Many retirement accounts, different country pensions, exchange rates, and multiple tax rates. Working both in the U.S and Canada sure does make things complicated. However, if you are retiring here in the U.S., your tax situation is much more favorable than retiring in Canada. Here, I want to summarize the taxation of all of the different retirement accounts (RRSP, RRIF, and TFSA) as well as the retirement benefits (CPP and OAS).
First, we will lay out a quick summary, and below is a little more detail on these accounts/benefits here in the U.S. I’ll try to make this as clear as possible, but will use the caveat that you should always consult with your tax person if you have both U.S. and Canada accounts. Dealing with U.S. taxes alone is hard. Adding in additional Canadian benefits makes it that much more difficult.
|Canadian Asset||Minimum Federal Tax Rate|
|Retirement Savings Plan (RRSP)||25%|
|Retirement Income Fund (RRIF)||15%|
|Tax-Free Savings Account (TFSA)||N/A|
|Canadian Pension Plan (CPP)||Same as U.S. Social Security|
|Old Age Supplement (OAS)||Same as U.S. Social Security|
Registered Retirement Savings Plan (RRSP)
The RRSP is like the IRA or 401(k) here in the U.S. Initially when you contributed to the RRSP, you received a tax deduction. When you withdraw funds from the RRSP, you then have to pay the taxes. If you live outside of Canada, you will have 25% withheld from the distribution to pay the Canada tax. This should take care of your Canada tax liability, but may not satisfy U.S. taxes. Taxes are complicated but I’ll try to make this as easy as possible.
When you have the 25% withheld to pay the tax in Canada, you will then be able to use this money as a foreign tax credit on your U.S. income tax return. For example, if you take a $10,000 RRSP distribution, you will have $2,500 withheld for taxes. You will have to include the $10,000 on your U.S. taxes as income but can take credit for $2,500 on foreign taxes paid. If your U.S. marginal tax bracket is under 25%, the foreign tax credit will cover all of your U.S. taxes. The issue is if your U.S. tax bracket is over 25%. For example, let’s say that you are in the 32% tax bracket. On a $10,000 distribution, you are responsible for $3,200 of U.S. taxes, but you have only had $2,500 withheld for foreign taxes. In this situation, you would need to pay another $700 in taxes. Here is a chart of the examples that we just described.
|U.S. Marginal Tax Bracket||RRSP Distribution||Canada Withholding||U.S. Taxes||Total Taxes Paid|
In other words, when you take an RRSP distribution here in the U.S., you pay the higher of the 25% tax withholding or your U.S. tax bracket. If your U.S. tax bracket is higher than 25%, you pay the same amount of taxes on the RRSP distribution, as you do your U.S. retirement account distributions. If your U.S. tax bracket is under 25%, you are paying higher taxes on the RRSP withdrawal.
Registered Retirement Income Fund (RRIF)
If you are looking to lower the taxation of your RRSP, you can convert it to an RRIF. Instead of the 25% tax withholding on an RRSP, the RRIF only requires 15% withholding. For those here in the U.S. that are in lower tax brackets, this may make sense, as you will be paying less in taxes. So doesn’t it make sense to always convert your RRSP to an RRIF in retirement, if you live in the U.S.? Not necessarily, and here are a few reasons why:
Once you convert from an RRSP to an RRIF you need to start annual distributions
At age 71, you are required to convert your RRSP to an RRIF and begin minimum distributions. If you convert your RRSP to an RRIF before age 71, you will need to maintain yearly distributions forever.
Here is the minimum amount that needs to be withdrawn each year.
From RBC Wealth Management:
Remember, you don’t need to start taking withdrawals until age 71, but if you start early, you will need to maintain the minimum withdrawals above.
You are limited on your annual distributions from the RRIF, or additional taxes will be required
The easy question arises, “Why don’t I convert my whole RRSP to an RRIF and withdraw the total amount and only pay 15% in taxes?” Unfortunately, this is also not an option. You are only able to withdraw the larger of 2 times the minimum distribution, or 10% of the total account value as of January 1, to maintain the 15% taxation. For example, let’s say that you have a $100,000 RRIF at the start of the year, and you are 65 years old. The minimum distribution is 4%, or $4,000. 2 times the minimum distribution is $8,000 which is less than $10,000. Therefore, you can withdraw $10,000 and maintain the 15% tax withholding.
If your U.S. tax bracket is over 25%, you will end up paying the same amount of taxes
However, if your tax bracket is over 25% in the U.S., you are going to end up paying the same amount of taxes anyway on the RRSP and RRIF, just less will be withheld initially from the RRIF.
Let’s use the same example as we did before on the RRSP distribution:
|U.S. Marginal Tax Bracket||RRIF Distribution||Canada Withholding||U.S. Taxes||Total Taxes Paid|
As you can see, someone in the 32% tax bracket (or anyone over 25% tax bracket) ends up paying the same amount of taxes on both an RRSP and RRIF distribution. The difference is that less money is initially withheld from the RRIF for Canadian taxes. Anyone under the 25% tax bracket will pay less if they convert the RRSP to an RRIF.
Tax-Free Savings Account (TFSA)
The TFSA is very similar to the Roth IRA here in the U.S. You make after-tax contributions, the money grows tax-free and the withdrawal is completely tax-free. Seems simple enough. However, as you have probably realized, nothing is easy when it comes to cross-border taxation. The problem with the TFSA is that it was created after the U.S. – Canada Totalization Agreement, which laid out taxation and qualification for Canadian benefits here in the U.S. Therefore, there is a lot of confusion in regards to the taxation of the TFSA here in the U.S.
Most people believe that the TFSA is a foreign trust, and requires filing paperwork with the IRS on a yearly basis. Also, the U.S. taxpayer may have to pay taxes on withdrawals here in the U.S. as well. The typical recommendation is to withdraw the TFSA while living in Canada, before moving to the U.S. This way you can avoid all of the grey areas currently with the TFSA. If you live in the U.S. and have a TFSA, make sure that you are working with a competent tax planner.
Canadian Pension Plan (CPP) and Old Age Supplement (OAS)
I hear clients complain all of the time that they have to pay taxes on social security here in the U.S. “What do you mean I have to pay taxes on social security?! Social security is a tax, to begin with!” Unfortunately, there is no getting around paying taxes on social security. The good news, however, is that there are some tax advantages from social security income. The other good news, if you have a CPP and/or OAS, you receive these same tax benefits. This is because your CPP and OAS are taxed the same way as your social security benefit here in the U.S. This is a huge benefit compared to the taxes that you would pay if you collected the same benefit in Canada.
You are taxed on social security, as well as CPP and OAS, at the same federal rate as your normal taxes. However, the tax benefit is that at least 15% of your social security benefit is tax-free. In other words, only up to 85% of your social security benefit is included in your taxes.
Social Security Tax Formula
The amount that is included in your taxes depends on a somewhat complicated formula. First, we have to start by calculating your combined income. From the Social Security Administration:
Your adjusted gross income (AGI)
+ Nontaxable interest
+ ½ of your social security benefit
= Your Combined Income
For reference, your AGI is the bottom number on the front page of your tax form 1040. It is essentially all of the income that you earn, minus deductions such as IRA and HSA contributions. Nontaxable interest is interest that you earn from municipal bonds, which is not subject to federal income taxes.
Now that you know your combined income, you can determine the amount of your social security benefit that is taxable. Again, from the Social Security Administration:
File a federal tax return as an “individual” and your combined income is:
- between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your benefits.
- more than $34,000, up to 85 percent of your benefits may be taxable.
File a joint return, and you and your spouse have a combined income that is:
- between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your benefits
- more than $44,000, up to 85 percent of your benefits may be taxable.
In other words, if you are single you will pay no federal taxes on social security if your combined income is less than $25,000. If combined income is over $34,000, pretty good chance that 85% of your social security benefit will be added to taxable income and subject to federal taxes. If your combined income is between $25,000 and $34,000, between 50% and 85% of your benefit is subject to taxation.
If you are married and your combined income is less than $32,000, your social security benefit will be tax-free. If over $44,000, 85% of your benefit will be added to income and subject to federal state taxes. If combined income is between $32,000 and $44,000, between 50% and 85% of your benefit is subject to taxation.
As you can tell, nothing’s easy about social security taxes. The short version is this; the more you make, the more taxes that you pay on your social security benefit. Still, at most, only 85% of your social security, CPP, and OAS is subject to taxation.
After reading this post, you probably came to the same conclusion as before you started reading; taxes are complicated. Dealing with different taxes in multiple countries makes it just that much more difficult. I’d strongly consider working with a financial advisor that can help you navigate the complicated cross-border tax planning when you have lived in multiple countries. However, I do have some good news for you. Cross-border taxation in complicated. It is also much less in total taxes paid, than if you lived in Canada.
Have you lived and worked in both the U.S. and Canada? Cross-border tax and financial planning can be very difficult and a small mistake could cost you thousands. If you are interested in talking with a cross-border financial planning specialist, schedule a meeting below.