If you’ve been living and working in the United States, you’ve likely accumulated retirement savings while employed. Now that you’ve returned to Canada, you’re probably considering transferring the retirement savings you accumulated abroad to a Canadian registered retirement savings plan (RRSP) but are concerned about the tax implications and the logistics associated with such a transfer.
If you lived and worked in a country other than the United States, you may be still able to transfer your pension to an RRSP. See “Transferring foreign pensions to Canada” to learn more.
Overview of U.S. retirement plans
Typically, there are two types of retirement plans that you would’ve contributed to while working in the United States: a 401(k) plan and a traditional individual retirement account (IRA):
- 401(k) plan – A 401(k) plan is an employer-sponsored pension plan that’s 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 Contributions to a 401(k) plan are redirected from your pre-tax income and the funds can grow tax-free until withdrawn.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to a Canadian RRSP and allows you to make tax-deductible contributions while the earnings are tax deferred until withdrawn.
Transferring 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) plan1, to an RRSP on a tax-deferred basis. 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 must relate to services rendered by you, your spouse,2 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.
- The amount transferred must be designated as a transfer on Schedule 7 of your Canadian income tax return in the year of transfer to obtain an offsetting deduction from the income inclusion.
As this is considered a transfer, the RRSP contribution doesn’t 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 or any registered retirement income fund (RRIF). In addition, on 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’s no carryforward deduction available).
Although a tax-deferred rollover from a 401(k) plan to an RRSP is available, it’s 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% (and as high as 30%).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’d like to transfer the full pre-tax amount, it’ll 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’re under the age of 59½ at the time of the withdrawal, the funds may be subject to a further 10% early withdrawal tax. Previously, this amount was particularly punitive as the Canada Revenue Agency (CRA) disallowed the portion of the foreign tax credit related to the 10% early withdrawal tax. However, CRA reviewed its position and has determined this 10% 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.
Transferring an IRA to an RRSP
Under Canadian tax law, an IRA4 is considered 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 or former spouse. Any contributions made to the plan by your employer wouldn’t qualify as an eligible amount and consequently wouldn’t be eligible to be transferred to an RRSP under this provision.
The other important distinction is that there’s no requirement for you to be a non-resident for your IRA contributions to be considered 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 that’ll 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.
A Roth IRA is similar to a tax-free savings account (TFSA). It’s not eligible to be transferred to an RRSP like a 401(k) or IRA.
Transferring a 401(k) to an IRA to an RRSP
When a 401(k) is rolled over to an IRA, the full amount (employer and employee contributions) are deemed to be an eligible amount, as described earlier.5 Assuming the other conditions for such transfers are met, the IRA can be transferred to an RRSP. This can be beneficial if, for example, your 401(k) plan isn’t eligible for a rollover directly to an RRSP (e.g., because the benefits weren’t attributable to services rendered by you, your spouse, or former spouse while a non-resident in Canada), provided the conditions required for a transfer from an IRA to an RRSP, as outlined above, are satisfied.
Case study: IRA transfer to RRSP
Richard is 60 years old and recently re-established his Canadian residency by moving back to Ontario this year. Previously, he was a resident of the United States and contributed to an IRA. The IRA is worth $100,000 (all funds in Canadian dollars) and he would like to transfer it to his RRSP. Richard’s current employment income is $125,000. His U.S. financial institution confirmed that a 30% non-resident withholding tax will apply to the IRA withdrawal, so he’ll receive $70,000. He has the $30,000 needed to top up the net withdrawal back to the original $100,000 pre-tax amount in a separate bank account.
Tax results for RRSP transfer
|Gross IRA withdrawal||$100,000|
|Income before tax||$125,000|
|Foreign tax credit||$30,000|
When Richard files his Canadian tax return, he includes the gross withdrawal of $100,000 as income on line 11500 of his T1 General. The RRSP deposit of $100,000 is included on Schedule 7 as a transfer in Part C. This transfer value is subsequently reported on line 20800 of his T1 General. The withholding tax of $30,000 is reported on line 40500 of the T1 General, representing the foreign tax credit. If Richard’s plan was a 401(k) and all the other information was the same, the steps outlined here would also apply.
It may not be necessary to deposit the pre-tax withdrawal amount to an RRSP to fully utilize the foreign tax credit. See our case study from the “Transferring foreign pensions to Canada” Viewpoint article, where the RRSP deposit is less than the gross withdrawal.
Inheriting a 401(k) or IRA
For U.S. tax purposes, when a 401(k) or IRA account owner passes away, the beneficiaries are taxed on the proceeds they receive. There may be options for a beneficiary to defer U.S. tax—those options vary based on whether the beneficiary was the deceased’s spouse or not. Consult with the U.S. financial institution about these options and a qualified tax advisor regarding their tax consequences
For Canadian tax purposes, if the amount received by a beneficiary would be taxable in the U.S., then it’s taxable in Canada. When a spouse beneficiary takes a lump-sum payment, the spouse can transfer that amount to an RRSP as previously described for both a 401(k) and IRA transfer. For non-spouse beneficiaries, the inherited lump-sum amount could be contributed to an RRSP but would require enough RRSP contribution room and wouldn’t be eligible for transfer, as previously discussed.
If the beneficiary is also a U.S person (i.e., citizen or green card holder), the U.S. taxes related to the inherited amount can be used as a foreign tax credit on the beneficiary’s Canadian tax return.
Should you transfer your 401(k) plan or IRA to an RRSP?
It’s 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 There are other U.S. plans, such as a 403(b) or 457(b). While the CRA hasn’t provided guidance on their eligibility for transfer to an RRSP, their eligibility should be assessed on a case-by-case basis. Consult your tax advisor regarding your specific plan and whether it meets the conditions for transfer outlined in the “Transferring a 401(k) plan to an RRSP” section. 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 30% U.S. 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%. 4 Foreign retirement arrangements are IRAs referred to in subsections 408(a) – Traditional IRA, 408(b) – Individual Retirement Annuity, and 408(h) – Custodial IRA of the U.S. Internal Revenue Code. Other IRAs, such as a Simplified Employee Pension Plan (SEP) IRA and Simple IRAs, allow for employer contributions and may be eligible for transfer like a 401(k) or IRA. Speak to your tax advisor to review the specifics of your plan. 5 Other U.S. retirement plans are eligible for a rollover to an IRA, similar to a 401(k). It’s unclear whether a rollover of these plans would receive the same treatment as the 401(k) for Canadian tax purposes. Consult your tax advisor if you’re considering a rollover to an IRA. For more information about rollovers, see the IRS rollover chart.
This communication is published by Manulife Investment Management. Any commentaries and information contained in this communication are provided as a general source of information only and should not be considered personal investment, tax, accounting or legal advice and should not be relied upon in that regard. Professional advisors should be consulted prior to acting based on the information contained in this communication to ensure that any action taken with respect to this information is appropriate to their specific situation. Facts and data provided by Manulife Investment Management and other sources are believed to be reliable as at the date of publication.
Certain statements contained in this communication are based, in whole or in part, on information provided by third parties and Manulife Investment Management has taken reasonable steps to ensure their accuracy but can’t be held liable for such information being inaccurate. Market conditions may change which may impact the information contained in this document.
You may not modify, copy, reproduce, publish, upload, post, transmit, distribute, or commercially exploit in any way any content included in this communication. Unauthorized downloading, re-transmission, storage in any medium, copying, redistribution, or republication for any purpose is strictly prohibited without the written permission of Manulife Investment Management.
Manulife Investment Management is a trade name of Manulife Investment Management Limited and The Manufacturers Life Insurance Company.
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.