The tax implications depend on the plan
From time to time, we come across clients who have U.S.-type retirement accounts, having worked in the U.S. for a number of years before moving back to Canada. A common question asked is whether such accounts can be transferred to Canadian RRSPs on a tax-free (or at least tax-deferred) basis.
The answer depends on what type of plan is being transferred. So, before discussing the transfers themselves, let’s examine three types of U.S. retirement plans.
401(k) plans
A 401(k) plan is named after the section of the U.S. Internal Revenue Code that created it. It is an employer-sponsored pension plan that is typically funded by both employer and employee contributions. Contributions to these plans are deductible from pre-tax income and the funds grow tax-free until withdrawn.
Traditional individual retirement accounts (IRAs)
Traditional IRAs are similar to Canadian RRSPs in that they are personal savings plans that allow employees to make tax-deductible contributions to the account. The earnings as well as contributions are tax-deferred until withdrawn. Just like Canadian plans, traditional IRAs can be established at many different U.S. financial institutions, including banks, insurance companies, and brokerage firms.
Roth individual retirement accounts (Roth IRAs)
A Roth IRA is similar to a traditional IRA, but in reverse. In other words, while contributions to a Roth IRA are not tax deductible, distributions (including earnings) from a Roth IRA are not included in income when withdrawn. The Roth IRA is similar to the tax-prepaid savings plan (TPSP) now being discussed in Canada. Roth IRAs can be set up at the same types of financial institutions as traditional IRAs.
Transfers from a 401(k) plan to an RRSP
The Canada Revenue Agency takes the position that a 401(k) plan is a U.S. pension plan and, as a result, the gross amount, before any U.S. non-resident withholding taxes, paid to a Canadian resident would be fully taxable in Canada.
That being said, this income inclusion can be offset by a deduction to the extent that the amounts received from the 401(k) plan are contributed to an individual’s RRSP within 60 days after the end of the year (i.e., the normal RRSP deadline). This deduction is only available if certain conditions are satisfied.
Firstly, the amount received from the 401(k) plan must be a lump-sum amount. It must also be attributable to services rendered by the individual (or his or her spouse or common-law partner) during the period in which the individual was a non-resident. Finally, the amount transferred to an RRSP must be specifically designated as a transfer on Schedule 7 of the personal income tax return for the year of transfer.
Transfer from an IRA to an RRSP
An IRA is considered under Canadian tax law to be a "foreign retirement arrangement." As a result, the gross amount paid out of an IRA would also be fully taxable in the year of receipt.
If, depending on the circumstances, the amount withdrawn from the IRA qualifies as an "eligible amount," this income inclusion can be offset by a deduction provided that the amounts received from the IRA are contributed to an individual’s RRSP within 60 days after the end of the year. Again, as with transfers from a 401(k) plan discussed above, the amount contributed to an RRSP from an IRA must also be designated on Schedule 7.
What is an "eligible amount" for purposes of this transfer? The amount must be included in income, received as a lump-sum payment and not as part of a series of periodic payments, and must have been derived from contributions made to the plan by either the individual or the individual’s spouse or partner, not his or her employer.
Transfer from a Roth IRA to an RRSP
Although the analysis of the tax treatment of Roth IRAs in Canada is complex and beyond the scope of this column, the general consensus is that the receipt of moneys from a Roth IRA will not be taxable in Canada. As a result, there would be no benefit (and in fact, it would be quite disadvantageous) to transferring a Roth IRA to an RRSP, even if permitted.