Pitfalls for Maintaining IRAs after Moving to Canada

Retirement Accounts: Strategies for US Persons Moving to Canada

US persons moving to Canada, or those who’ve already moved, have likely already been introduced to a myriad of sophisticated tax planning strategies regarding their retirement accounts. Employing strategies such as transferring IRAs or 401(k)s into Canadian RRSPs or converting US-qualified accounts into Roth IRAs can, over time, significantly increase after-tax net worth post-move. However, there is a little-known rule under the Income Tax Act (ITA) regarding any IRAs that US persons retain while in Canada; for the unprepared, this rule may result in headaches during retirement.

The Challenge: Converting 401(k)s and Retaining IRAs in Canada

401(k) plans provide individuals with a higher contribution limit to save for retirement when compared to the limit imposed on IRAs. They also provide the opportunity for employers to make matching contributions. However, since there is no benefit to continuing to contribute to a US-qualified account after moving to Canada, these advantages lose their relevance. Rather, 401(k) plans suffer from a higher likelihood of limited investment options held within the plan when compared to IRAs. This makes it attractive to transfer 401(k) plan balances into an IRA before moving to Canada.

However, the definition of “eligible pension income” under subsection 118(7) of the ITA does not include IRA income. Accordingly, IRA income is not eligible for the joint election to split pension income for Canadian tax purposes. This can be an issue for couples with a large discrepancy in their net worth who were expecting to use the Canadian joint election to split pension income as a remedy for a lopsided tax burden on one spouse.

IRAs: The Potential Solution

An in-depth assessment of a taxpayer’s facts and circumstances will assist in determining whether maintaining IRAs after moving to Canada is appropriate from a tax perspective. Depending on the likelihood of a lopsided tax burden being imposed on one of the spouses, strategies can be implemented to avoid any such risk. The earlier this potential risk is identified, the more likely a strategy can be implemented to optimize both spouses’ tax burdens during retirement years.