Transferring a U.S. retirement plan to an RRSP
If an investor worked in the United States, they may have participated in a 401(k) or 403(b) plan, or contributed to a traditional Individual Retirement Account (IRA), or another U.5.-based retirement plan (see Annex 1 for a description of various U.S. retirement plans).
It may be possible to transfer these plans into a Canadian RRSP on a tax deferred basis, using the procedure mentioned above. 401 (k) and 403(b) are transferable under par 60U)(i) /TA, and IRAs are transferrable under par 60(j)(i) of the ITA.
There a few things to note however with the transfer of U.S. retirement plans:
- A lump sum withdrawal by a Canadian (non-U.S. citizen/Green Card holder) should be subject to a 30% U.S. non-resident withholding tax rate.2 However, some plan administrators have a different interpretation of the Internal Revenue Code and of the Tax Treaty signed between Canada and the U.S., and, in some instances, might use a 15% withholding rate. The first step for the investor would be contact the U.S. plan administrator to confirm the tax withholding rate applicable to their situation.
- If a taxpayer is under the age 59 ½ when transferring amounts from a Traditional IRA, 401(k) or 403(b), a 10% early withdrawal penalty will apply.3 This 10% penalty is considered foreign tax credit for Canadian income tax purposes and may be claimed on a Canadian income tax return.
- Note that Roth IRAs are not considered to be foreign pension plans nor foreign retirement arrangements so withdrawals from these plans do not qualify under the provisions discussed above. (See section on Roth IRA.)
- If the taxpayer or their employer made contributions to a 401 (k) for services rendered in a period when they were a resident of Canada (for example, they lived near the border and commuted to the U.S. to work), the plan will not qualify for a transfer under par 60(j) ITA.
- Note that if the investor is a U.S. citizen or green card holder, it is possible that they also have the obligation to file an income tax return in the US (on their worldwide income). In this case, the tax payable on the collapse of the 401 (k)/IRA could be higher than the amount of the withholding tax.
Roth IRA
Note that Roth IRAs are not considered foreign pension plans nor foreign retirement arrangements, so a deduction under paragraph 60(j) of the ITA cannot be claimed in connection to withdrawals from these plans.4 Therefore, you cannot contribute lump sum withdrawals from a Roth IRA plan to your RRSP without using available RRSP contribution room.
That being said, would it be worthwhile for a Canadian resident to transfer sums held in a Roth IRA into a Canadian RRSP, or even to transfer them into a Canadian TFSA?
More precisely, what is the tax treatment, in Canada, for a Roth IRA held by a Canadian resident?
Under the Canadian Income Tax Act, a Roth IRA is not considered a registered plan, and income and distributions should therefore be taxable for Canadians.
However, Article XVIII of the Canada-United States Tax Convention (1980), commonly referred to as the Canada-US Tax Treaty, may apply to either defer or relieve taxation in Canada.5 The Fifth Protocol to the Canada-US Tax Treaty specifies that under the new subparagraph 3(b) of Article XVIII, a Roth IRA is considered a "pension" for purposes of the Convention as long as no contribution is made to the Roth IRA by or on behalf of the individual, while the individual is resident in Canada.
2https//www.irs.gov/retirement-plans/plan-distributions-to-foreign-persons-reguire-withholding
3https//www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions
4Income Tax Folio 55-F3-C1, Taxation of a Roth IRA. 'Income Tax Folio 55-F3-C1, Taxation of a Roth IRA.
Thus, if no contribution is made to the Roth IRA, while the holder is a Canadian resident, the Roth IRA will continue to be subject to Article XVIII of the Convention. And, under paragraph 7, the individual can elect to defer Canadian taxation with respect to the income accrued in the Roth IRA.
Thus, Canadian residents are exempt from taxation on accrued income and distributions from a Roth IRA, provided that a valid Election is filed, a contribution is not made while the holder is a resident of Canada, and provided distributions would not be taxable in the U.S. if the individual were resident there.
Any individual resident in Canada who wishes to defer taxation in Canada of income accrued in a Roth IRA should file a onetime irrevocable Election for each Roth IRA that they own.
Once an Election is made, there is no requirement to make another Election for subsequent years.
If an Election has been filed and no contribution has been made to the Roth IRA while the holder is resident in Canada, there is no requirement on the part of the holder of the Roth IRA to include information relating to the Roth IRA in the Form T1135, Foreign Income Verification Statement.
In conclusion, while it might be tempting for Canadian to repatriate sums held in a Roth IRA, doing so, a Canadian resident taxpayer could lose a tax sheltered instrument equivalent to a Tax Free Savings Account (TFSA) provided a proper election is made.
Inheriting a foreign retirement plan for Canadian Residents
For a spouse or a common-law partner who is the beneficiary of a foreign pension plan, an IRA, and a 401(k), the amount received may be taxable as income under paragraph 56(1)(a)(i) of the Income Tax Act. It is however possible to contribute the proceeds of such a plan into a Canadian RRSP following the procedure outlined in a previous section.6
A person that is the beneficiary of a foreign pension plan, an IRA, and a 401 (k), other than from a late spouse or commonlaw partner, must also include the value in their income under paragraph 56(1)(a)(i) /TA. If they have sufficient RRSP contribution room, this inheritance, or a portion of it, can be contributed in an RRSP to lessen the impact of this income inclusion.
5Income Tax Folio S5-F3-C1, Taxation of a Roth IRA.
62011-0409121E5. See also IT-528, par. 26.
Considerations of transferring a foreign pension plan to an RRSP
Here are some considerations of consolidating a foreign retirement plan with an RRSP:
- It could simplify the management of a retirement portfolio, helping to ensure proper asset allocation is in place at all times, and allowing portfolio rebalancing in a timely manner.
- It could simplify managing income in retirement and could help us to ensure that tax-planning opportunities are optimized.
- It could reduce exposure to foreign currency. For a person wanting to retire in Canada, transferring a foreign retirement plan into an RRSP will allow for better matching of the currency of the future income stream with that of the future cost of living expenses. This will avoid foreign exchange risk that could potentially undermine the level of retirement income received.
- It could potentially reduce or eliminate the exposure to foreign estate tax. Canadians who own U.S. assets may be subject to U.S. estate tax at death, even if they are not a U.S. resident, citizen or Green Card holder. For the purposes of U.S. estate tax, assets held in a U.S. retirement plan are considered to be situated within the U.S., irrespective of how the funds are invested. Assets held in an RRSP, will generally not be considered situated in the U.S. for the purpose of the U.S. estate tax.
- Securities regulations may impose restrictions on the trading activities of non-U.S. residents and limit the ability of their investment advisors to manage pension assets in a jurisdiction other than Canada, including retirement plans based in the U.S. and other foreign countries. Transferring a foreign-based retirement plan to an RRSP in Canada may provide more investment choice and greater flexibility to adjust investment holdings, as needs and market conditions change.
- It might not be right for everyone. It might be best to leave the foreign investment in place. (See, Conclusion.)
Conclusion
While there are good reasons to transfer a foreign retirement plan into an RRSP, there are many issues to consider and tax implications to be aware of before proceeding. This strategy might not be right for everyone. In some cases, it may be best to leave the foreign retirement plan in place, and receive an income stream from it in retirement.
It is thus important to seek advice from a qualified professional tax advisor, advisor, and/or legal advisor with cross-border experience before making any decision.
Annex 1
Definitions
Individual Retirement Account (IRA). Often called a Traditional IRA, this is a tax-advantaged account that individuals can use to save and invest for retirement.7 It is comparable to an RRSP.
401(k). A tax-advantaged, defined-contribution retirement account offered by many employers to their employees. It is named after a section of the U.S. Internal Revenue Code. Workers can make contributions to their 401 (k) accounts through automatic payroll withholding, and their employers can match some or all of those contributions.8 They are similar to a Defined Contribution Pension Plan.
403(b). Similar to a 401 (k), the 403(b) is a retirement account for certain employees of public schools and tax-exempt organizations. Participants include teachers, school administrators, professors, government employees, nurses, doctors, and librarians.9
Roth IRA. An individual retirement account that allows qualified withdrawals on a tax-free basis provided certain conditions are satisfied. They are funded with after-tax dollars and the contributions are not tax-deductible. Money can be withdrawn tax-free.10 They are similar to a TFSA.
