The availability of a sizeable down payment is the key towards a less stressful journey for home ownership. To ensure our millennials are well positioned, the planning has to start today.
With real estate prices keep soaring at an unbelievable pace across the entire Lower Mainland (B.C.), and throughout Canada, almost every parent of a graduating millennial has these troubling questions constantly on their minds: “How will my kids be able to own a home? How will they even afford to rent a decent place?” Unfortunately, we are no longer able to defer worrying about this type of issue hoping it will somehow “correct” itself. Today, housing is something that one must plan for at an early age.
As parents of graduating millennials ourselves and observing the present reality and “predicting” the inevitable future outcome, we don’t want to find ourselves in a position where we see our children struggling and we are unable to help[i]. Therefore, we have decided to take a proactive approach and plan ahead.
We believe that with little effort from the parents and young adults, it is possible for millennials to have a sizeable down payment at their disposal, when the right time arrives. The starting point is, of course, to have an open dialog with your graduating child and a discussion of his or her own budget, the province’s current housing and affordability concerns and the need to prepare and plan for the future—together.
There are quite a few details to consider and understand their impact on the successful execution of such a plan. However, before diving into the details, here is the basic outline of the plan:
- It requires a 10-year savings term that starts as early as your child’s 17th birthday, or earlier, if you can.
- Both the parents and their children commit to contribute $55 each week into the fund. The young adults match as soon as they begin to work part-time.
- The plan uses both parents’ and the child’s TFSA allowance to ensure that earnings are always tax-free.
- Contributions are used to purchase ETFs (Exchange-Traded Funds or other investment tools) with a variable risk profile.
- An option is to accelerate the contributions once the young adult becomes a full-time employee, while switching to an RESP to exercise the RESP Home Buyers’ Plan (HBP) eligibility down the road.
A 10-year fund. How much to expect.
While it may seem to take a long time, the idea is to have enough time to benefit from the power of compound interest and other investments tools and, at the same time, to make the contributions small enough for most households and young adults.
With a basic outlay of $110 per week in combined contributions, and a realistic (and optimistic) average annual rate of return of 5%, it is estimated that the fund’s future value will exceed $74,000—an agreeable, sizeable down payment that can grow even further with some future individual planning, help from the would-be significant other and, possibly, other First-Time Buyer’s government initiatives and incentives.
The Tax-Free Savings Account cumulative limit for 2019 is $63,500 per person. If the parents have not used the maximum combined allowance of $127,000, they should use their own TFSA as the initial investment vehicle. This will ensure that all future growth of the down payment fund is tax-free. However, once the child turns 19 and can open his or her own TFSA[ii], all contributions to the fund should be made to the child’s TFSA. Then, with the basic contribution outline mentioned above, annual contributions of $5,720 will not exceed the present TFSA annual room limit of $6,000.
Exchange Traded Funds (ETFs)
With the market conditions of the past few years, accumulating funds has become a challenge due to the extremely low interest that the banks offer (between 0.5% and 1.75%). Therefore, the suggestion is that, with a 10-year term, the risk of investing in ETFs, for example, is relatively low, because you will be averaging the market’s short-term volatility. The portfolio of the overall down payment fund can be a tad bit more aggressive at the beginning of the term, and gradually reduce exposure to risk during the remaining years of the fund. You can even transfer some of the accumulated funds from time to time to more conservative investments.
How to approach this type of long-term savings plan exactly is really up to you. Of course, you need to consult your Financial Advisor and discuss how to meet the objectives of your fund to ensure that you are comfortable with the decisions that you make.
Further Individual Planning
No savings plan addresses everyone’s objectives or needs. However, anyone who truly embraces the concept of saving for home ownership should monitor the performance of the fund from time to time and adapt the fund to their changing circumstances.
For example, once the young adults join the workforce and begin to earn a more substantial income, they should convert their portion of the TFSA contributions into RESP to benefit from these following three aspects: (1) with a minimum combined federal and provincial personal income tax rate of 20.06%, $66.33[iii] in gross pay is equal to the $55.00 previously contributed from the net pay, thereby effectively increasing the fund’s contribution by the top tax bracket percentage, (2) paying less taxes, or more accurately, deferring some taxable income until retirement and (3) when the time to purchase a home arrives, being able to take advantage of the RRSP Home Buyers’ Plan (HBP) and withdraw up to $35,000 from the RRSP without paying taxes[iv].
Moreover, the now working young adult has redirected his or her portion of the fund’s weekly contributions to an RESP, effectively leaving room in his or her TFSA annual allowance. Although the parents are finally relieved from supporting their child throughout post-secondary education, they may choose to top up their contribution until the child’s TFSA allowance is maxed ($115/week) and as long as they do not jeopardize their own retirement plan.
If just the two changes above are adopted in the last three years of the fund, the value of the fund could grow by an additional $10,000 and potentially exceed $84,000 in total.
believe that with proactive planning and positive thinking today, we can ensure
that our millennials will be better positioned for home ownership and have a far
less stressful journey towards it.
[i] Some parents will go far out of their way to help their children, including using the equity in their own properties or even downsizing, and risking their own retirement.
[ii] It is worth noting that the child should bank at the same financial institution, so that transfers between the accounts are not subject to bank fees. Also, if the TFSA is registered with an external investment firm, it might be wise to set the outbound payment as a bi-weekly or monthly payment – again to minimize the bank fees.
[iii] Obviously, at this stage, the working young adult is now incurring new types of of expenses (i.e., rent, vehicle and utilities). However, as the young adult was playing an active part of this plan from the first day of the fund, it is likely that he or she will understand the importance of the fund and prioritize it accordingly.
[iv] Note however, that 1/15 of the funds withdrawn from the RRSP must be repaid each year, beginning two years after the funds were withdrawn.