Written by Tiffany Woodfield, CRPC®, CIM®, TEP®
Reading Time: 8 minutes 42 seconds.
When retiring from the US to Canada, many people discover that their 401(k) might not be the best retirement vehicle. Once moving to Canada, the 401(k) is frozen and cannot be actively managed. In many cases a holder cannot even see the individual holdings.
Once an account is restricted, essentially frozen, it is hard to find information on what to do and there is usually nobody there to help. Is there a way to have your 401(k) moved and managed from Canada? What are the options?
US persons want two basic things: to be onside with the IRS and to avoid a large tax bill.
An option may be to move a 401(k) or 403(b) into a rollover IRA and have the IRA managed from Canada. In order to do this, a dual Canada/USA licensed cross-border financial advisor is needed. This dual licensing means an advisor is familiar with the rules regarding rollovers to an IRA and can guide an individual on how it can be managed whether they live in Canada or the USA. This also works with multiple 401(k)s or 403(b)s that need to be simplified to plan an income stream now and into the future.
SUMMARY OF KEY POINTS:
- Do not collapse your 401(k). It can be moved into a Rollover IRA and be
managed from Canada by a dual licensed advisor. - Do not transfer your 401(k) or Rollover IRA into an RRSP.
- Minimize exposure to anything the IRS treats as a PFIC (Passive Foreign
Investment Company). - You may be entitled to both Canada Pension Plan and US Social Security
benefits depending on your work history. - Plan ahead by consulting with a cross-border financial advisor, so you can
understand the options on how to move your 401(k) to Canada and keep the tax
deferred status. - Have a pre-immigration consultation with a Cross-Border Accountant.
- Understand the 401(k) equivalents in Canada.
It is possible to transfer a rollover IRA into a Canadian RRSP, but this is often not the best solution for U.S. citizens because it likely results in double taxation. In addition, when an individual transfers an IRA to a RRSP, this causes withholding taxes in the US. It also means they have to top up the RRSP with funds from another source to fully offset the IRA income inclusion in Canada. If they don’t have other sources to top up the RRSP, this room will be lost forever and the taxpayer will be taxed in Canada on the difference between the amount of the IRA and the amount contributed to the RRSP.
In addition, an IRA may be a superior vehicle because it allows an investor to name multiple non-spouse beneficiaries for tax deferral; whereas, with the RRSP/RRIF, one can only name their spouse for tax deferral purposes. This means after the last surviving spouse passes, the RRSP/RRIF goes to the estate, and taxes must be paid by the estate at the deceased taxpayer’s marginal tax rate. These additional taxes paid in the year of passing on an RRSP/RRIF greatly reduce the funds an individual would leave to their beneficiaries. An IRA enables the beneficiaries to stretch the taxable income over a number of years and exclude the value from the deceased’s terminal tax return.
Table of Contents:
- 401k Equivalents in Canada
- 3 Main Differences between a Canadian RRSP and 401k
- Similarities between a Canadian RRSP and 401k
- Roth 401k vs. TFSA in Canada
- RRSP vs. Group RRSP
- How to Bring 401ks and IRAs to Canada
- Retirement in Canada vs. USA: CPP, Old Age Security, and Social Security
- Minimize Your Retirement Tax Burden as a Dual Citizen
- Working with a Cross-Border Financial Advisor and Accountant
401k Equivalents in Canada
A 401(k) is similar to a Canadian Group Retirement Savings Plan. They both were set up by governments to help people save for retirement and are administered by an employer. These plans allow an employee to divert a portion of their salary into long term investments and the employer may match the contribution of the employee up to a limit.
A Roth 401(k) is similar to a Canadian Group TFSA in that a person can contribute with after-tax money so there is no deduction when they contribute, there is tax free growth, and the withdrawals aren’t taxed if the withdrawals meet certain conditions.
3 Main Differences between a Canadian RRSP and 401k
1) Set Up
The main difference between a RRSP and 401(k) is that a 401(k) is usually set up in the US through an employer and contributions are deducted from the employee’s paycheck. Or if you are self-employed you can set up an individual 401(k). A Canadian self-directed RRSP is opened by an individual as long as they have earned income in the year prior. A Group RRSP is similar to a 401(k) and is set up and opened with an employer.
2) Withdrawal Penalty
A Canadian RRSP does not have early withdrawal penalties, aside from withholding tax and income tax; whereas, a 401(k) has a 10% penalty for early withdrawal. This penalty applies if someone withdraws money prior to turning age 59.5.
3) Contributions & Carry Forward Rules
The RRSP contribution limit is 18% of an individual’s previous annual salary and other earned income. The unused RRSP room can be carried forward indefinitely*. A 401(k) contribution limit is not based on income but a standard yearly amount set by the IRS and the contribution room cannot be carried forward. The 401(k) also offers a “catch up” provision with higher contribution levels after the age of 50. The contribution limit for a 401(k) in 2020 is $19,500 if under age 50 and $26,500 if age 50 or older by year end.
*Or until age 71 when a RRSP must be converted to a RRIF.
Similarities between a Canadian RRSP and 401k
A Canadian RRSP and a 401(k) plan are designed to build savings to help plan for retirement. They are government sponsored and have rules and contribution limits. All the money in a RRSP and 401(k) are pre-tax dollars unless it is a Roth 401(k) which is after-tax contributions. Holders have the benefit with both plans of tax-deferred growth and only pay tax when they withdraw funds. They both allow a diverse mix of investments such as stocks, bonds, mutual funds and GICs.
Roth 401k vs TFSA in Canada
A Roth 401(k) and a TFSA are similar in that they are both funded with after-tax dollars, allow tax-free growth and contributions are not deductible. The main difference is the rules around how to contribute, how much is allowed to be contributed, and when to withdraw. A Roth 401(k) has a 5-year rule which means someone must wait 5 years from the day they first contribute, before they can take out earnings and not pay tax.
A contributor to a TFSA doesn’t need to have earned income but they need to be 18 years of age and be a resident in Canada with a SIN. A Roth 401(k) is an employer program and only taxpayers with earned income can contribute. In 2020, the yearly limit for a TFSA is set at CAD $6,000; whereas, the 2020 limit for a Roth 401(k) is USD $19,500 and up to USD $26,500 if 50 or older.
Background on TFSA
A TFSA came into effect in Canada in 2009 and contributors must be at least 18 years old and a Canadian resident to accumulate room in a TFSA. There is an annual contribution limit each year which has ranged from CAD $5,000- $10,000. If someone has never contributed, but has been a Canadian resident and was at least 18 years of age in 2009, they will have $69,500 of room in their TFSA in 2020. The annual limit adds to a taxpayer’s TFSA contribution room at the beginning of each year.
Important Note: As a US person living in Canada, a brokerage TFSA isn’t the best tool as the IRS views these as foreign trusts causing complicated tax filing and extra fees.
RRSP vs. Group RRSP
An RRSP is a Registered Retirement Savings Plan that can be set up by an individual or as a Group Retirement Savings Plan. The major difference is an RRSP is set up by the individual and a Group RRSP is set up by an employer for the employees as a benefit. The employer’s contributions are tax-deductible for the business and employers will often match the employees’ contributions as a percentage or dollar match up to a maximum. The employees can contribute directly from their payroll using pre-tax dollars. Both plans allow pre-tax money to grow tax-deferred until it is withdrawn and then it is taxed at their marginal rate.
How to Bring 401ks and IRAs to Canada
The way to bring a 401(k) to Canada is to rollover the 401(k) to an IRA and have it managed from Canada. If an individual works with an advisor who is licensed in Canada and the US (dual licensed), they can do this rollover before they move to Canada, or once they are in Canada. Multiple 401(k)s can be rolled into one IRA to make retirement planning easier when planning income streams and when one needs to take Required Minimum Distributions (RMDs).
Retirement in Canada vs. USA: CPP, Old Age Security, and Social Security
Both the Canada Pension Plan (CPP) and US Social Security are government sponsored mandatory old-age pension systems. They are both funded by wages and provide retirement, disability, and survivor benefits. In Canada, the CPP income thresholds, tax rates, and therefore benefits, tend to be lower than those of US Social Security. The amount an individual will receive is based on their earned income and how much they contributed through mandatory payroll taxes.
In the US, the maximum monthly social security retirement benefit in 2020 is USD$3011* for someone who earned full credits and retired at the full retirement age. The maximum Canadian Pension Plan (CPP) monthly benefit in 2020 is CAD $1175**
*www.investopedia.com/ask/answers/102814/what-maximum-I-can-receive-my-social-security-retirement-benefit.asp
**www.canada.ca/en/services/benefits/publicpensions/cpp/payment-amounts.html
Find more information from the CRA here >
Find more information about pensions in Canada here>
Canada also has an Old Age Security (OAS) pension that starts at age 65 and is based on time living in Canada, over the age of 18. The average OAS payment in 2019 is CAD $613. It can be clawed back by the government if someone earns more than CAD $75,910, and will be reduced to zero if their income is more than CAD $122,843.
Find more information about Old Age Security here>
Minimize Your Retirement Tax Burden as a Dual Citizen
The main tactics to prevent overpaying taxes as a dual citizen are:
- Minimize exposure to anything the IRS sees as a Passive Foreign Investment Company (PFIC) as this causes increased reporting and potential taxes.
- Keep investments in an IRA and have it managed from Canada rather than transferring to a RRSP.
- Work with an advisor that knows the investments that are beneficial to a Canadian resident and do not cause an additional IRS tax liability.
- Work with an accountant familiar with both Canadian and U.S. tax obligations, foreign tax credits, and who understands the Canada-U.S. Income Tax Treaty.
Working with a Cross-Border Financial Advisor and Accountant Is Critical
Before moving, a US citizen or green card holder should consult with a cross-border financial advisor and a cross-border accountant to prevent costly mistakes. The US advisor is no longer licensed to help once a move to Canada is made. A cross-border financial advisor can advise on which accounts to keep and what not to do. A cross-border accountant can help plan ahead to mitigate what could be a large taxable event.
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ABOUT THE AUTHOR
Tiffany Woodfield is a dual-licensed financial advisor and the co-founder of SWAN Wealth Management, along with her husband, John Woodfield. Tiffany specializes in advising clients who live both in Canada and the United States and need to simplify their cross-border financial plan, move their assets across the border, and optimize their investments so they can minimize their tax burden. Together Tiffany and John Woodfield, CFP and Portfolio Manager, help their clients simplify their cross-border finances and create long-term revenue streams that will keep their assets safe whether they live in Canada or the US. Click here to schedule an introductory call with SWANWealth Management.
