Stuart Dollar

The situation

Gordon Ayade* is a Canadian citizen living in Ann Arbor, Mich. A celebrated psychiatrist, Ayade attended medical school at McMaster University where he met his wife, Grace,* now an accomplished surgeon, in their graduating year (1990). They worked separately at various Ontario hospitals and clinics for nine years. Neither was incorporated.

In 2000, an Ann Arbor hospital made the power couple an offer they couldn’t refuse, and they settled in Michigan as U.S. green card holders. They accepted partly to remain close to Gordon’s hometown of Windsor, Ont. (Grace is from Whitehorse.)

The Ayades, both 53, have fulfilling careers, but their thoughts are turning toward retirement. As they have no children but several nieces and nephews back in Windsor, they’re wondering if they should retire in Canada. The Ayades would like to finish working by 2025, when both will be aged 60. They each earn US$250,000 per year.

If all goes as planned, the pair will have worked nine years in Canada and 25 years in the U.S. They will also have contributed to CPP for nine years and Social Security for 25.

Their current assets are as follows:

  • RRSPs of CA$20,000 each (all contributions made while in Canada)
  • 401(k)s of US$1 million each
  • Roth individual retirement account (IRA) of US$250,000 each
  • House worth US$650,000 (paid off)

Assuming they move back to Canada in 2025, and using current tax law, what should the Ayades do?

First, some context around their entitlements. While the Ayades won’t qualify for full OAS pensions, they may qualify for partial ones if they live at least 10 years in Canada by 65. Because of pension income splitting, they may also be able to reduce or eliminate some of the OAS clawback.

The Ayades won’t receive full CPP benefits, as they’ll have contributed to the plan for only nine years by the time they retire. But they’ll get a Social Security pension at 67. They’ll have to report that benefit on their Canadian income tax returns and can deduct up to 15% of the amount reported.

What are the choices?

The Ayades have five options for dealing with their 401(k) plan, Roth IRA and RRSPs.

  1. Withdraw the 401(k) and IRA money in a lump sum before returning to Canada.Their 401(k) withdrawal will be taxed at U.S. federal and state rates. Money withdrawn after returning to Canada will be subject to 30% U.S. non-resident withholding tax and will be treated as income for Canadian tax purposes. They may be able to use a foreign tax credit on their Canadian returns to partly or fully offset the withholding tax. If they leave their 401(k) money in the U.S., they must start required minimum distributions (similar to minimum formula withdrawals) by the end of the year they turn age 70½ (though they can delay their first withdrawal to April 1 of the following year).

    A withdrawal strategy may make sense only to finance anticipated short-term needs arising over the first few years after returning to Canada. Given the size of their 401(k) plans, it’s likely that those plans will have to support most of their retirement income needs, so continuing tax deferral for the bulk of their plans is important.

    There’s no taxation for Roth IRA withdrawals made after the plan owner reaches age 59½, as long as at least five years have passed since the original Roth IRA contribution. By 2025, when the Ayades will be 60, that’s no worry. If they don’t withdraw any money, tax deferral can continue until their deaths.

  2. Transfer the 401(k) plan money to a traditional IRA and leave the IRA in place.U.S. securities rules generally prohibit non-residents from owning mutual funds or securities, including those in their IRAs. Guaranteed investments are allowed, but returns are low. A 401(k) plan to IRA transfer therefore isn’t a good option if the Ayades need higher potential returns.

  3. Before returning to Canada, transfer the tax-deferred 401(k) plan assets to a designated Roth account in their 401(k) plans, if their plans offer them.The strategy could help them eliminate taxes on some or all of their future 401(k) plan growth. A downside to this strategy is that the conversion is treated as a taxable withdrawal, though taken at lower U.S. tax rates. Another downside is that the same securities rules that make a traditional IRA problematic for a Canadian citizen and resident to own apply also to a Roth IRA.

    Once the Ayades become Canadian residents, they just need a one-time election to maintain a Roth IRA’s tax-free status on growth and distributions in Canada.

  4. Leave the balance with the former employer’s 401(k) plan.All investments in the 401(k) should be allowed under U.S. securities rules (unlike the case with traditional or Roth IRAs). Any plan growth is tax deferred and can be transferred tax-free to the surviving spouse at the plan owner’s death.

    401(k) plans offer limited investment options. But this could be a good route if the Ayades are satisfied with their 401(k) plans, and can cope with the tax complexity arising from a large part of their retirement assets remaining in the U.S.

  5. Transfer the 401(k) plan balances to an RRSP.This can be done on a tax-neutral basis. There is a potentially greater range of investment options than under a 401(k), and no need to worry about complying with U.S. 401(k) plan rules. There’s also no need to worry about currency fluctuations once the transfer is done.

    The Ayades can transfer traditional IRA and 401(k) assets to an RRSP, but not the reverse. So they must be very certain that they’re returning to Canada for good.

    It’s important that the Ayades consult a tax advisor to help them plan each stage of the transfer. If one stage fails, the entire strategy can fail, potentially generating adverse tax consequences. This can be an appealing option if the Ayades want to consolidate as much of their retirement portfolio as possible, simplifying administration.

Consider estate taxes

The Ayades have a net worth of US$3,203,200 (assuming a 75¢ Canadian dollar). Under current rules, if they both died, their estates wouldn’t pay estate tax.

If the Ayades sell their house and return to Canada, only their U.S. situs assets would be subject to estate tax – their 401(k) plans and Roth IRAs. Under U.S. estate tax rules, a U.S. citizen or resident is exempt from estate tax for a certain part of their estate (currently US$11.18 million per person). Under the Canada-U.S. Tax Treaty, the Ayades will be entitled to a proportionate exemption equivalent.

However, they may incur a capital gain on the sale of their house. U.S. law generally allows fewer opportunities to shelter such gains than Canada’s principal residence exception. Considering their home’s value, though, they should be able to exclude all their gains from tax if they purchased it for over $150,000.

The Ayades’ situation has many moving parts. The discussion here is not intended to be a complete analysis. They should speak with a tax adviser and with a cross-border financial planner who understands the tax and government benefits issues that arise in both Canada and the U.S.