Moving north across the Canadian border causes enough headaches in the administration and logistics of changing homes. Having to worry about your U.S. retirement account is another matter, with different tax regulations applying to your retirement savings on either side of the border.
If you’re making a move to Canada and have a U.S. retirement account, consider these four main options.
1. Leave the account in the U.S.
Keep in mind Canadian residents can continue to defer tax on their U.S. retirement accounts until withdrawal. If, as a Canadian resident, you have an American individual retirement account (IRA), only an advisor who’s licensed in both the U.S. and Canada can help manage the funds.
2. Withdraw the money as a lump sum.
Note that this is a taxable event, and the taxing jurisdiction depends on your residency status. If you’re a Canadian resident, U.S.-Canada tax treaty may allow the plan administrator to withhold 15% instead of the typical 30%, provided she files Form W8-BEN with the administrator. Talk to you tax advisor about this, as it’s ambiguous whether lump-sum withdrawals qualify for the 15% withholding rate.
3. Transfer your U.S. plan to an RRSP
If you’re a U.S. person for tax purposes, the rules below do not apply to you.
The U.S.-Canada tax treaty allows plan participants to transfer 401(k)s and IRAs to RRSPs without the penalty of double taxation — at least in principle. Canadian residents who collapse a U.S. plan will have the proceeds taxed as Canadian income in the same year.
Typically, your U.S. plan administrator withholds 15%, which, thanks to the treaty, covers off the U.S. tax obligation. The transfer creates RRSP room for the amount moved, which is meant to offset the income inclusion.
So, if you’re a Canadian resident and you transfer $100,000 from your IRA, $100,000 will be included on your Canadian income, and you’ll get $100,000 in new RRSP contribution room. That amount must be used in the same tax year and cannot be carried forward. Crucially, your carrier will withhold $15,000, netting you $85,000 — even though you still have $100,000 in RRSP room.
If you can’t contribute the remaining $15,000 from another source in the same tax year, you’ll lose that room forever. And, being unable to contribute means you’ll be taxed on the $15,000 income inclusion ($7,500 based on a 50% tax rate), which can be partially offset by the $15,000 in U.S. tax paid.
The remaining $7,500 foreign tax credit (FTC) cannot be carried forward, and can only be used to offset Canadian tax owing. If you owe less than $7,500 in Canadian tax, the remaining FTC goes to waste.
Even if you find $15,000 to contribute, you’ll be left with a $15,000 FTC that cannot be carried forward. And you’ll need to owe at least $15,000 in Canadian taxes to come out tax neutral.
4. Convert an IRA to a Roth IRA
This allows you to create a tax-free account in the U.S. for life while you’re a Canadian resident. To be effective, this must be done before you become a Canadian resident, says Matt Altro, president and CEO of MCA Cross Border Advisors.
The conversion is a taxable event in the U.S., but assuming you’re moving to a higher-tax jurisdiction (e.g., Canada), the Roth conversion allows you to access lower tax rates.
The catch is that earnings (but not contributions) must be held for at least five years for the withdrawals to be tax-free. Altro also points out you cannot contribute to Roth IRAs after moving to Canada. “That would contaminate the whole thing. The only way Canada deems it to be tax-free is if you’ve contributed before you became a Canadian resident,” he says.
As a result, it’s a good idea to convert to a Roth IRA several years before moving to Canada. That will also allow you to spread the tax bill from the conversion over several years, and to stay in lower tax brackets.