When it comes to tax-sheltered accounts in Canada, the First Home Savings Account (FHSA) stands out as one of the most powerful options available. Combining the tax benefits of both the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA), the FHSA offers a tax break on contributions and tax-free withdrawals. The catch? You have to use the funds to purchase your first home eventually.
If you’re eligible to open an FHSA and plan to do so, one important question arises: What should you invest your FHSA funds in? The options include bonds, Guaranteed Investment Certificates (GICs), stocks, and funds. While investing in stocks is often recommended for long-term savings like retirement when it comes to the FHSA, a different strategy might be more suitable.
Why GICs Are Best for the FHSA
The FHSA is designed to help you save for a specific purchase of a home. Because of this, it’s wise to invest the money in low-risk assets. Here are a few examples of low-risk securities and assets, along with reasons why they are considered safe:
- Cash held at banks: Insured by the government up to $100,000.
- Canadian treasuries: Backed by government taxing power and the Bank of Canada’s monetary policy.
- GICs: Insured up to $100,000, similar to cash.
Each of these options comes with its advantages and limitations.
- Cash in regular chequing and savings accounts earns minimal interest but is ideal if you’re planning to buy a home within a month, as GICs usually take at least a month to mature, and treasuries can be subject to price fluctuations.
- GICs and treasuries are suitable for holding periods ranging from one month to 10 years. They currently offer similar yields, but treasuries are more liquid since they can be sold on the open market, unlike GICs. However, Canada bonds have a minimum order size of $5,000, which could be a limiting factor for smaller FHSA contributions.
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Where to Invest in Stocks
While GICs and bonds are ideal for the FHSA, stocks and stock funds are better suited for RRSPs, where you can hold your investments long-term, potentially until you reach 71 years of age.
One popular stock among Canadians for their RRSPs is the Royal Bank of Canada (TSX). As a stable, mature, blue-chip banking stock, Royal Bank offers many qualities that investors seek in defensive portfolios.
Royal Bank is a dividend stock with a 3.8% yield. If you hold $100,000 worth of RY stock in an RRSP, you could receive $3,800 per year in dividend income (assuming the dividend remains consistent). Historically, Royal Bank’s dividend has grown slightly each year, offering the potential for rising income over time.
This dividend growth makes Royal Bank a strong candidate for RRSPs. Dividend stocks benefit from the RRSP’s tax-deferred status because you can avoid taxes on non-dividend stocks by not selling them. However, dividend stocks in taxable accounts generate taxable income each year. Holding a dividend-paying stock like Royal Bank in an RRSP allows you to maximize the benefits of tax deferral.
When it comes to the FHSA, it’s best to keep your investments in cash and bonds. Stocks, with their inherent volatility, may not be the best fit for an account meant for a near-term purchase like a home. The last thing you want is for market fluctuations to delay your home purchase. Instead, consider reserving your stock investments for your RRSP, where long-term growth and dividends can be more effectively utilized.