When moving between Canada and the USA, there are common challenges that individuals often face. Aside from the practical aspects of the move, there are also tax and financial considerations to assess. In particular, you may have accumulated savings in a recognized retirement arrangement like a 401k plan or an individual IRA. What should you do with these retirement plans if you move across the border, and what are some consequences? Unfortunately, there is no simple answer for the procedure, but below are some tips and general information.
Crossborder investment specialists often expatriate employees accrue retirement and pension benefits while working for an employer. If you decide to move back home (Canada), what should you do with the 401k or IRA account?
Your options are to:
1. Leave your 401K or IRA in the US and have someone manage the investments for you;
2. Cash out the plan and pay a lot of unnecessary tax;
3. Start to take a retirement distribution (if you are of retirement age);
4. Transfer the plan to an RRSP in Canada.
An added complexity to these four choices is that they are affected by tax implications and securities regulations.
Option 1: Leave your 401k/IRA in the US:
If you choose this option, you would essentially leave the plan intact until you require the income during retirement. Unless the manager of the 401k permits, you may be required to transfer the 401k to an IRA. If you are over 59.5, you will see a 20% withholding tax on your distributions. If you are under this age threshold, there would be an additional 10% penalty tax unless you meet certain conditions. There would be no real tax implications on the earnings within the plan until you begin to withdraw. In Canada, the Canada Revenue Agency (CRA) would typically tax you on an IRA if the USA’s Internal Revenue Service (IRS) takes a similar position, which normally happens once you start withdrawals.
Choosing to leave the plan as is in the US can also lead to other challenges. Many investment firms and brokerages will not allow an investment account (retirement account or otherwise) to be held by a non-resident. Before terminating your US residency, you must open an investment account with either a discount/online broker or a full-service investment firm. If you wait until you have moved to Canada to secure investment accounts and initiate transfers of IRAs, it may be cumbersome, although not impossible. Unlike some Canadian investment firms, US investment firms are very reluctant to have an investment/retirement account held by a non-resident of the US.
Option 2: Cash out the plan and pay a lot of unnecessary tax:
This option is perhaps the least favored. There is no compelling reason to redeem your IRA and cash out the plan unless you desperately need cash. For most individuals, it just doesn’t make sense from an investment management or tax perspective.
Option 3: Start to take a retirement distribution:
This option is only truly relevant for those old enough to consider retirement. While resident in Canada, retirement distributions from your US-based 401K will be subject to US withholding tax. CRA will also declare the distribution as a foreign pension in Canada. Consult a qualified cross-border tax professional to ensure proper reporting of such foreign income and to optimize the use of foreign tax credits.
Option 4: Transferring a 401k / IRA to an RRSP in Canada:
A 401k is an employer-sponsored defined contribution (DC) retirement arrangement. If your employer made contributions while you were a resident of the US, you will be allowed to make a lump-sum transfer from your 401k. Specifically, you can transfer a 401k to a rollover IRA (employer permitting) and then transfer the IRA to a Canadian RRSP.
In more detail, the transfer of a 401k ultimately to an RRSP usually occurs as follows:
1. Open a Rollover IRA account with a firm capable of cross-border investment management.
2. Roll over the 401k to an IRA while still a resident of the US. You cannot roll a 401k directly to an RRSP.
3. Withdraw all of the IRA as a Canadian resident (you will be assessed a 20% withholding tax, possibly reduced to 15%). If you are under 59.5 years, an additional 10% penalty will not be recoverable.
4. The net resulting lump sum payment is then transferred to an RRSP. The subsequent deposit into an RRSP must occur in the year of withdrawal or within 60 days of year-end.
5. Determine the value of the transfer in Canadian dollars.
6. The full gross withdrawal, including the withholding tax, is included as Canadian income with a deduction referencing a section 60(j)(ii) transfer. This results in no additional tax liability to Canada.
7. The 20% withholding tax paid to the IRS in point number “3” above may be claimed as a foreign tax credit (FTC) for Canadian tax purposes. FTCs require a more detailed explanation.?
Checklist of transferring a 401K to an RRSP Now, the complications. The 401k must be a lump-sum transfer from a pension or superannuation and employment services rendered while a non-resident of Canada. There are different rules for individuals living in Canada and working in the US or the case of temporary employees working in the US for less than five years.
The withholding tax paid to the IRS that is claimed as a foreign tax credit in Canada requires the advice of a tax practitioner. Generally, the taxes paid in the US can be used to reduce the tax liability in Canada. However, since FTCs are multi-faceted, it can take several years of claiming credits to attempt to recoup the initial 20% withholding tax that was paid.
Please remember that you haven’t paid tax to Canada on the IRA withdrawal, only to the IRS. Therefore, you need to have sufficient Canadian income tax owing from certain sources to utilize the FTCs. Canada views the IRA withdrawal as a transfer, while the US views it as an early lump sum withdrawal and thus applies the 20% withholding tax.
A final distinction must also be made if the IRA account has been subject to proceeds from a ROTH conversion. Such conversions would taint the account, and this technique would become muddied because Canada does not recognize ROTH plans in the same context as “foreign retirement arrangements.” Furthermore, Canadian Tax-Free Savings Accounts (TFSAs) and ROTHs are separate categories with another set of rules and guidelines for anyone wishing to move across the border.
What about the reverse, transferring from an RRSP/LIRA to an IRA?
Thus far, we have only explored the mechanics of a person moving from the US to Canada, but what solutions exist for a person moving from Canada to the US? Unfortunately, RRSPs or LIRAs (locked-in plans) cannot be transferred to an IRA. Please also be aware that the place and timing of these transactions should be aligned with pre- and post-move planning that captures the realities of residency and the ceasing of non-residency. Many aspects of the information contained herein can also apply to retirement arrangements from other countries like the United Kingdom.
Disclaimer (as per Circular 230). To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in our communication (including any attachments) was not intended or written to be used and cannot be used for (i) avoiding any tax penalty or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Our communication is limited to the conclusions specifically set forth herein and is based on the completeness and accuracy of the facts and assumptions as stated. Our advice may consider tax authorities subject to change, retroactively and prospectively. Such changes could affect the validity of our advice. Our advice will not be updated for subsequent changes or modifications to applicable laws and regulations or the judicial and administrative interpretations thereof.