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If you’re planning on buying a home in the next few years, you might consider parking your down payment in a First-Time Home Buyer Savings Account (FHSA). A few states currently sponsor FHSAs, and they’re different from basic savings accounts in that they can save you thousands of dollars in tax deductions. However, they come with restrictions on contributions and the money in these accounts must be used to purchase a home, so you have to be pretty darn sure you’re going to buy a home. Here’s a look at whether these accounts are worthwhile.
What is an FHSA?
To encourage home ownership—particularly for younger people struggling to pay off student loans—some states offer savings accounts that must be used for homebuying expenses. The benefit is that a certain amount of your total contributions for a given year can be deducted from your taxable income. The tax-deductible portion of your contributions varies by state, but it’s typically around $2,500-$5,000 (you’ll pay taxes on contributions that exceed that amount, however). However, the funds in this account have to be used to purchase a home in the state sponsoring the account, otherwise there’s a penalty on withdrawals—it’s sort of like a 529 plan for homes.
Currently, only Alabama, Colorado, Idaho, Minnesota, Mississippi, Montana, Oregon and Virginia offer FHSAs, although legislation is either planned or under discussion in Louisiana, Massachusetts, Michigan, Missouri, Nebraska, New Jersey, New York, and Pennsylvania.
The potential tax savings vary quite a bit between states. For example, Minnesota’s FHSA only allows you to deduct the interest and dividends earned from the account, which is capped at $50,000 for individuals. Oregon’s plan, by comparison, allows you to deduct $5,000 worth of contributions annually from your taxes, for an account that phases out for individuals after $104,000.
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How to know whether a FHSA is right for you
Since each state has different rules about account maximums, tax deductions, contributions account limits and withdrawal penalties, you’ll want to do your own research and make sure that the benefits of a FHSA makes sense for you. To get you started, Value Penguin has a chart that breaks each state’s plan.
The other concern is how long you’d want to actually use these accounts. As we’ve discussed before, when you’re ready to buy a home it’s a good idea to keep your down payment somewhere that’s accessible and low-risk, typically a savings account. The drawback is that the interest rates are super-low, usually around 0.6%.
For that reason, you might be better off growing your down payment for as long as possible by parking it in an investment account, like an IRA, as they have returns closer to 10% (that’s not always guaranteed, of course). When you’re within a year of actually shopping for a house, then you might consider using a FHSA account. The advantage is that if your home buying quest takes longer than expected—day, 12-18 months—you’d at least get some kind of tax deduction for keeping your money in an FHSA rather than a basic savings account.
Bottom line
FHSAs can definitely save you a few thousand dollars in taxes per year while you save your home, but you have to be certain that you’ll buy a home in the state sponsoring your plan.
Plus, there are some opportunity costs to consider since that money could grow at a faster rate if placed into an investment account. Of course, investment accounts carry more risk than savings accounts, so you’ll have to assess which one is the better option based on your risk tolerance. This is why it’s a good idea to consult with a financial advisor or CPA before you decide what to do with your down payment.
