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Canadian living in the USA: Your RRSP, TFSA, and the IRS


Canadian living in the USA: Your RRSP, TFSA, and the IRS

Contributed by: martingale

Canadians in the USA If you are a Canadian who lives and works in the United States, or are considering moving to the USA for work, there are a few things you should know about how the IRS will treat your Canadian RRSP, your Canadian TFSA, as well as your RRSP, and a few comments on what may become of your Canadian real estate when you move to the United STates. There are a couple of real gotcha's here!

The first thing you should know is that there is a Canada/US Tax Treaty, and this tax treaty governs what will happen to your retirement accounts on either side of the border. This article is written assuming that you are going to become a US Person, and a US Resident for tax purposes. Not every Canadian who works in the USA becomes a US residient for tax purposes--if your Canadian employer sends you to the US on assignment you may not need to pay US taxes. Basically, if you're going to be filling a tax return to the IRS, then this information should be relevant to you.

You need to close your TFSA

The problem with the tax treaty is that it was negotiated before the Canadian government introduced the TFSA. As a result, the tax treaty does not provide any special benefits to your TFSA: The IRS will treat your TFSA as a taxable account, and you will have no tax benefit whatsoever from retaining your TFSA. In fact, the IRS will consider your TFSA to be a "foreign trust", and impose on you a very painstaking and onerous tax reporting burden. The short story is, close down your TFSA--it's not going to provide any tax benefit, and it's going to create a ton of paperwork.

Ideally, you should close down your TFSA before you become a US resident, so that you can avoid this foreign trust reporting requirement.

This naturally raises the question of what to do with your TFSA money? There are really a couple of choices here, which we will come back to later in the article: You could use the TFSA funds to make a large RRSP contribution; you could use the TFSA money to establish a tax protected account in the United States; or you could convert your TFSA funds to a regular brokerage account.

You can keep your RRSP--but with restrictions

The good news is that the Canada/US tax treaty does recognize your RRSP as a tax protected account, and IRS will allow you to keep it, and continue to benefit from your RRSP assets compounding tax free until you retire. The bad news is that you may owe state taxes on earnings within your RRSP. Some states tax RRSP earnings. Some states do not. The federal government does not.

If you are moving to a state that does not tax RRSP earnings you can keep your RRSP as is -- you will need to make a special declaration on your tax return to continue deferring taxes. If you live in a state that DOES tax your RRSP, like California, you should rebalance your RRSP to contain tax-efficient investments such as a low-dividend ETF or a short-term bond fund.

More bad news is that you are going to be subject to some rather extreme conditions on your ability to manage your RRSP. There are two primary restrictions you will face:

#1 - You will not be allowed to purchase any more Canadian ETFs, mutual funds, or trust accounts.
#2 - Your ability to trade within your RRSP account will be severely restricted by your bank

You CAN purchase Canadian or US stocks, and you can purchase US ETF's in your RRSP, once you are a US resident. You will be prohibited from purchasing any new Canadian ETFs or mutual funds. However, you can keep any you already have. So this means rebalance your RRSP before you depart Canada. Take advantage of your last days in Canada to put in any orders you wish to place to purchase Canadian ETF's and Canadian mutual funds--it'll be your last chance!

Once you are in the US your bank will severely limit your ability to trade within your RRSP. This is because their regular investment advisors are not licensed to trade securities in the United States, which is where you are--it's illegal. As a result your RRSP administrator or brokerage will almost certainly shut down your online access to your account, and force you to conduct all trades by telephone. This is so that they can route your calls to specific individuals who ARE licensed to trade securities in the United States. Also, only the largest brokerages will do this for you, if your RRSP is with a smaller firm, you should find out what their policy is--they may lock you out entirely.

Check what your broker's policy is for US residents and potentially transfer your RRSP to a more favourable institution before leaving Canada!

These restrictions are fairly harsh, but fortunately there are lots of good ETF's in the United States that you will be allowed to trade. Vanguard has excellent ETF's, and these will all be available to you.

So what are your options in the United States?

After settling up your affairs before leaving Canada, you may find yourself wanting to invest a chunk of retirement money on the US side of the border. This is obviously a complex topic with lots of options, so I'm just going to scratch the surface.

First off, you will need a SSN or an ITIN in order to do anything. Some financial institutions only deal with US permament residents or citizens, while others are more lenient. The good news is that a couple of the really good ones are lenient -- you can open up an account with either Vanguard or E-Trade using an ITIN or a SSN, even if you are a "resident alien" in the United States. They're OK with it. Other institutions like Merrill Lynch are not OK with it and will require you to be a permanent resident of the United States.

I highly recommend Vanguard owing to their ultra low costs. You will have to mail in a paper application if you are applying using an ITIN, but they'll set you up. If you have an SSN, you can open the account online.

Once you have settled on a financial institution, here are a few brief pointers:

  • You can open up an IRA for yourself and deposit $5500/year (as of 2016), more if you are over 50
  • You can also open up an IRA for your spouse, even if they have no income, provided you file your taxes "married filing jointly"
  • Unlike Canada, IRA limits are use-it-or-lose-it, you get the same amount every year regardless of income and it doesn't carry over
  • If you move back to Canada, Canada will recognize your IRA as a tax protected account under the US/Canada tax treaty
This means that you can contribute $5500 to your IRA on arrival in the United States. If you have a spouse, you can double that, by opening up one IRA each. If you later move back to Canada you can keep your IRA. You will have to file a special reporting form with your taxes, and this form is not automatically provided--but assuming you file the required tax paperwork, your IRA will remain tax protected once you are back in Canada.

There are two kinds of IRA's, which you can research elsewhere. First there are "traditional IRAs" that are like Canadian RRSPs: You get a tax deduction when you contribute money, and you pay tax when you withdraw. Second there are "roth IRA's" that are like Canadian TFSA's: you get no deduction when you deposit money, but you can withdraw in retirement tax free.

If your employer has a 401k plan, you can participate in that as well, and it will be treated like an IRA, and considered tax protected by Canada. The only difference between an IRA and a 401k is that you self-fund an IRA, while a 401k is funded through payroll contributions. You can have both!

What about my RESP?

Unfortunately an RESP is not considered a tax protected account from the perspective of IRA, and you will pay tax on the contents. The best thing to do is try and find a relative who is still a Canadian resident, and transfer the RESP to them. If you have a parent or grandparent who is going to remain in Canada, you can transfer the RESP to them, and it can continue to be in the name of your child. If you don't have anyone you can transfer it to, consult an accountant--it's going to get a little complicated.

Similarly, the United States has a college savings system called a "529 plan" that you can contribute to as an American resident. However, once again, it will not be considered a tax protected account in Canada if you cross back to Canada again. As with an RESP, you can deal with this by transfering it to a friend or relative who will remain a US resident, keeping your child as the beneficiary. If this is not an option for you, again consider consulting an accountant for the best way out of the mess.

One bit of good news is that your US 529 plan will happily pay for an education in Canada, if your child returns there for school, while you remain a US resident.

A few words about your home

There's one topic I'm not going to cover because it's complicated, and that's your home in Canada. When you leave Canada for the United States if you choose to continue owning your Canadian home, and you cease being a resident of Canada, there is going to be a "deemed disposition" of your home. Depending on whether you qualify for the Primary Residence exemption you may not owe any tax, but if you have a secondary residence--like a cottage--you may face a rather large tax bill.

In either case it's worth doing some serious tax planning. Even if you pay no tax on the deemed disposition of your home, it can have an impact on how much tax is later owed when you do ultimately sell the property: You'll owe taxes from the date of the deemed disposition to the date of sale, at a minimum. It will be worth your while to get a good appraisal of the value of your home before you leave Canada. This will help you out later when you need to figure out how much the property was worth at that time!

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