Tag: RRSP/RRIF

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.

Depositing an employee bonus directly to RRSP

Implications of ‘no taxes withheld’

It’s February 2016, and many fortunate employees will be looking forward to the payment of their 2015 year-end bonus.  Particularly in sales roles where year-end figures dictate the amount of those bonuses, payments necessarily occur after December 31st.

Most employers will target to have those bonuses paid before the end of February, in part to enable the employee to use those funds to make an RRSP contribution that can be applied against the prior year’s income.  Often employers will go even further by offering to route the gross amount of the bonus – that is, with no federal or provincial income tax withheld – directly into an employee’s workplace group RRSP.  

For a conscientious RRSP saver, this is a great way to assure that contributions are being systematically socked away.  However, one must be careful to understand the mechanics of this process, in order not to receive a nasty tax surprise later. 

Timing and source of RRSP deposit

By the way, the 60-day deadline this year is Monday, February 29, 2016 to be able to claim against 2015 income.  For our ‘no-taxes-withheld’ bonus deposited directly to an RRSP, that means you will be using income taxable in 2016 to reduce income taxable in 2015.  

To illustrate, let’s assume for simplicity that Bonnie claimed no RRSP contributions for 2014, and her marginal tax rate is 40% at all times in this example.  She earned a base salary of $90,000 paid in 2015, and bonus of $10,000 paid in February 2016.  By making the RRSP contribution in February 2016, she reduced her 2015 taxable income to $80,000, yielding a tax refund of $4,000.  If Bonnie earns the same $90,000 base this year, her total income will be $100,000 in 2016.  

Unfortunately, Bonnie is terminated at the end of 2016, and by her employment contract is not entitled to any further bonus payment.  

Tax refund and next year’s tax return

It now comes to tax filing time in April 2017.  Bonnie’s employer perfectly withheld the tax due based on her $90,000 base, but Bonnie actually earned $100,000 in 2016.  She now owes another $4,000 in tax.  If Bonnie had the foresight to set aside the refund money when she received it in the spring of 2016, she would have the exact cash necessary to pay that difference.

Though somewhat in hindsight, this begs the question: what should Bonnie actually do with the tax refund?  A common recommendation is to make a further RRSP contribution with any refund that is generated from an RRSP contribution.  Apart from cultivating a savings habit, this enables the person to boost the RRSP each year by repeatedly applying the tax refunds to, in a sense, pre-fund the tax liability on the eventual drawdown.   

In this case however, had Bonnie made that second RRSP contribution, it would have generated a corresponding refund of $1,600.  That certainly helps build her retirement savings, but from a cash flow perspective she would still be $2,400 short of the $4,000 she needs to pay her 2016 tax bill on that bonus payment.

Real, or could it be worse?

On a rolling annual basis, if Bonnie has a consistent income and RRSP deposit habit, this phenomenon may never even be noticed, at least not until the year (or rather the year after) she retires.  

On the negative side of things, what if Bonnie had a $40,000 one-time/exception bonus one year that she used to catch up carried forward RRSP room?  This could play havoc with her cash flow when it comes to filing her taxes the following year.

As a final note, be aware that premiums for Canada Pension Plan and Employment Insurance are applicable to bonus payments.  That means that if the full bonus is directed to an RRSP, the employer will be taking those CPP and EI deductions out of the employee’s regular pay.  Though not as substantial as the income tax implications, this helps explain the slightly lighter regular pay cheque the employee would receive at February month-end.

Named beneficiary ordered to reimburse estate for tax on father’s RRIF

At issue

Ever since the Supreme Court of Canada (SCC) decision in Pecore, there seem to be more reported cases where siblings are battling over a deceased parent’s joint account.  In truth, it’s surely no more common now than before, but the arguments – both personal and legal – may be cast differently in the wake of that case. 

Even before that ruling, financial advisors may have been cautious about carrying out such transfers.  As case law continues to build, the scope of concern threatens to press beyond joint ownership and reach out toward beneficiary designations.

2007 SCC 17 Pecore v. Pecore, 2007 SCC 18 Madsen Estate v. Saylor

The SCC held that the presumption of a resulting trust applies when a parent gratuitously (ie., no consideration given) adds an adult child as joint owner of property.  Following the parent’s death, that child would have to prove it was the parent’s intention to pass a beneficial interest, else the child is deemed to hold the property in trust for the estate.  On the respective facts, the daughter in Pecore succeeded and daughter in Madsen did not.

The case has been cited in hundreds of subsequent lower court cases dealing with joint accounts.  One hopes it has also headed off destructive litigation in similar fact situations once the parties had given it sober second thought. 

McConomy-Wood v. McConomy, 2009 CanLII 7174 (ON SC)

This case discussed the potential that the presumption of resulting trust could apply to a RRIF beneficiary designation.  After summarizing Pecore and other potentially relevant cases, the judge stated that it was not necessary to resort to this presumption in order to decide the case.

Rather, there was ample evidence from all parties (including the daughter who was the RRIF beneficiary) that the mother had intended that the three children would “all be treated equally.”  

Morrison Estate (Re), 2015 ABQB 769

In this case, the deceased had four children and eleven grandchildren.  One son, Douglas (who also happened to be the executor) was named as RRIF beneficiary.  Pursuant to the provisions of the Income Tax Act, the estate was responsible for the tax on the deregistered RRIF, while Douglas received the gross $72,683 RRIF proceeds.

As in McConomy, the court grappled at length with whether the presumption of resulting trust could be applied to a RRIF beneficiary designation.  This included considering whether there was a relevant distinction between the inter vivos nature of a joint ownership transfer, and the apparent testamentary nature of beneficiary designations.  In the end, the judge determined that the case could be decided without addressing these issues.

On the evidence, the judge made “a very thin finding” that on a balance of probabilities, the father intended Douglas to be the sole RRIF beneficiary.  However, he went on to infer that the father was either unaware or mistaken how the tax liability would be borne.  Douglas could not be compelled to share the RRIF (as it was his outright), but the judge invoked a provision of the Alberta Judicature Act to find that Douglas was unjustly enriched, and therefore that he must “reimburse the Estate for the tax it paid on his behalf.” [my emphasis]  By the judge’s own admission, his approach was “extraordinary.”

The costs of the son who brought the application were ordered to be paid out of the estate.  Douglas was left to bear his own costs.  

In his closing, the judge voices his concerns over the implications if Pecore is eventually determined to apply to beneficiary designations.  He warns of a “floodgate of litigation against the designated beneficiaries by disappointed siblings.”  One is left to wonder how much this perspective may have fed into the circuitous route used to reach the resolution, particularly as the financial results appear to be similar to what would have happened by recognizing a resulting trust.

Practice points

  1. If possible, a parent should make clear the reason and nature of a joint ownership transfer or beneficiary designation.  Ideally this will be recorded contemporaneous with the event, assisted and informed by independent legal counsel. 
  2. Realistically, such actions are usually undertaken with an eye on informality, privacy and low-cost.  And that likely means that we’ll continue to see cases like these before the courts when disappointed siblings learn the details. 
  3. Financial advisors should always take care in assisting transfers and completing beneficiary designations.  They may also want to keep their own notes, should the ‘right’ facts align and the advisor be called as a witness.