For those who are fortunate enough to begin their retirement, maximizing retirement funds should be a top priority, especially, when settling in Canada with funds in foreign-based retirement plans.
For example, Canadian residents who have spent time working in a foreign country may have accumulated funds in a foreign-based retirement plan. This is a common occurrence if an individual has worked in the United States and participated in a 401(k), 403(b) and/or Individual Retirement Account (IRA).
Under Canadian income tax rules, Canadian residents can transfer funds from a foreign-based plan to a Canadian Registered Retirement Savings Plan (RRSP) under certain conditions. There are many benefits to the consolidation of retirement funds and professional advice should be obtained from a qualified tax advisor to determine the best course of action. The tax professionals at Welch LLP can help. It’s as easy as one, two, three.
Step 1: Withdraw a lump sum amount from your foreign-based retirement plan. Typically this will attract 30 percent US withholding of tax.
Step 2: Contribute to the US funds from step 1 to an RRSP. The amount of the contribution should be equal to the gross value of the withdrawal from your foreign-based retirement plan.
Step 3: Report the amount of the withdrawal and RRSP contribution on your Canadian tax return in the year the transaction occurred.
The following example illustrates the application of these steps. For simplification, foreign exchange currency rates have not been applied.
Ms. Smith is a 68 year-old Canadian citizen and resident and is not a US citizen nor US green card holder. She previously worked in the US but has returned to Canada. Ms. Smith has $250,000 in a US IRA. She has no unused RRSP room.
After meeting with her financial and tax advisors, it was determined that her US based retirement plan is eligible to be transferred to a RRSP. As a result, Ms. Smith instructed her US plan administrator to collapse her IRA and Ms. Smith received net proceeds of $175,000 as the withdrawal is subject to a withholding tax of 30 percent.
For Canadian tax purposes, the $250,000 withdrawal from the IRA will be treated as taxable foreign pension income. In addition, there is a special rule, which allows an RRSP deduction for contributions funded from a foreign pension plan. This contribution does not require RRSP room. However, there is a slight catch. In order to receive the full off-setting deduction of $250,000, Ms. Smith will need to come up with $75,000 in cash, given the amount lost to US withholding taxes.
The US tax withholding of $75,000 (i.e., the 30% US withholding tax), will be treated as foreign tax paid. In order to fully recover the total $75,000 of US withholding taxes as a foreign tax credit on her Canadian income tax return, Ms. Smith must have sufficient income generated from other sources, otherwise the unused portion of the foreign tax credit will never be available to Ms. Smith. In the event that a portion of the US withholding is not recoverable, Ms. Smith will ultimately be subject to double tax on a portion of the pension (i.e., US withholding at the time of the US IRA withdrawal and Canadian taxation when the funds are withdrawn from the RRSP in future years).
As a result of the potential double taxation, it is critical that calculations be prepared prior to collapsing the US IRA. Therefore, before transferring your foreign-based plans to an RRSP in Canada, speak to a professional tax advisor at Welch LLP as there are many issues to consider. The planning noted above is not available for US citizens or US green card holders.