Canadian Rollovers

Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans, and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security, and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in Idaho is representative of a common question regarding Canadian residents with U.S. retirement assets, IRA rollovers, and avoiding tax traps.

"Can my Canadian client roll his 401(k) balance into an IRA?"

Highlights of the discussion

The tax treaty between the U.S. and Canada allows Canadian residents to accumulate retirement assets in U.S. retirement plans and, potentially, have these amounts taxed under the Canadian tax rules once distributions are taken, subject to the provisions of the Canada–U.S. Income Tax Treaty.

In the case at hand, a 65-year-old Canadian resident with approximately $1,000,000 in their 401(k) was planning to retire and return to Canada. They were going to roll their account balance over to an IRA after retirement.

While the client could roll the 401(k) assets into an IRA on a tax-deferred basis under U.S. law if executed as a direct (i.e., trustee-to-trustee) rollover, careful consideration should be given before proceeding with an IRA rollover due to potential Canadian tax implications.

The reason for this recommendation is that Canadian tax rules provide for potentially more favorable tax treatment of 401(k) distributions when compared to IRA distributions. Canadian tax rules treat 401(k) payments as foreign pension income, whereas IRA distributions are typically not treated as pension income under Canadian domestic tax law (see Eligible pension income under the Canada Revenue Agency).

This distinction is important because amounts treated as pension income may be eligible for special tax treatment. Certain 401(k) distributions may be considered pension distributions and eligible for special tax treatment, including pension income splitting between spouses (subject to age and other conditions), which could reduce their overall tax rate. In addition to income splitting, the individual may be eligible for a Canadian pension income tax credit, further lowering the effective tax rate. By contrast, IRA distributions do not qualify for these Canadian pension-related tax benefits.

Conclusion

The nuance of the Canadian tax system is beyond the scope of this article, but we encourage advisors to be aware of the pitfalls and opportunities available to Canadian clients. Consider consulting a cross-border tax professional. Advisors should also note that rollovers from a 401(k) plan to an IRA, while nontaxable in both the U.S. and Canada if properly structured, may alter the character of future distributions for Canadian tax purposes.

Additional information on tax rules is available at:

Canada-Tax treaty documents,

Convention Between Canada and the United States of America

Publication 597, Information on the United States–Canada Income Tax Treaty, and

Publication 519, U.S. Tax Guide for Aliens .