Canadian couple working in the U.S. faces retirement risks

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?

* These are hypothetical clients. Any resemblance to real persons is coincidental.

The experts

L.J. Eiben president and CEO, Raymond James (USA) Ltd., Vancouver

JD Greenberg president, Paisley Pike, Toronto

Lea Koiv principal, Lea Koiv & Associates Inc., Toronto

Stuart Dollar director, tax and insurance planning, Sun Life Financial Read Stuart Dollar’s analysis here

Planning misses

JD Greenberg: Before we start plugging in numbers, I would take a step back to figure out the clients’ lifestyle goals. That’s based on how much they spend. Where do they want to live? Do they want to spend six months somewhere warm? Do they want to have a cottage in Ontario so they can visit family, or have a place where everyone can congregate every summer?

Also, are they even in the position where they can retire by 2025? How much of a cutback would they have with their living expenses, and how long will $2 million last?

Lea Koiv: I looked at the Canadian pensioners’ mortality table, and they say you should do the financial plan to the age at which they have a 25% chance of being alive. Age 50 is when half the population is dead. At age 55, looking at that table, a male has a 25% likelihood of making it to 94; a female to 96. One of the two [will live until age] 98. And the wealthy and healthy tend to outlive the population.

L.J. Eiben: As doctors, they’re probably a bit healthier than average. I don’t see any savings other than the retirement accounts. I don’t see any cash accounts or liquid investments. So that tells me they’re throwing it all into their retirement accounts and spending the rest. If they’re going through $250,000 per year, for instance, they’re not on track to making their retirement plans. It seems like a lot of money, but it depends on how much they plan on spending.

To retire in the U.S. or Canada?

JDG: It’s a balance between costs. You’ve got lower taxes and cost of living, but higher medical costs in the U.S. In Canada, you’ve generally got higher taxes, but lower medical costs. It’s such a trade-off that you don’t have anything clear cut, which is why asking those lifestyle questions is important.

LJE: No matter where they live, as U.S. persons with green cards, we do not recommend the RRSP 60-day transfer from an IRA. There is no incremental benefit of moving the money up to RRSPs when you can continue to work with a financial advisor that can manage an IRA or 401(k) account.

JDG: Yes, as long as you’re a U.S. green card holder, it’s going to be tax-costly to move the money to an RRSP because you’re going to be taxed at your U.S. rates. They’re in Michigan and, at their income level, they’re probably at an almost 40% tax rate. If they give up their green cards, then a lump-sum withdrawal would be at a 30% tax rate. Plus they’re young, so they’ve got a 10% early withdrawal penalty.

LJE: Instead of the RRSP 60-day transfer, they can convert the 401(k)s to IRAs upon retirement. Some of the initial benefits are collapsibility of investments and having more choice and control over most investments.

The other reason why we like the IRA over the RRSP is the stretch IRA feature, which allows the individual to pass their retirement accounts from one generation to the next. It sounds as if the nieces and nephews are a big part of their daily life, and the Ayades could pass the IRA on to them.

Also with the IRA, if they have a year in very low income, they can actually pull money out of the IRA and convert the IRA to a Roth IRA, which would then [keep] those millions of dollars in assets tax-free forever. That’s because you pay taxes on your Roth IRA contributions every year, instead of paying taxes upon withdrawal. But they’ll be converting from an IRA to a Roth IRA, making it tax-free.

LK: What’s the latest you can take income from these U.S. plans?

LJE: 70.5 years old. At age 59.5, there are no more penalties. By 70.5, the IRS has a required minimum distribution (see “More on IRAs,” page 32).

JDG: It’s similar to a RRIF in that there’s a formula that has to be followed to determine the minimum withdrawal.

LK: Like Canadian plans, do these plans have maximum [withdrawals]?

LJE: No, you can take a lump-sum distribution. Another consideration: based on their work experience, they’d qualify for social security benefits in Canada and the U.S. Since they have 25 years working in the U.S., it would probably outweigh the nine years in Canada. So it’s a small impact on their U.S. social security. Further, the totalization agreement between Canada and the U.S. means they can avoid double taxation of income for their social security taxes.

LK: To collect OAS, you need to have lived in Canada for at least 10 years past age 18, so they’ll meet that test. But they cannot collect it in the U.S. If they moved back to Canada, they’d get it. But given the income they have, OAS will be clawed back. Basically, OAS is off the table.

To get CPP, you simply have to have been employed and paid in Canada, which they have done. So they could collect that. If they stayed in the U.S., they would collect Social Security.

And if we go back to when these people would have been employed in Canada, the year’s maximum pensionable earnings (YMPE) would have been quite low. The YMPE is the maximum, annually, on which you pay into the CPP, and the amount is indexed. The YMPE when they left Canada in 2000 was $37,600, so quite low. They likely hit that amount.

JDG: So they would have qualified for maximum CPP eligibility for the years they worked, but there weren’t that many years.

LK: Yes. Also, we don’t know if they have any life insurance policies. If they come to Canada with life policies issued in the U.S., the policies may or may not be exempt within the Canadian legislation. A lot of these policies have a savings component. The Canadian policies get designed by Canadian companies in such a way that the investment component is not taxable. Without seeing if they have U.S. policies and how they’ve been designed, they could be offside the Canadian legislation.

LJE: I agree. So as they’re reviewing any insurance plan, make sure that it does meet the setup and structure so that it still achieves the same sort of goal or equivalent tax treatment in Canada. It’s an area we need to consider if they’re coming back to Canada.

Tax-filing obligations

JDG: They want to stay in compliance with all of their tax filing and reporting obligations. As U.S. people with green cards, they’re required to do U.S. returns every year, no matter where they live. They’d likely be filing one joint tax return, so everything gets lumped together.

And if they maintain their green cards and establish residency in Canada, they’re also going to have a Canadian tax return. They’ll be planning for both, effectively paying the higher rate.

Because they already have RRSPs in Canada, they’ve got Foreign Bank Account Report (FBAR) filing that they have to do every year, as well.

LK: What could this couple expect to pay for annual tax filing in the U.S.?

LJE: About $5,000 to $6,000 per year.

Estate planning

LJE: As mentioned, the stretch IRA feature is a good estate planning benefit. There would be a 15% non-resident alien withholding tax. If [beneficiaries] don’t want to pay the 15% withholding on that money, then they can file IRS Form 1040-NR. We typically find that they turn around within a few months and most are accepted.

LK: As U.S. citizens, could the Ayades give other money to their Canadian nieces and nephews and not have it subject to gift tax in the U.S.?

JDG: They have to watch the actual threshold. It’s US$15,000 for 2018 per donee. That’s the maximum annual amount they can give before gift tax kicks in.

LK: So the tax authorities don’t look at the status of the donee? Really?

LJE: No, the IRS doesn’t. Also, all the Ayades’ accounts are registered, so that’s a problem. You can’t gift $15,000 of a 401(k) to a person. It would have to be taxable assets and I don’t see any taxable assets here, which is another consideration for their financial planning.

LK: I agree. Overall, if the plan is to cease employment at age 60, they do not have much time left. So doing the financial plan now is essential. They don’t have any open money. They seem to have been spending what they make, so they need to get a handle on things now.