Article written by Jennifer Black and Dedicated Financial Solutions.
THE SAVINGS SWITCH
Transferring a U.S. 401(k) Plan or IRA to an RRSP
In addition to luggage, furniture and other belongings, Canadian residents who have moved to the U.S. for a period of time often bring home a retirement savings plan that’s accumulated during their time away.
Given U.S. retirement savings plans can differ significantly from Canadian plans, many people are not clear about what they can do with their U.S. plans now that they’re back on Canadian soil – and whether or not the plans can be transferred into an equivalent option, such as a Registered Retirement Savings Plan (RRSP).
TRANSFER OF A 401(K) PLAN TO AN RRSP
Canadian tax law permits a Canadian resident to transfer a foreign pension plan, such as a 401(k) plan, to an RRSP on a tax-deferred basis.
However, certain conditions must be met:
- The payment must be a lump-sum amount
- The payment must relate to services rendered by your client, his or her spouse or a former spouse when he or she was a non-resident of Canada
- The payment must be fully taxable in Canada and included in your client’s income in the year of transfer; and
- The amount transferred must be designated as a transfer on Schedule 7 of your client’s Canadian income tax return in the year of transfer in order to obtain an offsetting deduction
401(K) PLAN: An employer-sponsored pension plan typically funded by both employer and employee contributions. Contributions to a 401(k) plan are redirected from pre-tax income, and the funds can grow tax-free until withdrawn.
IRA: Similar to a Canadian RRSP, an individual retirement account (IRA) allows investors to make tax-deductible contributions, while earnings are tax-deferred until they’re withdrawn.
The contribution does not impact your client’s RRSP room, and must be contributed to his or her own RRSP – not a spousal plan. The contribution and corresponding deduction must be made in the year or within 60 days after the end of the year the payment is reported in your client’s income; a carry-forward deduction is not available.
For U.S. tax purposes, a taxable distribution from a 401(k) plan is subject to a mandatory withholding tax of at least 15 per cent (and perhaps as much as 30 per cent), which your client is eligible to claim as a foreign tax credit or similar deduction when filing his or her Canadian income tax return.
This means only a portion of the withdrawal is available for an RRSP contribution in the year of transfer. Therefore, additional funds from other sources are required to make up the difference to fully offset the income inclusion on the transfer.
Withdrawals made by persons under age 59.5 years at the time of the withdrawal may be subject to a further 10 per cent early withdrawal tax. While also eligible as a foreign tax credit, planning may be required to maximize a client’s ability to make use of it.
TRANSFER OF AN IRA TO AN RRSP
The rules and consequences for transferring an individual retirement account (IRA) to an RRSP are similar to those that apply to a 401(k) plan. One important distinction, however, is the concept of an “eligible amount,” which, in this situation, is an amount included in income, received as a lump sum and derived from contributions made to the plan by either your client or his or her spouse/former spouse. Contributions made to the plan by the employer do not qualify as an eligible amount and consequently cannot be transferred to an RRSP and deducted from income.
There is no requirement to be a non-resident for your client’s contributions to an IRA to be considered an eligible amount. As with 401(k) plans, the taxable amount transferred from an IRA to an RRSP is subject to withholding taxes that are eligible for the foreign tax credit or similar deduction when your client files his or her Canadian income tax return. Similarly, the early withdrawal tax is eligible for the purpose of computing the foreign tax credit.
TRANSFER OF A 401(K) PLAN TO AN IRA TO AN RRSP
If the 401(k) plan can’t be transferred to an RRSP because, for example, the benefits were not attributable to services rendered by your client, his or her spouse or a former spouse when he or she was a non-resident of Canada, the plan can be rolled over into an IRA that qualifies for a transfer to an RRSP. The “new” IRA can then 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.
If you wish to discuss your situation further and understand if moving your 401(K) to an RSP would be right for you contact us today.
This article was written by and used with permission from Manulife Financial. The commentary in this publication is for general information only and should not be considered legal, tax or other professional 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.
1 Spouse includes common-law partner as these terms are defined in the Income Tax Act (Canada).
2 A lump-sum distribution from an individual retirement account (IRA) or 401(k) plan 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 IRA or 401(k) plan qualify as periodic pension payments under the Canada–U.S. Income Tax Convention, the withholding tax rate may be reduced to 15 per cent.