Planning for retirement can be an extraordinarily complex process, particularly when there are cross-jurisdictional issues like the Canada-US Tax Treaty. As a non-resident or expat, you’ll need to understand how each country taxes withdrawals on Registered Investment Plans such as the RRSP, TFSA or certain pensions.
This article will shed light on the notoriously grey area of retirement planning for US expats living in Canada.
The Good: Registered Retirement Savings Plan (RRSP)
An RRSP is a retirement savings plan that is registered with the Canada Revenue Agency (CRA). Contributions to your RRSP can be made by yourself or your spouse/common-law partner. The last year that you can contribute to an RRSP, is by December 31st of when you turn 71 years of age. You can contribute to an RRSP under which your spouse or common-law partner is the annuitant until the end of the year your spouse or common-law partner turns 71.
The benefit of an RRSP is that the contributions can be used to reduce your tax payable in the year in which contributions are claimed. Any income you earn in the RRSP is usually exempt from tax as long as the funds remain in the plan. However, once you receive payments from the plan, they are taxed at your current tax rate.
Canadian Taxes on RRSP Withdrawals for Residents
In addition, at the time of withdrawing, the bank/investment company withholds taxes as follows for Canadian residents:
- 10% (5% in Quebec) on amounts up to $5,000;
- 20% (10% in Quebec) on amounts over $5,000 up to including $15,000; and
- 30% (15% in Quebec) on amounts over $15,000.
Canadian Taxes on RRSP Withdrawals for Non-Residents
For non-residents of Canada, withholding is 25% for lump-sum RRSP withdrawals and 15% for periodic pension payments.
US Treatment of RRSPs
Previously, the IRS required Form 8891 to be filed to report contributions, undistributed earnings and distributions received from RRSPs and RRIFs.
However, due to the recent changes, Form 8891 no longer needs to be filed, and individual will be considered to have made the treaty election for deferral.
Distributions from these accounts must be reported on the US individual income tax return, as they would be on your Canadian Tax Return.
In addition, this policy change does not affect any other US reporting requirements that Americans with RRSPs and RRIFs may have to meet. For example, you may have to file an annual Report of Foreign Bank and Financial Accounts (FBAR) and a Form 8938 Statement of Foreign Financial Assets if the value of your plans meets the relevant thresholds.
Registered Retirement Income Fund (RRIF)
An RRSP is required to be converted to a retirement income option such as a RRIF by December 31 of the year that you turn 71. However, you do have the option to convert your RRSP to a RRIF at any time before then. RRIFs are similar to RRSPs in several respects; however, once, your RRSP is converted to a RRIF, you are not allowed to make any further contributions and must make a minimum mandatory withdrawal each year.
The amount of the mandatory withdrawal is determined by the beginning of each year, by a calculation that uses your age and the market value of the assets in the account as of December 31st of the previous year.
RRIF payments are considered taxable income in the year they are withdrawn and are taxed at your current tax rate. You may make withdrawals as often as you like and you may withdraw over your minimum annual amount.
A RRIF has the same withholding tax rates as an RRSP on withdrawals. For non-residents, withholding rates are 25% for lump-sums, and 15% for periodic pension payments.
US Treatment of RRIFs
The US tax treatment for RRIFs is identical to RRSPs, therefore distributions must be reported on the US tax return.
The Okay: Canada Pension Plan (CPP)
The Canada Pension Plan is similar to Social Security Benefits in the US. All employed Canadians who are over 18 years of age have to contribute a portion of their earnings to CPP. Employers match the employees contribution. For 2019, the employee and employer contribution rate is 5.10% of a worker’s gross employment income between $3,500 and $53,900, up to a maximum contribution of $2,748.90. Self-employed individuals must pay both the employee and employer portion of CPP, up to a maximum contribution of $5,497.80. You can apply for, and begin receiving, CPP benefits as early as 60, up to the age of 70.
If you contributed to both the Canada Pension Plan and US Social Security, you may qualify for a Canadian or an American benefit, or both, under the Agreement on Social Security between Canada and the US. This means that under certain circumstances, you can elect to transfer amounts paid into either program into the jurisdiction you choose.
In Canada, CPP payments are considered taxable income, and therefore the tax rate paid is dependent on your other income for the year. If you have income from other sources, you may elect to have federal income tax deducted each month from your CPP payment.
On the other hand, US Social Security benefits received by Canadian residents are only subject to tax in Canada. Canadian residents receiving US social security benefits are required to include 85% of those benefits in computing their Canadian income. Full benefits are reported on the Canadian return, and the non-taxable amount (15%) is claimed as a deduction from net income in calculating taxable income.
US Treatment of Canadian Pension Plans
The taxation of payments received from some Canadian retirement programs receive special tax treatment due to the income tax treaty between the United States and Canadian Governments.
The way this income is taxed depends on the recipient’s residency status, i.e. Canada, the United States, or both. This special tax treatment extends to payments received from the following Canadian retirement programs: Canada Pension Plan (CPP), Quebec Pension Plan (QPP), and Old Age Security (OAS), but not Private Pension Plans or Annuities.
If the recipient is an American resident, these benefits are taxable only in the United States, and are treated as US Social Security benefits for tax purposes. CPP payments are reported on Form 1040 or Form 1040A on the line on which US Social Security benefits would be reported.
If the recipient is a Canadian resident, these benefits are taxable only in Canada.
Old Age Security (OAS)
The Old Age Security (OAS) pension is a monthly payment available to most people 65 years of age and older who meet the Canadian legal status and residency requirements. Unlike CPP, you can receive the OAS pension even if you have never worked.
OAS has a clawback that kicks in if your net income is over $77,580 for 2019 ($79,054 for 2020), and therefore you must pay back a portion of OAS at a rate of 15% of net income. Once income levels reach $126,058 for 2019 ($128,137 for 2020), the full benefit of OAS is eliminated. Like CPP, OAS is taxable income, and no income tax is deducted unless it is requested.
US Treatment of OAS
Due to the US/Canada Tax Treaty, OAS falls under the same treatment as CPP.
The Ugly: Tax-Free Savings Account (TFSA)
The TFSA is a flexible, registered savings vehicle that allows Canadians to earn tax-free investment income by contributing after-tax dollars. For 2019, Canadian residents, age 18 and older, can contribute up to $6,000 annually to a TFSA. A TFSA can be hold cash, mutual funds, GICs, and certain stocks and bonds.
While any gains earned in the TFSA are tax-free, unlike RRSP contributions, they are not tax deductible for income tax purposes. If you do not max the contribution in the current year, the TFSA allows you to carry forward any unused contribution room. The full amount of withdrawals can be put back into the TFSA in future years, however re-contributing in the same year may result in an over-contribution amount that would be subject to a penalty.
As of 2019, the total cumulative contribution room for a TFSA is $63,500.
US Treatment of TFSAs
Canadian mutual funds held in TFSAs are generally considered by the IRS to be investments in a passive foreign investment company (PFIC), and must be reported on form 8621 by US citizens.
The TFSA may also be a grantor foreign trust from the perspective of the US. US citizens with a grantor foreign trust are required to file IRS Forms 3520A and 3520.
Again, if the thresholds are met, the TFSA would have to be reported on your Foreign Bank Account Report (FBAR) as well as Form 8938 to comply with Foreign Account Tax Compliance Act (FACTA). It is generally advised for US citizens not to hold TFSAs as the reporting costs of the account usually outweigh the benefits.
In planning your retirement, it is important to factor in cross-border tax issues, especially in the case of United States citizens planning to work until retirement in Canada.
Presently, the best Registered Investment Vehicle remains to be the RRSP, where there are clear guidelines and reporting requirements set out in the Tax Treaty. This means tax savings, without extraordinarily high reporting requirements as in the case of the TFSA.
At this point, it is uncertain as to what stance the IRS will take on TFSAs moving forward, however, as the growth of these accounts continue to their current exponential growth in value, we expect (and hope) for a formalized method of reporting in the future. Until then, and at least for the next few years, we are recommending that our US clients not invest in their TFSA accounts, as the cost of reporting greatly exceeds the benefit.
While this article serves as a guideline to current rules, it is clear that the treatment of Registered Investment Accounts continues to be an ever-changing landscape, as Governments on either side of the border try to incentivize personal savings and investment. As you plan for retirement and your future, it is critical to keep up to date with current tax laws to ensure that your savings remain yours, rather than Uncle Sam’s.