US pension transfer to a Canadian RRSP?

The if, when, what & how of repatriating retirement savings

We Canadians share much with our southern neighbour, well beyond the world’s longest undefended border. Many of us have stints or entire careers in the United States, then return home to Canada.

However, pension savings don’t automatically come back with us. While that money could remain tax-sheltered there, then drawn and taxed in our later years, it could simplify things if those savings could come back home too.

The process to make this happen is a bit complicated, but manageable with good preparation. Mechanics aside, the most important issue to understand is the taxation – and potential double-taxation – that may result if you’re not careful .

What plans qualify?

Generally, the kind of US plans we’re talking about are:

- 401(K) plans – The contributing employer-sponsor is a private sector for-profit enterprise
- 403(B) plans – For government employees, and those in religious, education and non-profit sectors
- IRAs – Individual retirement accounts, which are self-contributory plans similar to our RRSP

Plans from other countries may also qualify, but US plans are seen most frequently, again given the close proximity and economic ties between our two countries. Notably, if the foreign pension benefit is exempt from Canadian tax then these rules can’t be used.

You can’t transfer directly to your RRSP

From your personal view, you expect it all to remain tax-sheltered, so why shouldn’t you be able to make a direct transfer to your RRSP? Well, apart from maintaining the sovereignty and privacy of our tax system, there could be conflicting definitions, timing mismatches, and of course currency/exchange rates.

Instead, our system makes an allowance within our domestic tax rules once the foreign pension has been cashed-out. As this collapse of the foreign pension is almost certainly irreversible, you will want to be sure that the particular plan and transactions qualify under these rules; what gross and net-of-tax amounts are involved; and whether the actions can be completed in the available time frame.

Foreign withholding tax on cashing-out

The pension administrator will be required to withhold taxes, which is normally your final tax duty to the United States as the source jurisdiction. The general US withholding rate on a lump sum distribution from a retirement plan to a non-resident is 30%.

Comparatively, the Canada-US tax treaty allows for a reduced withholding rate of 15% on periodic payments from a retirement plan. In some cases, a pension plan administrator may take the position that the particular transaction qualifies for the reduced rate. This should be confirmed with the administrator, as well as with a US tax advisor whether you may nonetheless be responsible to the US for the higher rate, despite that a lesser amount may have been withheld at source.

Some pension administrators may (incorrectly) use the 20% withholding rate that applies on some domestic US transfers.

If you are under age 59.5, an additional 10% penalty tax applies to the withdrawal. Some administrators withhold this amount, but if not then you may need to file a US return to pay it yourself. In the past, the Canada Revenue Agency had not allowed a credit for that age-related penalty (more below on claiming credits), however it reversed its position a few years ago. It would be advisable to verify with the CRA on its current practice before proceeding.

Whether it’s 15%, 20%, 25%, 30% or 40%, the net amount to you will be in US dollars. Be sure to confirm with the plan administrator and a US tax advisor as to which of these apply and how they are handled. Apart from clarifying your US reporting obligations, this will help you determine how much cash you will need to come up with to meet your Canadian tax obligations, as we turn to that part of the process.

Canadian income tax inclusion

As a Canadian resident, you are taxable on your worldwide income. The gross amount received from the US pension – converted into Canadian dollars – must therefore be added to your other income in the year of de-registration and reported on your Canadian tax return.

Special RRSP contribution and deduction

A special RRSP deduction is available if the plan meets the Canadian definition of superannuation, pension benefit or foreign retirement arrangement. This is generally true for a 401(K), 403(B) or a regular IRA. (Different rules apply to a Roth IRA, which is similar to our tax-free savings account.)

Key to this special deduction is that the withdrawal must be a lump sum and specifically not be part of a series of periodic payments. Note that if the US plan administrator applied the reduced 15% withholding rate (that normally is used for periodic payments), the withdrawal should still qualify for the special deduction if it meets the lump sum definition under Canadian rules. Ask your Canadian tax advisor.

This special deduction does not require or affect existing RRSP contribution room. But unlike regular RRSP room, the special deduction can only be used in the same taxation year as the income inclusion or within the first 60 days of the following year. Any unused room cannot be carried forward.

Bear in mind that the plan administrator withheld tax before paying the net amount to you. To take advantage of the full deduction, you will have to top-up the contribution from another money source. On the other hand, if the amount is not topped-up then Canadian tax will still be due, based on the difference between the gross payout and the lesser amount of your contribution, in which case you will still need to come up cash to cover that tax.

Claiming the foreign tax credit

Once your preliminary Canadian tax for the year is calculated, the next step is to determine whether a foreign tax credit may be claimed for the amount withheld in the US. A key consideration is that if you have a large pension withdrawal but have relatively little income in the year, you may not be able to use the full credit, which cannot be carried forward. This opens up the possibility of double taxation on some part of the withdrawn pension: first in the year of withdrawal from the foreign pension, and then a second time on drawdown of the RRSP/RRIF.

Once more, it is critical to obtain advance tax advice on issues and estimates on both sides of the border.

Your retirement plans

Obviously, your decision will be affected by where you expect to retire, especially if you may end up back in the United States. And if you are a US citizen, there are additional considerations, even if you remain here in Canada. Be aware that the special contribution can only go to your RRSP, not to a RRIF, so this procedure must be completed no later than the end of the year you turn 71. As you can’t be certain how long it may take for that foreign plan administrator to process things, it would be prudent not to push it too close to that deadline.

Coming to Canada

How to advise Americans who want to cross the northern border for good

Donald Trump has recently been sworn in as the 45th President of the United States. For some Americans, that prospect may have been too much to bear, as increased traffic volume crashed the Citizenship and Immigration Canada website on election night.

Politics aside, there has long been a regular flow of people across the Canada–U.S. border in both directions, both temporarily and permanently. Regardless of their politics and motivations, all Americans residing in Canada require informed professional assistance with their wealth matters, both before and after the big leap. Here are some key issues to consider.

Renouncing U.S. citizenship?

Also known as expatriation, this is obviously an extreme measure, so all implications for personal liberty and financial wellbeing should be fully understood. While it is not within the licensing of a financial advisor to provide legal advice, an important item to bring to the potential expatriate’s attention is the U.S. expatriation tax.

This tax is invoked if the person is a “covered expatriate,” which may apply if their net worth is more than $2 million (all figures are in U.S. dollars), if their average income over the last five years is more than $160,000 (2015 figure, indexed annually), or their federal tax filing obligations have not been met for the last five years. If any of these apply, all assets are deemed disposed at fair market value the year of departure, forcing tax on realization of gains.

Ongoing tax filing

Assuming the person remains a U.S. citizen, annual tax return filing is required, regardless of residence. And if that person has more than $200,000 in non-U.S. financial assets (including RRSPs, RRIFs or pensions), Form 8938, which discloses details of those holdings, must be included. The annual deadline is April 15, or the next business day if that lands on a weekend or holiday.

There is a separate filing obligation for U.S. citizens holding more than $10,000 in foreign bank accounts. This online form, FinCen Report 114 , the Report of Foreign Bank and Financial Accounts (FBAR), is due by June 30 each year (with no mention of any “business-day” extension in the FBAR guide).

Constraints on investment accounts

An American who has earned income in Canada will be entitled to make RRSP contributions beginning the following year. Prior to 2014, a Form 8891 was required to protect RRSP growth from taxation in the U.S., but the U.S. Internal Revenue Service has eliminated that requirement. However, the aforementioned Form 8938 may still be required if minimum asset thresholds have been reached. Also, note that RRSP contributions are not generally deductible in the U.S., though a U.S. tax advisor may be consulted to determine whether a limited deduction using Form 8833 may be possible.

Many other common Canadian registered plans are not accorded tax-sheltered treatment by the U.S. These include the Tax Free Savings Account (TFSA), Registered Education Savings Plan (RESP), and Registered Disability Savings Plan (RDSP). Not only will the account holder be subject to tax on income and growth (and likely government grants for the latter two), but the information filing requirements can be onerous, and there are associated additional compliance costs.

In terms of non-registered investments, Americans holding Canadian mutual funds may be subject to the punitive passive foreign investment corporation (PFIC) rules. Some of this harm can be alleviated if the fund company provides customized income data (prepared under U.S. tax rules) to be filed with the investor’s U.S. tax return. Even with that, tax counsel with expertise from both sides of the border should be consulted to advise on dealing with non-registered investments.

Pension issues

A U.S. pension is not deemed disposed just because a person takes up residence in Canada, nor even on expatriation. However, a “covered expatriate” may be subject to a higher withholding tax when payments are made in the future, so those rules should be reviewed in this context.

If instead, that new Canadian resident wishes to bring the U.S. pension money to Canada, it can’t be transferred directly, but there is a two-step procedure to obtain RRSP room when a foreign pension is collapsed. (For more detail, see “Come from Away” in our April 2016 issue.)

U.S. gift tax and estate tax

The U.S. gift and estate taxes continue to apply to U.S. citizens who reside in Canada. The gift tax can apply on per-person gifts of more than $14,000 in a year, though many exceptions apply.

The U.S. estate tax may apply to a U.S. citizen who is a resident in Canada on death, though only if the worldwide estate is more than $5.49 million (2017 figure, indexed annually). It’s worth noting that during the election campaign Mr. Trump vowed to repeal this tax, so stay tuned.

Generally, there is no problem advising a Canadian resident with respect to Canadian accounts, within the scope of a financial advisor’s licensing. For assets that remain with a U.S. institution, a discussion with compliance counsel is in order to determine if you have the business capacity and regulatory clearance to proceed.

Bringing a foreign pension to Canada – A two-step technique

Our nation was born through immigration, and it continues to welcome new arrivals in a steady stream. While some newcomers will be at the start of their careers, many will be arriving in the midst of their working lives.

Frequently, immigrants have significant tax-sheltered savings in foreign pension plans, and may wish to bring those funds over to their new home in Canada. They may be surprised, however, to learn that our system does not allow tax-free transfer of foreign pensions to Canadian registered retirement or pension plans. However, all is not lost.

If appropriate steps are taken – on a timely basis – the net result can be continued tax-sheltering of their retirement savings.

No direct transfers

While it may seem harsh to not allow direct tax-free transfers, it’s simply not practical for our tax system to be so intimately intertwined with foreign tax systems.

Instead, our system makes allowance within the domestic tax rules once the person has collapsed the foreign pension. As this “deregistration” of the foreign pension is likely irreversible, at minimum the person will want to be certain:

what gross and net-of-tax amounts are involved,
that the particular plan and transactions qualify, and
whether the actions can be completed in the required time frame.

Step 1 – Foreign tax procedure

Generally, the foreign pension administrator will be required to withhold taxes according to that jurisdiction’s laws. This may include the administrator evaluating the nature of the transaction to determine whether it has a withholding obligation at all and, if so, for what amount. The amount of withholding tax may in turn be reduced if there is an applicable provision in the tax treaty Canada has entered into with the foreign state.

Some jurisdictions also impose penalties on some withdrawals when taken below a specified age. In the past, the Canada Revenue Agency had not allowed credit for that type of penalty imposed on individual retirement plans from the United States. However, it reversed its position a few years ago. It would be advisable to verify CRA position on plans originating from other countries to be sure what to expect.

The Canadian resident will receive a payment denominated in the foreign jurisdiction’s currency, net of all withheld amounts. Unless there is a continuing connection, this withholding will usually satisfy the person’s final tax obligation on the pension to the foreign jurisdiction.

Step 2 – Canadian tax calculation

Income inclusion

Canadian residents are taxable on worldwide income. Accordingly, the gross amount received from the foreign pension, converted to Canadian dollars, must initially be included in calculating Canadian tax liability.

The withheld foreign taxes entitle the person to claim a foreign tax credit when calculating this initial Canadian tax due. Depending on the circumstances, however, the credit may be less than the withheld amounts (see provisos below).

Special RRSP/RPP deduction

A special deduction will be allowed if the pension satisfies the Canadian definition of superannuation, pension benefit or foreign retirement arrangement. Additionally, the payment must be a lump sum and specifically not be part of a series of periodic payments.

The deduction is in the form of an allocation of contribution room toward either a registered pension plan (RPP) or registered retirement savings plan (RRSP). Though not obligated, the person may make an RPP or RRSP contribution up to the amount taken as income as a result of collapsing the foreign pension. This does not require or affect existing contribution room.

The special deduction must be used in the same taxation year as the income inclusion or within the first 60 days of the following year. To be clear, any unused room from this allocation cannot be carried forward.

Some practical provisos

Bear in mind that the actual payment received from the foreign plan will be net of withheld amounts. If the person wishes to take advantage of the full contribution/deduction, other cash will be required for that top-up. On the other hand, if the amount is not topped up, then Canadian tax will still be due on the difference between the gross income amount and the chosen contribution.

The foreign tax credit is limited to the lesser of the actual foreign tax paid/withheld (up to a maximum of 15%) and the Canadian tax due on the foreign-sourced income. The credit may thus be less than the withheld amount. Furthermore, this type of credit cannot be carried forward for use in future years.

As you’ve likely come to realize, determining how to deal with a foreign pension can be a complicated matter. As a starting point, the person should obtain a clear statement from the pension administrator as to the procedure and amounts from that end. The statement can then be analyzed with the person’s Canadian tax advisor to determine how best to proceed.