Tax planning for Canadians moving to the United States

There are significant differences in taxation of investments for Canadian citizens who live and work in the United States. To manage these differences, it’s important for individuals to properly structure their investment portfolios before they depart Canada.

When a person's tax residency changes from Canada to the U.S., questions often arise about whether their investments can continue “as is” and what the tax implications are for a portfolio. We offer some investment strategies for individuals planning to live in the United States.¹

Registered retirement plans—U.S. taxation

For U.S. tax purposes, only the income portion of withdrawals from a registered retirement savings plan (RRSP)² and registered retirement income fund (RRIF) is taxable. The portion that represents an individual’s investment in the contract, or the capital portion, may be received tax free.

The capital portion is the lesser of:

• fair market value (FMV) of plan assets at the time an individual became a U.S. citizen or resident
• sum of contributions to the plan plus the earnings in the plan at the time the individual became a U.S. citizen or resident. This doesn’t include unrealized appreciation in the plan assets.

If the RRSP or RRIF assets reflect unrealized appreciation, you should consider crystallization of plan growth before becoming a U.S. resident. By increasing the amount that’s considered to be the investment in the contract, you can reduce the taxable portion of the withdrawals and enjoy significant tax savings.

Making it work for an RRSP—example

Sandra’s RRSP has grown to a market value of $350,000. She crystallizes the growth in her RRSP just before leaving Canada to increase the capital portion for U.S. tax purposes to $350,000.

If Sandra cashes in her RRSP immediately after her move, the withdrawal will equal the capital portion and be exempt from U.S. tax. The full value of her RRSP would be subject to a 25% withholding tax in Canada, but these taxes ($87,500) can be used as a foreign tax credit in the U.S. Compare this to cashing in the RRSP before leaving Canada: if Sandra is in a 45% tax bracket, $157,500 of her RRSP is lost to taxes.

The different tax treatment of RRSP withdrawals from within Canada and the U.S. provides an opportunity to reduce taxes with proper planning.

The non-resident withholding tax rate on RRIF withdrawals is generally 25%; however, it can be reduced to 15% when payments from the RRIF during the calendar year are less than the greater of twice the year’s minimum payment requirement or 10% of the RRIF’s FMV at the beginning of the year.

The withholding tax rates on locked-in retirement account withdrawals (locked-in RRSPs, RRIFs, and equivalents) is the same as those for RRSPs and RRIFs. However, the ability to withdraw is more restricted due to pension legislation. Before leaving Canada, find out if there are any options available to unlock these funds. Generally, pension legislations offer an unlocking option for non-residency, which allows a non-resident to fully unlock their locked-in account. While a cash withdrawal is fully taxable and subject to the same non-resident withholding tax applicable to RRSP and RRIF withdrawals, there may be an option to transfer this amount to an RRSP or RRIF tax deferred.

Tax-free savings accounts—U.S. tax rules

A non-resident can continue to hold a Canadian tax-free savings account (TFSA) that’ll be exempt from Canadian tax on its investment income and withdrawals. However, for U.S. tax purposes, the income earned in the TFSA will be taxed each year, as there’s no treaty relief.

When leaving Canada, individuals should consider liquidating their TFSA investments and withdrawing the proceeds. Remember, the withdrawal will be added back to their unused TFSA contribution room in the following year and may be utilized in the future if they become a Canadian resident again.

Registered education savings plans—U.S. taxation

A non-resident can continue to be a subscriber of a Canadian registered education savings plan (RESP) and the funds will be exempt from Canadian tax while in the plan. However, under U.S. tax rules, the annual income earned, as well as any grant and bond money received in the year, is considered taxable income to the subscriber. Because there’s no Canadian tax payable on the RESP, there’s no offsetting foreign tax credit.

When a non-resident beneficiary draws from the RESP for post-secondary education, the accumulated income is taxed to the student, resulting in double taxation. This can be avoided by having a Canadian resident who’s not required to file a U.S. tax return as the RESP subscriber. Government incentives, including the Canada Education Savings Grant (CESG), Canada Learning Bond (CLB), and some provincial incentives,³ would have to be repaid.

Trust income and capital gains—U.S. tax rules

Taxable trust income (dividends and foreign income) from mutual funds and segregated fund contracts is reported to non-residents as it occurs each year. Tax withholding of 15% on this income is generally paid by surrendering units from the funds. Taxes aren’t withheld on interest income or capital gains. However, there’s a deemed disposition on these types of investments when moving from Canada to the U.S., making any gains or losses subject to Canadian tax laws. Because of this, the decision to hold or sell before leaving Canada isn’t usually based on Canadian tax considerations.

However, U.S. residents and citizens need to consider U.S. tax rules as well as any additional reporting requirements to U.S. authorities that may apply to holdings in Canadian trusts and corporations. For example, U.S. tax rules deem a non-registered investment in a Canadian mutual fund trust or mutual fund corporation to be an investment in a passive foreign investment company (PFIC), resulting in unfavourable U.S. tax consequences. A segregated fund contract is a variable annuity contract and the Internal Revenue Service (IRS) hasn’t indicated whether it would be subject to the same PFIC rules.

Transaction restrictions within the U.S.

Due to securities regulations, U.S. residents are generally limited to redemptions and otherwise prohibited from managing their Canadian investments from U.S. soil. Certain states allow brokers or dealers to apply for exemptions on registered accounts but no exemptions exist on non-registered accounts. Therefore, it’s important that Canadians moving to the U.S. to work should realign their portfolios for the long term unless they plan to return to Canada on a regular basis.

Ideal candidates

Individuals moving from Canada to the U.S. and who hold these investments:

• RRSPs, RRIFs, or their locked-in equivalents
• RESPs
• TFSAs
• non-registered mutual funds or segregated fund contracts

Take action

To help maximize the tax-efficiency of their portfolios, investors should:

• consider crystallizing unrealized growth in their RRSP assets to a new plan before leaving
• consider liquidating their TFSA investments and withdrawing the proceeds
• make sure they’re not the subscriber of an RESP
• make sure their portfolio has been structured for a long-term holding period
• consider holding their non-registered investment funds with an insurance company in a segregated fund contract, which may avoid the PFIC rules.

Investment options with Manulife Investment Management

Manulife and its subsidiaries provide a range of investments and services.

Mutual funds from Manulife Investment Management can help meet your specific financial needs throughout your life. Whether you’re just starting out, accumulating wealth, or nearing/in retirement, mutual funds offered by Manulife Investment Management can provide you with solutions to help build a portfolio that meets your needs. Manulife Investment Management uses four principal asset management firms to oversee its extensive fund family. Each firm is recognized for its strength and depth of experience in various asset classes and investment styles. We’re committed to providing superior investment products and services so you can enjoy life and worry less.

Segregated fund contracts combine the growth potential offered by a broad range of investment funds with the unique wealth protection features of an insurance contract. Through Manulife segregated fund contracts, investors can help minimize their exposure to risk through income, death and maturity guarantees, potential creditor protection features, and estate planning benefits—all from a single product or insurance contract.

Before proceeding with any of these strategies, speak to a cross-border tax specialist about your personal situation.

1 The U.S. tax rules discussed apply to a “U.S. person,” which includes U.S. residents but also includes U.S. citizens (even those residing in Canada who are Canadian residents for Canadian tax purposes) and U.S. green card holders. Individuals who have to file a U.S. tax return should speak to a cross-border tax specialist about their specific situation. 2 The application of this strategy to locked-in RRSPs is uncertain at this time. Individuals should consult their tax advisor before proceeding. 3 For the Saskatchewan Advantage Grants for Education Savings (SAGES), RESP beneficiaries must be Canadian residents when the educational assistance payment (EAP) is made. The beneficiary doesn’t need to be a Canadian resident to have the British Columbia Training and Education Savings Grant (BCTESG) included in an EAP. For all other provincial incentives, consult the provincial authority for EAP residency criteria. For more information, see “Residency requirements for an EAP.”