on children with this risk in mind.

The typical strategy involves purchasing a “participating whole life policy” (although other policy options are available) and paying the maximum amount allowed under the tax rules into the policy each year, which is usually many times more than the minimum required payment for at least 10 years, although 20 is better. The excess cash grows virtually tax-free in the policy at a set rate each year determined by the insurance company that usually increases when interest rates increase, although lagging slightly. After contributions stop, some of the annual income (called “policy dividends”) on the accumulated cash value is used to pay that year’s premium and the remainder is reinvested. Moreover, some policies also have guaranteed annual increases to the cash value as well, which further grows the war chest that junior can tap into in later life.

Still others are “paid up” in a set number of years (usually 10 or 20), which means that no further premium payments are required or deducted from that year’s policy dividend payment. For safety-minded investors, a participating whole life policy is ideal, as it works a lot like a savings account -- all policy dividends and the cash value are locked in once earned and accumulate like compound interest. The only way the cash value will ever decrease is if the owner makes withdrawal or to pay the annual premium or policy fee. At this point, policies typically pay about six per cent per year, although the expectation is that this will increase due to the drastic increase in interest rates this year, although increases inside the policy usually lag interest rate increases.

Relating all of this to home purchases, the process works as follows. The (grand)parent(s) buys and own the policy and maximizes allowable contributions each year for 10 or 20 years on a policy on the child’s life. Eventually, they transfer the policy to their child or grandchild. The youngster can then withdraw all or some of the cash value, some of which can come out for free and some which will be taxed as income. The money can be used towards that first home either directly or perhaps to fund contributions to one of those government accounts mentioned earlier, particularly the FHSA, in order to offset any potential tax owing on the withdrawal.

There are other potential ways of accessing the money, such as “borrowing” your money from the insurance company through what is called a policy loan, so the cash value continues to accumulate inside the policy or, for policies with larger cash values, using them as collateral for bank loans. And if youngster isn’t attracted to the allure of home ownership, the money in the policy can always be used for other purposes, like educational funding, or continue to grow inside the policy until the time is right or add to the eventual death benefit used to protect that youngster’s own family.

Conclusion

As I stated in my last article, buying a new home in Canada right now is likely harder than at any point in history. Fortunately, “difficult” does not mean “impossible.” Careful planning can make all the difference, particularly if done many years in advance and if older generations are part of the solution. Moreover, like so many aspects of life, one size does not fit all. Your job is to review the information in this article and my last effort, plus from whatever other sources you trust, to create a plan custom-fit just for you. Moreover, your plan might involve a variety of people helping in a variety of ways, particularly since there are funding limits on the various registered plans earmarked to help you buy a place to call home. In my next article(s) on the subject, I’ll reach out to parents and grandparents who are eager to assist if junior is still short of cash when it’s time to buy, such as through loans, gifts and direct ownership of a pie of the pie. Until then, happy saving!

Colin S. Ritchie, BA.H. LL.B., CFP, CLU, TEP and FMA is a Vancouver-based fee-for-service lawyer and financial planner who does not sell investment or insurance, just advice. To find out more, visit his website at www.colinsritchie.com.