If you have been living and working in the United States you would have likely accumulated retirement savings while employed. Now that you have returned to Canada, you are probably considering transferring the retirement savings that you have accumulated abroad to a Canadian Registered Retirement Savings Plan (“RRSP”)¹ , but, are concerned about the tax implications and the logistics associated with such a transfer.
Overview of U.S. Retirement Plans
Typically, there are two types of retirement plans that you would have contributed to while working in the United States – a 401(k) plan and an Individual Retirement Account (“IRA”).
401(k) Plan: A 401(k) plan is an employer sponsored pension plan that is typically funded by both employer and employee contributions. Contributions to a 401(k) plan are redirected from your pre-tax income and the funds can grow tax-free until withdrawn.
IRA: An IRA is similar to a Canadian RRSP and allows you to make tax-deductible contributions while the earnings are tax-deferred until withdrawn.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 individual living in Canada, to transfer a foreign pension plan, such as a 401(k) plan, to an RRSP on a tax-deferred basis. In order to do so, 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 spouse², or your former spouse during the period in which you were a non-resident of Canada,
- The payment must be fully taxable 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 on 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 carryforward deduction available).
Although a tax deferred rollover from a 401(k) plan to an RRSP is available, it is important to be aware of the U.S. tax consequences in connection with the transfer. In the United States, a taxable distribution from a 401(k) plan is subject to a mandatory withholding tax of at least 15 per cent (and perhaps as high as 30 per cent)³. The U.S. 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 RRSP contribution in the year of transfer. Therefore, if you would like to transfer the full pre-tax amount it will be necessary for you to come up with the additional funds to fully offset the income inclusion on the transfer.
An additional consideration are the consequences associated with an early withdrawal from the plan. If you are under the age of 59½ at the time of the withdrawal, the funds may be subject to a further 10 per cent early withdrawal tax. Until recently, this amount was particularly punitive as the Canada Revenue Agency (“CRA”) 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 purposes of computing the foreign tax credit. While the change in CRA’s position is favourable, 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 qualify as an eligible amount and consequently 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 was the case with the transfer from the 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 purposes of computing your foreign tax credit.
Transfer of a 401(K) to an IRA to an RRSP
If your 401(k) plan is not eligible for a rollover directly to an RRSP (i.e. because the benefits were not attributable to services rendered by you, your spouse or former 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 an RRSP, as outlined above, are satisfied.
It is important to consider the alternatives and implications of transferring a 401(k) plan or IRA from the United States to a Canadian RRSP. Plans transferred from the United States to Canada may have certain stipulations that must be considered before a transfer can take place. Speak to your advisor to see if this strategy is right for your situation.
1 The reference to a Canadian RRSP is specific to an unmatured RRSP. There is no provision to allow for the transfer of a 401(k) plan or IRA to a matured RRSP or a Registered Retirement Income Fund (“RRIF”). 2 Spouse includes common-law partner as these terms are defined in the Income Tax Act (Canada). 3 A lump sum distribution from a 401(k) plan or IRA to a non-U.S. citizen, non-U.S. resident is generally subject to a U.S. 30 per cent withholding tax. If the payments from the 401(k) plan or IRA qualify as periodic pension payments under the Canada-U.S. Income Tax Convention, the withholding tax rate may be reduced to 15 per cent.
This publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.