The Big Shell Out Abroad
Understanding tax treatments for non-residents with RRSPs and RRIFs
by Jamie Golombek
If you're like most advisors, chances are you either have clients who have moved abroad or at least have advised you of their intentions to emigrate upon retirement. One of the most common questions facing emigrants is the tax treatment of moneys held inside a registered retirement savings plan (RRSP) or a registered retirement income fund (RRIF) after departure.
The domestic rules
There is no obligation to dispose of any RRSPs or RRIFs upon becoming a non-resident. The general rule is that when a Canadian resident ceases to be a Canadian resident, he or she is deemed to have disposed of all their properties with certain exceptions. One of those exceptions is their pension plan, which includes both RRSPs and RRIFs.
In most cases, it does not make sense to withdraw RRSP or RRIF monies prior to emigration since any withdrawals will be taxable at full marginal tax rates while the annuitant is still a resident of Canada. As a result, most clients will choose to maintain their retirement plans upon leaving Canada, unless your client has very little income in retirement and pays tax in the lowest bracket of approximately 22 per cent, which would be lower than the typical withholding tax rate of 25 per cent.
Once your client has left Canada, while the earnings and growth inside the RRSP or RRIF continue to grow tax-deferred, the Income Tax Act imposes a non-resident withholding tax on all payments out of the plans. The rate of withholding varies from zero to 25 per cent, depending on the amount and the country of emigration and any tax treaties that Canada has entered into with the foreign jurisdictions.
Reduced withholding under Canada's tax treaties
While Canada's tax treaties provide for different withholding tax rates for pension paid to non-residents of Canada, there are several common definitions that are applicable to all treaties and are defined in the Income Tax Conventions Interpretation Act (ITCIA). If a tax treaty does not specifically define a pension, a pension will include any payment made under an RPP, RRSP or RRIF, among other plans.
The ITCIA also defines the term "periodic pension payment", which is extremely important as many treaties offer a reduced withholding tax on periodic pension payments. For example, under the Canada-U.S. tax treaty, a reduced withholding tax rate of 15 per cent applies to such payments. Under the Canada-U.K. treaty, there is no withholding tax on periodic pension payments.
So, what exactly is a "periodic pension payment"? Under the ITCIA, it is essentially a payment out of a RRIF that does not exceed the greater of twice the "minimum amount" for the year and 10 per cent of the fair market value (FMV) of the RRIF at the beginning of the year.
Let's illustrate this seemingly convoluted definition with an example.
Assume your client, Amy, moves to the U.S. with an RRIF that was valued at $100,000 on December 31, 2004. Amy has set up a systematic withdrawal plan (SWP) that pays her $2,000 monthly from her RRIF. Based on Amy's age, we'll also assume that her "minimum amount" of this RRIF is $8,000 for 2005.
Twice the minimum amount of Amy's RRIF would be $16,000 and 10 per cent of the FMV of her RRIF would be $10,000. Thus, the greater of these two amounts is $16,000. To determine the appropriate withholding tax that will be deducted from her RRIF payments, each SWP payment must be determined to see if it is a "periodic pension payment" as described above.
For the first eight months of 2005, Amy's monthly withdrawals of $2,000 will total $16,000 and thus each qualify as a "periodic pension payment" and be subject to only 15 per cent withholding tax, reduced from the normal withholding tax rate of 25 per cent.
Beginning September 2005, however, each $2,000 payment would not qualify as a "periodic pension payment" since the total of all payments under the RRIF in 2005 exceeds $16,000. As a result, the $2,000 RRIF payments for September to December of 2005 would not qualify as periodic pension payments and, therefore, would be subject to the general non-resident tax rate of 25 per cent.
Based on the above discussion, one planning point should be obvious. If a client is moving to a country that offers a reduced withholding tax rate on RRIF payments, he or she may wish to consider converting an RRSP to a RRIF before age 69 as long as he or she is willing to withdraw at least the minimum amount annually.