If you have been living or working in the United States you would likely have accumulated some retirement savings while employed. Now that you have returned to Canada, the question becomes should I transfer the retirement savings that has accumulated to a Canadian RRSP?
Overview of the US Retirement Plans
Typically there are two types of retirement plans that you would have contributed to.—a 401 (k) plan and an individual Retirement Account (IRA)
401 (k) is an employer sponsored pension plan that is typically funded by both the employer and the employee. Contributions to the plan are redirected from your pre-tax income and the funds can grow tax free until withdrawn.
The IRA is similar to the Canadian RRSP and allows you to make tax deductible contributions while the earnings are tax deferred until withdrawn.
Transfer of a 401 (k) Plan to an RRSP
Canadian tax law will permit you as a resident living in Canada to transfer a foreign pension plan, such as a 401 (k) plan to a RRSP on a tax deferred basis. In order to do this certain conditions with respect to the payment being transferred must be met:
- The payment from the plan must be a lump sum amount,
- The payment relates to services rendered by you, your spouse or former spouse during the period in which you were a non resident of Canada,
- The payment must be fully table in Canada and included in your income in the year of transfer; and
- The amount transferred must be designated as a transfer on Schedule 7 of your Canadian income tax return in the year of transfer in order to obtain an offsetting deduction from the income inclusion.
As this is considered a transfer, the RRSP contribution does not impact your RRSP room and is in addition to your regular RRSP room. The transfer payment can only be contributed to your RRSP and not to a spousal RRSP. In addition, upon the transfer of the funds, the contribution and corresponding deduction can only be made in the year or within 60 days after the end of the year that the payment is reported in your income. I.e. there is no carry forward deduction available)
Although a tax rollover from a 401 (k) plan is available, it is important to be aware of the US tax consequences in connection with the transfer. In the US, a taxable distribution from a 401 (k) plan is subject to a mandatory withholding tax of at least 15% and perhaps as high as 30%. The US withholding tax on the withdrawal would be eligible to be claimed as a foreign tax credit or similar deduction when filing your Canadian income tax return; however, this means that only a portion of the withdrawal will be available for an RSP contribution in the year of transfer. Therefore, it will be necessary for you to come up with the additional funds from other sources in order to make up the difference to fully offset the income inclusion on the transfer.
Additional considerations are the consequences associated with an early withdrawal from the plan. If you are under the age of 50 and a half at the time of the withdrawal, the funds may be subject to a further 10 percent early withdrawal tax. Until recently, this amount was particularly punitive as the Canadian Revenue Agency disallowed the portion of the foreign tax credit pertaining to the 10 per cent early withdrawal tax. However CRA has since reviewed its position and has determined this 10 per cent additional tax will be eligible for the purpose of computing the foreign tax credit. While the change in CRA’s position is favorable, planning may be required to maximize your ability to use the additional foreign tax credits earned. This should be an important consideration when making the decision to transfer the plan to Canada.
Transfer of an IRA to an RRSP
Under Canadian tax law an IRA is considered to be a foreign retirement arrangement. The rules and consequences for transferring an IRA to an RRSP are very similar to the 401 (k) plan transfer rules. One important distinction, however involves the concept of an eligible amount. For the purpose of transferring an amount from an IRA to an RRSP, an eligible amount is an amount included in income, received as a lump sum and derived from contributions made to the plan by either you or your spouse/former spouse. Any contributions made to the plan by your employer would not be eligible to be transferred to an RRSP and deducted from your income.
It should also be noted that there is no requirement for you to be a non resident for your contributions to an IRA to be considered as an eligible amount. As well the case with the transfer from a 401 (k) plan to an RRSP, the taxable amount transferred from an IRA to an RRSP will be subject to withholding taxes which will be eligible for the foreign tax credit or similar deduction when filing your Canadian income tax return. Similarly, the early withdrawal tax is eligible for the purpose of computing your foreign tax credit.
Transfer of a 401 (k) Plan to an IRA to an RRSP
If your 401 (k) plan is not eligible for a roll over directly to an RRSP because the benefits were not attributable to services rendered by you or your spouse while a non resident in Canada) it can be rolled into an IRA that qualifies for a transfer to an RRSP. Subsequent to this, the new IRA can be transferred to an RRSP on a tax deferred basis provided the conditions required for a transfer from an IRA to and RRSP as outlined above are satisfied.
If you have any questions or would like a review of your current investments, please call 778-478-9759, or e-mail firstname.lastname@example.org
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