IRA TO AN RRSP WHAT ARE THE TAX IMPLICATIONS?
Are you moving to Canada from the U.S. or are already a resident in Canada and have a traditional U.S. Individual Retirement Arrangement (IRA) account?
You may be thinking about collapsing your traditional IRA or transferring to an RRSP because you want to consolidate your assets in Canada. However, both of those actions are not necessarily in your best interest.
We can help you maintain IRAs in Canada, so you won’t have to collapse or liquidate them, which can result in significant penalties or tax consequences.
As a resident of Canada, when withdrawing from an IRA, the proceeds are categorized as income and subject to tax. If the funds are transferred to an RRSP, it could result in a “tax-neutral” outcome for the year of transfer under certain conditions.
The individual must pay U.S. tax on the IRA withdrawal, and as a resident of Canada, the individual must report the IRA withdrawal as income on their Canadian tax return. Additional care should be taken in light of the additional 10% early withdrawal penalty tax that the IRS will levy if the withdrawals are taken before retirement age, which is currently 59½.
The individual can claim the tax paid in the U.S. as a foreign tax credit. The foreign tax credit can be used to offset the Canadian tax on the IRA income.
If the individual withdraws the IRA funds and contributes the proceeds into an RRSP, they can get an RRSP tax deduction, which can be used on their Canadian tax return to reduce tax on their income as well as reduce the tax on the IRA income not fully covered by the foreign tax credit. Under certain conditions, the gross amount of a lump sum IRA withdrawal can be contributed to an RRSP without the use of RRSP contribution room through what is referred to as a 60(j) transfer. Absent of the conditions of the 60(j) transfer being met, it will be important to consider whether there is sufficient RRSP room to facilitate the contribution and deduction.
If both the foreign tax credit and RRSP tax deduction are fully used, the withdrawal of IRA funds into an RRSP may result in a “tax-neutral” scenario for the year of transfer.
But failure to fully utilize both could result in double taxation upon RRSP withdrawal. It is crucial to consider that the withdrawal of the IRA will have unavoidable US tax consequences that may be accelerated compared to leaving the funds in a traditional IRA.
Our cross-border financial advisors are experienced in helping Canadians and Americans with investment and retirement accounts on both sides of the border.
Simplify your cross-border investments
IRA TO AN RRSP five reasons to keep youR IRA
Here are the top five reasons why you would want to keep your IRA:
- The value of your IRA account is not taxable in Canada upon your death.
- Unlike the value of an RRSP or RRIF account, the IRA account is not included as income upon your death or your spouse’s death if they inherit your IRA.
- Upon your death, your adult children and other non-spouse beneficiaries can inherit your IRA even if they live in Canada.
- Inheriting an IRA is a tax-free rollover for both Canadian and US tax purposes.
- Your designated beneficiaries will inherit a tax-deferred investment account, unlike Canadian RRSPs and RRIFs, which lose their tax-deferred status upon the death of the last surviving spouse.
- After your death, the IRA investments can continue to grow many years following your death.
- Your spouse can draw the IRA minimum withdrawals over their lifetime, extending the tax-deferred growth.
- Your adult children can draw as much as they want from the IRA over a period of up to ten years. They have the flexibility to plan strategic withdrawals in low-income years to minimize their income tax. If you died before your required minimums started, they could let the account grow for the maximum period until it is time withdraw the entire amount in the tenth year.
- Tax on your IRA is only due when withdrawn, for both Canadian and US tax purposes.
- There is no requirement to file a US tax return if you are not a US citizen (non-resident alien) because the 15% US withholding tax is the final liability to the US.
- Periodic payments from an IRA paid to a Canadian resident receive a low withholding rate of 15%, rather than 30% that is applicable to a lump sum withdrawal (full collapse) which would be applicable on IRA transfers to an RRSP.
- Your IRA investments can remain in USD currency.
- Avoid costly conversion fees and unfavorable foreign exchange rates if you primarily invest in US securities and want to keep both the holdings and any dividends in USD currency.
Are you looking for a Canadian cross-border advisor to invest your IRA?
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