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 get a lot of questions regarding inheritances between Canada and the US. Whether it’s a Canadian client receiving an inheritance from a US relative or a US resident receiving an inheritance from their Canadian relatives, the tax intricacies can be significant and difficult to navigate. Outlined below are some of the most common question we get and some answers to provide context. Note however that the answers will be more general in nature as it would be impossible to take into account all the potential issues a client might encounter. If you have questions about your particular cross border inheritance or investments (IRA, 401k or US investments) please contact me for more information.
Disclaimer: The information contained below if for educational purposes only and should not be considered advice. Contact a competent cross border financial advisor for information on your particular situation.
How do I transfer my IRA or 401k to Canada?
We have written on this fairly extensively, so you’ll want to review some of the previous posts here:
- IRA, 401k and US Investments for Canadians (FAQ)
- the most recent cross border podcast
- How to Transfer my IRA to Canada (or into an RRSP)?
Although we get this question often from clients the answer may not be so simple. For example, Canadian advisors (those that are not regulated to serve US resident clients) often advise clients to transfer their IRA and/or 401k up to Canada into an RRSP. Although this may be a beneficial option for some, in many cases it simply does not either make sense, or is not possible given the client’s situation. So why would an advisor give their client only one alternative? The answer is simple…they only have the ability to help transfer the funds up to an RRSP as they can’t manage the IRA or 401k in Canada. For those Canadian investment advisors with a US license, the options are greater for clients.
Let’s use an example to illustrate this point. Let’s say Joanne, A Canadian resident and US citizen has a $300,000 IRA in the US that she wants to move up to Canada. Let’s also assume that her current income is $50,000. Making the choice to move the account up to Canada is common as US advisors often lack a full understanding of Canadian tax and investment planning. The planning performed on these accounts can become very US-focused and lack a Canadian perspective. Considering this challenge she has decided to move the money to Canada. What are her main options:
- Attempt to transfer the IRA to Canada within an RRSP
- Move the IRA to a firm in Canada that can manage the account.
Let’s look at both these options. Option 1 can certainly work and does have advantages, however, Joanne will be limited by how much she can actually transfer each year to the RRSP as the maximum amount transferable (the calculations are beyond the scope of this article) is approximately $50,000 or the amount of her Canadian sourced income. If she wanted to transfer the IRA to Canada in her RRSP it would take her 6 years to accomplish this while having to maintain 2 different investment accounts in Canada and the US.
“if she wanted to transfer the IRA to Canada in her RRSP it would take her 6 years to accomplish”
Given the size of the IRA and the inefficiencies in transferring it to her RRSP the most beneficial option is likely moving the account to a Canadian broker that can manage the IRA from Canada. In this case, she’ll be able to accomplish her goals of moving the account to her home country while keeping her tax compliance low on the transfer. The account can continue to be deferred from tax and a Canadian advisor will be able to integrate planning based on her overall financial situation and allow the advisor to give proper financial advice.
IRA distributions are specifically excluded from the pension splitting rules in Canada. In some cases, depending on a taxpayer’s spouse’s future income it may make sense to convert the IRA to an RRSP for future splitting options. The RRSP distributions will not be able to be split, however once the RRSP converts to a RRIF those distributions will be available to split with a spouse.
How do transfer my ROTH IRA to Canada?
The same general investment management ideas relate to ROTH IRAs, however, there are some significant differences between traditional and ROTH IRAs with respect to Canadian and US taxation. Both will allow you to defer the internal earnings of the plan from tax as long as funds remain in the plan, however, the traditional IRA distributions will be taxable as distributions are made from the plan. Unlike a ROTH distribution that is non-taxable (in most cases). Another way in which the ROTH differs from a traditional IRA is that for Canadian purposes you’ll need to file an election with the competent authority to ensure the ROTH maintains its non-taxable status in Canada.
Should I keep investments in USD or exchange to CAD?
This is dependent on a number of factors. Most IRA/401k/SEP IRA will remain denominated in USD for their duration (there are some custodians who will allow multi-currency investments, but this is rare). The assets outside of retirement accounts in the US can be converted to CAD if the client chooses to do so.
There are a number of factors that should be analyzed to determine the right “mix” of CAD and USD investments you should hold.
What percent of your investable assets does your IRA/401k comprise? If the percentage is large, you may want to diversify out of USD investments in your non-registered holdings. This is especially true if you have large CAD liabilities (mortgage on a Canadian residence, college tuition in Canada, etc).
If you are planning to stay in Canada for retirement, nearly all your future spending will be in CAD. It might be a good idea to try and match your spending with other CAD investments.
“This is especially true if you have large CAD liabilities”
The selection of USD investments is larger than CAD investments, and the costs associated are generally lower in USD investments. This is changing over time as lower-cost ETF and Index funds become more common here in Canada.
If converting large sums of USD to CAD, make sure the exchange rate you are getting is fair. A good rule of thumb to determine the “quality “of the exchange rate is to look at the difference between where you can buy a currency and where you can sell it. This is referred to as the bid/ask spread. The tighter, or smaller difference between the two, the better. For large ($100k+) conversions, the difference between the prices should be no larger than 10-20 pips (percentage in points), or put in decimals:
$3,110 buy USD/ 1.3125 sell USD = 0.0015% or 15 pips
Note, that if exchanging at some of the large Canadian banks this spread could be significant.
As with most financial decisions, currency conversions should be reviewed on a regular basis to ensure you maintain some efficiencies with your conversions.
What investment accounts need to be included on my T1135?
For those not familiar with Form T1135, Canadian taxpayers that hold more than $100,000 of foreign investment assets (valued at cost) are required to report these investments on form T1135. We won’t detail the full requirements of form T1135 in this post, however for more information on the full requirements click here. A simplified method of reporting foreign investments is available to those with under $250,000 of foreign accounts. For those over $250,000, the requirements are more onerous. For those with US investments in US brokerage accounts, the requirements are significant. Once again, let’s use an example to illustrate the potential filing requirements.
Along with her US IRA, Joanne also have a US non-registered (regular) investment account. Within the account, she holds 10 US-based stocks and a total value of $500,000 (cost is also over 100,000). For T1135 reporting purposes, each one of her US stocks will need to be reported. In contrast, if these US stocks were held in a Canadian brokerage account only the account would need to be reported. These rules result in a tremendous amount of reporting for taxpayers with US investments in US-based accounts. Not only do they need to report each stock, but they also need to report the highest cost in each and the year-end cost amount. In most cases, the US-based investment advisor does not readily have these figures available for their clients. If the investments were in a Canadian based account the Canadian advisor often supplies this information.
Considering the extra compliance and cost associated with Canadian residents holding US investments it makes lots of sense to transfer these investments to Canada. You’ll want to be sure however that the transfer happens without triggering any unwanted gains and the Canadian investment advisor understands the implications of cross-border investments. In addition, many of the US investment advisors in the US are actually prohibited from holding non-registered investment accounts for Canadian residents. Another reason why moving the funds up makes sense for Canadian residents.
“Considering the extra compliance and cost associated in Canadian residents holding US investments it makes lots of sense to transfer these investments to Canada.”
Also, note that the T1135 filings can attract a penalty if filed late. The penalty is $25 per day to a maximum of $2,500 plus interest. In most cases, taxpayers will miss this form completely and hence max out the penalty to $2,500.
I’ll be moving from the US to Canada soon. What investment planning should I consider?
We get this question a lot and it’s certainly not something that is easy to answer in general terms. Every individual has a different mix of assets, a different timeline and a variety of different financial goals. That being said I’ve outlined below some considerations when moving to Canada:
For Canadian purposes, most of your investment assets will be adjusted for tax purposes. Essentially, Canada will not tax you on gains accrued before entering Canada. For example, while living in the US you purchased stock at $100 and now it’s worth $200. If you were to move to Canada and sell the stock immediately you would pay US tax on the $100 gain and no tax in Canada. This is accomplished by “resetting” your Canadian cost basis to the fair market value of the stock upon entry. You sell the stock at $200, your new adjusted cost basis is $200 (what it was worth when you entered) and therefore no Canadian gain. In some cases you may move to Canada with stock that is in a loss position. Upon moving to Canada your cost basis is “bumped” down to FMV. If the stock rises once you enter Canada you could be in a position to pay Canadian tax on a stock you’ve lost money on. In these cases you may consider selling some of your “losers” before moving to Canada
I have access to tax-free investments in the US that my Canadian broker cannot offer. Why should I switch?
When discussing moving investment assets to Canada we run into a fair amount if interesting challenges. In many cases, and not surprisingly, investors that have had a long-term relationship with their US based wealth advisor will have a hard time changing advisors. For example, they will cite that their Canadian brokers do not fully understand US investment planning and may miss opportunities like tax-free interest from municipal bonds.
Yes, I would agree that most Canadian wealth managers would not fully understand tax-free US investments, however, in most cases, it won’t matter to the client. In the above example let’s assume that the client is also a US citizen. As a dual resident of Canada and the US the client will be taxable in both Canada and the US. In this case, even though the municipal bond interest is in fact is not taxable on their US 1040 return, it will be taxed as straight foreign investment income for Canadian purposes, therefore negating the tax-free nature of the investment. In most cases the US advisor would not recognize this effect and would only plan based on US tax rules.
Once again, engaging a cross border wealth advisor is important so the client can ensure that both Canadian and US tax and investment strategies are employed.
Should I hold my cross border investments in a Canadian or US Corporation?
The simple answer is no, however, there are cases where holding your investments in a corporation is advantageous. In cases where Canadian residents that are also US citizens have excess capital in their Canadian corporations, and this income would result in accelerated personal income tax if withdrawn, it may make sense to invest this capital within the corporation. Making this decision should not be taken lightly and a review with a competent cross border tax professional is highly advised.
It should be noted that American’s with investments in Canadian (foreign) companies will be subject to very specific, and often burdensome tax filings and extra compliance. For example, investment income (and now business income under section 962 GILTI rules) earned in a controlled foreign company (CFC) is automatically taxable to US persons on their annual 1040 income tax return (subpart F). This is regardless of whether the amounts are withdrawn personally.
How do I withdraw from my RRSP as a non-resident?
Withdrawing your RRSP as a non-resident of Canada can be relatively easy. Assuming the bank understands that you are a non-resident of Canada (you’ll need to confirm this) they will withhold a specific amount of Canadian non-resident tax. This tax will be available as a credit on your US 1040 income tax return.
The amount of non-resident tax withholdings will depend on whether the RRSP has been annuitized or converted to a RRIF. General non-resident withholding tax will be 25%, however pursuant to the Canada-US tax treaty a reduced 15% rate will be available if the payments for the year:
are not greater than the greater of the 2 amounts below:
- Twice the amount of the minimum payment for the year
- 10% of the FMV of the RRIF at the beginning of the year
Note that the amount of non-resident tax withheld will be the final Canadian tax required on the distributions. That being said, you may have the ability to file a section 217 non-resident Canadian tax return and pay less than the 25% or 15% reduced rate. This elective tax return however will only be available to taxpayers if the distribution from the RRSP or RRIF is more than 90% of their total worldwide income for the year.
Is there inheritance or estate tax in Canada for non-residents?
This is another question we get often from our US resident clients. With an increasing trend in inheritance assets flowing between Canada and the US clients are more and more interested in Canadian inheritance and estate tax.
In most cases, our US resident clients assume that Canada has similar inheritance and estate tax rules. In fact, Canada has a significantly different tax system for dealing with estates and inheritances.
In most cases our US resident clients assume that Canada has similar inheritance and estate tax rules
Generally speaking, when individuals die in the US the government taxes the gross value of their estate over and above the US estate tax limit which is currently sitting at $11.4 million. This is amount can also transfer to a spouse for a total amount of $22.8 million.
Contrast that with the Canadian “estate tax” system. When Canadians die they are not taxed on the gross value of their estate, but rather the untaxed portion of their accrued capital gains and the total of their registered accounts. Note however that this tax will not be applied if you choose to “roll” your assets to your spouse. Upon their passing they would pay tax on the total accrued gain of all property and registered accounts.
This difference is one of the ways US individuals and families are able to transfer their wealth down generations without having to pay significant taxes.
Canadian taxes however are paid upon the death of the final spouse, thereby not allowing a tax-free transfer to beneficiaries.
So, how do non-residents of Canada handle Canadian inheritance and estate tax issues? The answer to this question is beyond the scope of this guide, however, it’s important to remember that the differences in taxation between the US and Canada can make estate planning challenging for most. When in doubt always engage a cross-border tax professional to help plan out an eventual Canadian inheritance or estate.
What should I do with my inheritance from the US?
One thing to note about the differences between the US and Canada tax code is in relation to estate taxes. Estate taxes in the US (if owed) are paid by the estate, while here in Canada there is no technical estate taxes owed. The person who dies is deemed to have disposed of his or her eligible assets on the last day of life and they file one final personal tax return to the CRA. This means that once the estate of the US person is settled all the funds received in Canada have already paid any US estate tax owed.
If you inherit an IRA or ROTH IRA you are allowed the option to open an inherited IRA account. This will allow you to tax-defer (only pay tax on the distributions when you take them). These distributions will be determined by your age, the older you are the higher percentage of the account you must take on an annual basis
These distributions (called RMDs) will be treated as income in Canada
You must first open an Inherited IRA account with a custodian and have the deceased person’s IRA transferred into this account. It must be a “trustee to trustee” transfer. Therefore, the funds should go directly from the deceased custodian to the inherited IRA custodian.
If the account is a ROTH IRA, you must make a declaration to the CRA the first year you inherit the account. These distributions will be tax-free in both Canada and the US per the US/CA tax treaty.
If you inherit cash you can simply move the USD to your Canadian bank account tax-free. You will file a form with the CRA disclosing the inheritance, but you will pay no tax.
If you inherit individual stocks, bonds, or ETFs you also will not pay any taxes upon receipt. However, your new “cost basis” in Canada will be the cost basis (in CAD, not USD) on the day the person died. Any capital appreciation/depreciation going forward will be a taxable event in Canada.
When dealing with an estate with multiple beneficiaries across the US/Canada. It may be advisable for the executor to sell any holdings as soon as possible and move the proceeds to cash so there is less issue with any capital gains/losses across the border. Example: Capital gains rates are lower in the US than in Canada, so some beneficiaries will be affected differently.
If you inherit mutual funds or index funds it is similar from a tax perspective to individual stocks, bonds, or ETFs. The difference however is that you are not allowed to hold these funds if you are a non-resident of the US, so they must be sold before the cash is transferred to Canada. You would only liable for capital gains tax in Canada if the mutual fund had appreciated since the date of death.
If you inherit property in the US you will only be taxed on any appreciation between the date of death and when you decide to sell the property. Upon which you could owe capital gains taxes in the US and Canada depending on how long you held the property.
This guide will continue to be updated with additional questions and answers. If you would like a specific cross-border investment question addressed please contact me today.