In both Canada and the United States, many employers are reducing their workforce numbers. If you have clients who have left jobs in the U.S. to resettle in Canada, you may be able to help them amalgamate their cross-border retirement plans. Under the right circumstances, this can simplify retirement planning and reduce or eliminate the need for duplicate tax reporting.
Depending on their age, citizenship and a few other criteria, Canadian resident taxpayers have the ability to transfer lump sum U.S. superannuation or pension benefits on a tax-deferred basis to a Canadian Registered Retirement Savings Plan. U.S. plans might include different salary-deferral arrangements (401K, 403b), or a foreign pension plan such as an Individual Retirement Account (IRA). Qualified transfers can be accomplished as a 60(j)(i) or 60(j)(ii) rollover under the Canadian Income Tax Act, and as such, will not utilize any RRSP contribution room.
Note that there is currently no opportunity in U.S. tax law to accommodate a reverse arrangement, Canada to U.S. retirement plan transfer.
How it’s done
This strategy works well when you have a client who is a resident of Canada for tax purposes and is a non-U.S. citizen. (U.S. citizens are subject to undesirable double taxation.)
To take advantage of the opportunity to roll over pension assets into an RRSP without contribution room, the transfer must be a lump sum distribution from a pension, or superannuation attributable to services rendered while the person was not resident in Canada. The U.S. plan will have to be collapsed, with proceeds deposited to a Canadian RRSP by the end of the year in which the U.S. plan was collapsed, or no later than 60 days after year-end.
The U.S. plan provider is required to withhold 20% from the withdrawal amount when the plan is collapsed. There may also be additional state withholding taxes. Withholding tax can be reduced to 15% under the Canada-U.S. Tax Treaty and claimed as a foreign tax credit on a Canadian income tax return. In addition to the withholding tax, there may also be an additional 10% penalty tax if your client is under 59-½ years of age. Unlike the withholding tax, there is no way to claim a foreign tax credit to offset penalty taxes.
The withholding tax, and any penalty taxes, will reduce the amount of plan proceeds deposited to the Canadian RRSP. The full withdrawal of 100% (including withholding/penalty taxes) must be included in income, but the client can offset this income inclusion using RRSP contribution receipts for net proceeds deposited. The difference — all taxes withheld by the U.S. plan issuer — is taxable in Canada. However, some or all of this tax can be offset by the foreign tax credit. In order to recover all of the U.S. withholding tax without paying out-of-pocket for the transfer, the client must have enough Canadian taxes payable to absorb all foreign tax credits in the same year the U.S. plan is collapsed.
For example, ignoring currency conversion, assume your client is 60 years old and has a $100,000 401(k) he/she would like to transfer to a Canadian RRSP. Upon collapse of the 401(k), the client will be subject to U.S. withholding taxes of $15,000 U.S. at source. No penalty taxes apply since the client is over 59-½ years old.
For Canadian tax purposes, 100% of the 401(k) amount, $100,000, is income; the offsetting 60(j) deduction is worth $85,000, leaving the $15,000 U.S. withholding tax to be included as income on the Canadian tax return. Even at an average tax rate of 45%, that $15,000 will only offset $6,750 in tax liability — leaving $8,250 in foreign tax credits that must be used in that calendar year in order to eliminate any tax cost to your client on this transfer. Strategies to utilize the entire foreign tax credit can include;
• A partial transfer of foreign monies to the RRSP, thereby incurring tax and freeing up some cash or;
• Ensuring there is other income (e.g., employment, investment) to be included when filing a Canadian tax return, as the foreign tax credit can be used to offset other Canadian taxes.
Pension repatriation steps
1. Examine plan specifics. Is this a Simple Individual Retirement Account (IRA)? A rollover or an inherited IRA? A 401(k), 403(b), etc.? Is the plan transferable?
2. Calculate the tax implications of collapsing the plan in the U.S.
3. Consider the U.S.-Canada currency exchange rate.
4. Discuss any probability of the client returning to the U.S. to work or live at some point in the future. (If clients intend to return to the U.S. to work or live at some point in the future, consider leaving the U.S. plan intact for use in retirement.)
5. Calculate the net effect of withholding taxes on the transfer.
6. Complete a W8BEN form (a U.S. form used to reduce the withholding tax to 15%) and forward this with the client’s request to collapse the plan.
7. If not already in existence, open a Canadian RRSP account to receive the transfer.
8. Deposit the plan proceeds in the tax year of the plan collapse, or within 60 days of year-end.
9. Process the contribution to the Canadian RRSP as a 60(j)(1) or 60(j)(ii) so funds will not absorb unused RRSP contribution room.
10. Discuss asset allocation, or review current asset allocation plans and discuss any adjustments that may be required.