I often hear the same thing while working with people here in the states that also have Canadian assets like the RRSP or TFSA. “I work with my Canadian advisor with helping me on Canadian planning and use an advisor here in the states to help with my U.S. planning”. If you aren’t working with an advisor that understands planning issues in both countries, you are really selling yourself short. For example, your CPP has a direct impact on your Social Security, and vice versa. In the case of the RRSP and RRIF, how can you create a retirement income plan, while only considering your U.S. or Canadian assets or income? This posts discusses some of the income and tax planning considerations when you have a RRSP and live in the U.S.
The Registered Retirement Savings Plan (RRSP) is very much like the pre-tax 401(k) and IRA here in the U.S. Contributions go in pre-tax, but you pay taxes on the withdrawals. Although you are typically not eligible to continue to make pre-tax contributions to an RRSP while in the U.S., the funds will continue to grow tax deferred (2014 ruling) until you take a distribution from the account. The RRSP is more lenient with withdrawals, as withdrawals can be made at any point penalty free, unlike the age 59 ½ rule here in the U.S. Like an IRA or 401(k), withdrawals need to begin at a certain age, which is age 71 for the RRSP. Now, let’s discuss how taxation works.
I have some really good news for those who have a RRSP but now live in the states; usually your RRSP has much more favorable tax rates than if you still lived in Canada. In Canada, when you take into account both Federal taxes and Provincial taxes, higher income earners could be facing nearly a 50% tax rate on RRSP distributions. Instead for U.S. taxpayers, there is a 25% Canadian tax withholding on RRSP distributions. In the U.S. you are also responsible for paying taxes on worldwide income, but if done properly, the foreign tax credit should exceed your U.S. tax responsibility on the distribution.
Even better, if you convert your RRSP into a Registered Retirement Income Fund (RRIF) the tax withholding drops to an extremely low 15%. However, if you convert from a RRSP to a RRIF you will need to start taking minimum distributions each year, and the amount is based on your age.
The chart below shows the minimum percentage that you need to withdraw each year from your RRIF. The withdrawal is based on your account value as of December 31, of the previous year.
If you do convert your RRSP to an RRIF, you are limited in your distributions if you want to keep the 15% tax withholding. To receive the 15% tax withholding the distribution must be less than greater of a) 2x the required annual distribution or b) 10% of the RRSP/RRIF fair market value at the beginning of the year. Essentially, you can’t convert to an RRIF and withdraw your whole account just to receive the lower 15% tax withholding.
RRSP Retirement Planning Strategies
Now, it’s time to discuss a few RRSP strategies.
Take a Full Distribution of your RRSP – If you aren’t planning on returning to Canada, you may prefer to distribute your RRSP and move all of your money to a taxable account here in the U.S. Consolidating everything here in the U.S. may be more convenient and also has some benefits. Such as, not having to pay advisors or mange accounts yourself in Canada and the U.S. This strategy eliminates currency risk and also can reduce costs by potentially eliminating tax preparation in Canada. The downfall of this strategy is that it will probably cost the most in upfront taxes, and if not done properly, can increase your U.S. taxes substantially. You are also giving up the tax deferral of the RRSP which is a huge benefit compared to an after-tax brokerage account. Still, convenience wise, and if you have a smaller RRSP this may be your best option.
Convert to an RRIF and begin distributions – When you are retired and ready to start taking distributions from retirement accounts, you may prefer to convert your RRSP to an RRIF and begin annual distributions. This will be your most tax friendly distribution strategy, as there is a small 15% tax withholding on RRIF distributions. You will also lose some flexibility with this strategy as the distributions will need to occur annually. Also, as you can see from the chart above, the distributions are pretty substantial. Of course the distributions are subject to currency fluctuations, which can hurt (or help) RRIF distribution here in the U.S. Still, if your goal is to minimize long-term tax liability, this may be your best option.
Keep the money in the RRSP- You may find the best option with your RRSP is to do nothing for now. You don’t need to start taking out money until age 71, and until then, the money grows tax deferred. Keeping the funds in the RRSP gives you the flexibility to take distributions when needed and if you need the funds prior to age 59 ½ there are no penalties, unlike the pre-tax retirement accounts here in the U.S. Also, if you move back to Canada in the future, you may be happy that you kept the RRSP. The only drawback is that you will need to, or have someone else, manage this additional account and could be subject to significant exchange rate risk.
You have many options with the RRSP, but it is important that how you treat your RRSP is not independent of your U.S. assets. Putting together a retirement income plan when you have both U.S. assets and Canadian assets is complicated, but if done correctly, you can create a tax friendly income stream in retirement.
Disclaimer: This article is meant to provide general education, but should not be construed as advice. I’m not a Canadian tax expert, and strongly suggest working with your financial advisor and international tax preparer, before implementing any of the strategies that are discussed above.