Each year I help over 500 clients file their Canadian and US tax returns as well as plan for both their Canadian and US investment accounts. I also regularly help new US clients plan for their move to Canada.
We meet with a lot of clients who are looking for some guidance on how to handle their US investment accounts. Whether they have moved from the US or inherited US assets from family members these individuals often have the same questions, concerns and tax planning issues.
Outlined below are some of the frequently asked questions by clients with US investments accounts:
What is a 401k plan in Canada?
Although we don’t have 401k plans in Canada we do have similar types of investments accounts. Registered Retirement Investment Accounts (RRSP) are the equivalent to a US 401k.
Similar to a 401k Canadians receive a tax deduction for RRSP contributions and the income and capital gains earned in the plan are considered tax deferred until money is withdrawn from the plan.
I have US investments including IRAs and 401ks. I’ll be moving to Canada soon, should I be planning for these assets?
The answer to this question is you should definitely be planning for these assets. Although some similarities exist, the tax rules between Canada and the US are quite different. Moving to Canada with US assets can result in significant tax consequences. Some planning points to consider before moving up to Canada from the US include:
- When you enter Canada your non-retirement accounts (regular investment accounts) are revalued for tax purposes to the fair market value (FMV) at the time of entry (the same date as your Canadian residency start date). This rule exists to ensure that Canada does not tax new residents on accrued gains earned before entering Canada. This is accomplished by “bumping” your adjusted cost basis (ACB) to FMV at the time of entry. Note however, that this does not apply to deferred retirement accounts (IRA and 401k) and also includes other non-portfolio investments such as real estate.
- Those that have made the move to Canada recently have experienced how difficult it is to maintain US investment accounts in the US. Most US brokers and investment companies are not registered to handle Canadian clients. In most cases your US broker will not be able to manage your investment account after you move to Canada. Simply maintaining a US address on the account is not sufficient to alleviate the resident filings requirements. It’s always best to discuss your US investments with a cross-border investment planner that resides in Canada. Preferably someone that lives in your new city.
- In some cases it makes sense to de-register retirement assets before moving to Canada. As most know, Canadian tax rates are be significantly higher than US tax rates. Especially for those that live in low or no income tax states. If you find yourself in a position of relatively low income in the years before you decide to move to Canada it may make sense to convert some of your IRA or 401k money to non-taxable ROTH IRA accounts. The tax you pay on the conversion now can be significantly less than the future savings experience in taking this income as a Canadian resident. Make sure however that you file appropriate ROTH IRA elections in the first year you become a resident of Canada.
Can I transfer my RRSP to an IRA or 401k?
We get this question less often, but often enough to provide some guidance. The IRS code does not contain any provisions that allow individuals to convert and/or transfer RRSP money to their IRA or 401k. So, the simple answer is no.
Can I transfer or convert my IRA or 401k to my RRSP?
It is definitely possible to transfer IRA or 401k money to an RRSP. However in many cases taxpayers will not be eligible or it will be more trouble than it’s worth to make the transfer. Let me further explain how this potential transfer is accomplished. The Canadian income tax act contains provisions under 60(j)(i) that allow taxpayers to essentially transfer money from their IRA or 401k to their RRSP. The transfer is accomplished in the following manner:
- Money is withdrawn from the respective IRA or 401k
- Within 60 days of the end of the year in which the IRA/401k was de-registered money needs to be contributed to the taxpayers RRSP
- In the year of tax filings the taxpayer needs to report the IRA/401k distributions as both taxable in Canada and the US. For US citizens and green card holders these amounts will be reported and taxed on a full year US income tax return. For non-resident aliens the appropriate 15% withholding (final tax) will be paid. These amounts are also reported and taxed for Canadian purposes
- The taxpayer will be allowed to offset as a deduction on their Canadian tax return the RRSP contribution.
- In order to complete the tax free transfer of the US money to a Canadian RRSP you’ll need to obtain a foreign tax credit on your Canadian tax return in order to recover the amount of withholding tax or actual tax calculated on your 1040 return. The technical calculations on how this is accomplished are beyond the scope of this article.
Although this technique can result in transferring some IRA money to an RRSP it is severely limited by the amount of income your are currently earning. Generally speaking you’ll need income equal to the amount of IRA money you intend on transferring in the year. This often results in larger IRAs not necessarily able to be transferred or moved to a respective RRSP. This is why I tend to advise clients talk to a cross border investment advisor that can manage the IRA from Canada. That way you can avoid the lengthy tax calculations required to properly execute the transfer and you’ll be able to maintain deferral of the account on an ongoing basis.
Do I have to report my IRA or 401k on my T1135?
Canadian taxpayers that own foreign assets with a cost more than $100,000 are required to report and file form T1135 – foreign income verification form with the CRA. Although this form will be required for any non-registered investment and/or cash accounts, they are not required for IRA and 401k accounts.
How do I report my US investments on my T1135?
Generally speaking Canadian taxpayers have 2 options when filing form T1135 to report foreign assets, the simplified method and the detailed method. The simplified method of reporting US investments (only required to report country by country), which would only be available to taxpayers with US investments in Canadian brokerage account is not available to Canadian taxpayers with US investments with US brokers. In this case, taxpayers need to report each investment line by line, versus the more simplified country by country options outlined above. This can result in much more complexity and filing cost for taxpayers with US based brokerage accounts. Resulting in another reason why Canadian may want their US investments managed in Canada.
What happens to my IRA or 401k when I die?
Unlike RRSP accounts which are deemed to be disposed when a taxpayer dies (unless transferred to a spouse), IRAs and 401k accounts can move down to a second generation without any tax levied on the amount of the account to the primary holder. This result is unlike anything in Canadian tax law (especially after the trust changes) and can be exploited to not only transfer deferred assets to a second generation, but to significantly take advantage of the immense power of compound investing. Imagine how much a $100,000 IRA gifted to a 15 year old will grow throughout their lifetime. This benefit would be eliminated if the IRA were transferred to an RRSP.
Will I pay tax twice on my IRA and 401k payments?
No, the treaty is in place to help taxpayers avoid paying tax twice on the same amount of income. For example, a non-resident alien of the US living in Canada receiving payments from their IRA will pay tax as follows:
- Assume a Canadian tax rate of 20%
- Assume a $10,000 IRA payment
- Payments from the IRA account will attract a 15% non-resident withholding tax at source e.g. $1,500
- This IRA payment will be fully taxable in Canada at 20% = $2,000
- However, you will receive a foreign tax credit for any US taxes paid, e.g. 1,500
- Therefore your net payment on the IRA payment in Canada will be $500 ($2,000 less $1,500)
- Total tax paid on the IRA distribution = $2,000 ($1,500 withheld at source and $500 paid to Canada). Essentially your Canadian tax rate, therefore no double tax.
My US broker invests in securities like Municipal bonds and tax free distribution funds. Are these efficient from a Canadian perspective?
We see this a lot. Unfortunately many, if not most US brokers have very little experience with Canadian clients, and if they do have experience with Canadian clients they have very little knowledge of Canadian tax rules, including treaty provisions.
The tax treatment of certain types of income and investment accounts in Canada and the US can vary significantly. In the case of tax free interest on municipal bonds and return of capital from US mutual funds these income amounts are not tax free from a Canadian perspective. Essentially the main reason and benefit for investing in these type of securities are nullified by Canadian tax rules. It’s always advisable for clients to find and engage a good cross border investment advisor to help them manage their Canadian and US investment assets.
As evidenced by the complexity of the information contained above it’s always a smart idea to engage the help of competent cross border professionals when planning for your US investments. It’s imperative that those that are helping you manage your money not only understand the US implications of maintaining such accounts, but the Canadian implications as well. Only understanding half of the tax and financial planning issues is certainly not value added to any client.