I have good and bad news for those of you that live in the U.S. but have a Canadian RRSP from when you lived in Canada. The good news is that there is a really good chance your taxation here in the states will be lower than if you took the same distributions in Canada. The bad news, trying to figure out just how much taxes you will pay, can be a pain in the butt. This article is meant to discuss the taxation of your RRSP, while living here in the U.S.
DISCLAIMER: I strongly suggest talking to your international tax expert before taking any RRSP distributions.
Can I keep my RRSP while I live in the U.S.?
A few years back the IRS made it very clear that not only can you keep your RRSP, you don’t need to fill out a bunch of forms and declare the assets each year. You can read more about the ruling here. Although you typically can’t contribute to a RRSP while living in the U.S., keeping the assets in the RRSP while working here in the U.S. may be your best strategy.
Foreign tax credits
If you are living in the U.S. as a citizen or resident, you need to file taxes on any worldwide income. Which means that if you take a RRSP withdrawal, you will need to include that as income and you need to pay taxes on the income in Canada and the U.S. So, you have to pay taxes two times?! Not necessarily. In order to avoid double taxation, you are able to take a tax credit for any Canadian taxes that you pay in the year. For example, let’s say that you take a $20,000 withdrawal from your RRSP. You will have $5,000, more on this later, withheld to pay Canadian taxes. The $20,000 will be added to your income here in the U.S. You will then be able to take a credit for up to $5,000 on your U.S. taxes, hopefully offsetting the higher income you now have to report on your taxes. Confused yet? Well, we’re just getting started.
The amount of the foreign tax credit that you can apply is the lesser amount of foreign taxes paid or the U.S. tax liability on the foreign income. For example, if you have a $5,000 tax credit but only had $2,000 of U.S. tax liability, you would only be able to use $2,000 of your tax credit. The remaining $3,000 can be used to offset prior or future tax liability for up to ten years. Of course, using the tax credit on previous tax returns, would require you to complete an amended return. Now that I have thoroughly confused you, let’s talk about the actual taxation of RRSP distributions.
Federal Taxation of RRSP distributions
If you are living in the U.S. and take a distribution from your RRSP, there is an automatic 25% withheld to pay Canadian taxes. For example, as I discussed above a $20,000 withdrawal would require $5,000 to be withheld for taxes and you would receive $15,000. This 25% should be good for your Canadian tax liability but may or may not be enough to cover your U.S. federal taxes. Below are the 2022 tax tables if you file single or married filing jointly (MFJ).
Source: Tax Foundation
As I mentioned before, you have to include all worldwide income here in the U.S. This worldwide income is added onto your adjusted gross income (AGI) and you are taxed here at the same rate as if you earned it here. Of course, the foreign tax credit helps offset this extra income. So, if your marginal tax bracket is under 25%, you should have no additional taxes due as the foreign tax credit is higher than your actual tax liability. If your marginal tax bracket is over 25%, you will actually owe additional taxes on the withdrawal than what was withheld. For example, if you are in the 32% tax bracket, but you only get a credit for 25% of your withdrawal, you will need to pay another 7% to the government in taxes.
I know, not confusing at all. We haven’t even gotten to state taxes.
State taxes on RRSP distributions
It can vary from state to state but in all likelihood, you will also have to pay state taxes on the income. Of course there are some states that don’t have income taxes, but here in Michigan you will need to pay state taxes on the RRSP income. Michigan relies on the federal 1040 to determine state taxes. Foreign income, including RRSP withdrawals, flow right into the 1040. In Michigan, the state tax rate is 4.25%.
Taxation on RRIF distributions
If you have an RRSP, you have the option to convert to an RRIF and start yearly distributions. The benefit of doing this is that there is only a 15% foreign tax withholding on the RRIF. This is a significant benefit, especially if you are in the lower 10% or 12% tax rate. Instead of paying taxes at 25% on RRSP withdrawals, and not use all of your foreign tax credit, you can just pay taxes at 15%. Now for folks in the higher tax brackets, there is not as much of a benefit. This is because you will probably have to pay additional taxes, if your tax bracket is over 15%. Again, let’s say that you are in the 32% marginal tax bracket. Yes, you are only having 15% withheld to pay for Canadian taxes, however, this distribution needs to be added to your income and you will have to pay U.S. taxes at 32%.
A quick summary:
|
RRSP Distributions – 25% Foreign Tax Withholding | |
| Tax Rate | Total Taxes Paid |
| Under 25% Marginal Tax Bracket | 25% |
| Over 25% Marginal Tax Bracket | Marginal Tax Bracket |
|
RRIF Distributions – 15% Foreign Tax Withholding | |
| Tax Rate | Total Taxes Paid |
| Under 15% Marginal Tax Bracket | 15% |
| Over 15% Marginal Tax Bracket | Marginal Tax Bracket |
Taxes are confusing and dealing with taxes from two countries can be downright brutal. The good news is that moving from Canada to the U.S. is probably the most tax beneficial thing that you can do. Lower taxes and the proper use of foreign tax credits can make distributions from the RRSP and RRIF not as painful as you may think.
Foreign Tax Credit Limits
Although many times foreign tax credits will cover your U.S. tax liability, this is not always the case. There are limits on how much foreign tax credits a person can use to offset their U.S. income.
Foreign Tax Credit Limit
Your foreign tax credit cannot be more than your total U.S. tax liability multiplied by a fraction. The numerator of the fraction is your taxable income from sources outside the United States. The denominator is your total taxable income from U.S. and foreign sources.
For example, let’s say that you have $10,000 in withdrawals from an RRSP, and $50,000 total taxable income on the year. In this case, 20% of your taxable income came from foreign sources. In this example, you cannot offset more than 20% of your taxable income using foreign tax credits. Using the same example, let’s say that the same person has a $10,000 tax liability. In this case, the foreign tax credit can’t offset more than 20% of the tax liability or $2,000.
If you are in a higher marginal tax bracket and the RRSP withdrawal is fairly small, you may not be able to take the full tax credit to offset your U.S. tax liability. This creates a situation in which your RRSP withdrawal is “double taxed”.
Need Cross-Border Planning Help?
RetireMitten Financial LLC specializes in cross-border financial planning. Do you have U.S. and Canadian accounts but are confused trying to determine a distribution strategy? Schedule a meeting below and have a conversation with a financial planner that truly understands your situation.
When I take distributions from my Canadian RSP, the withholding rate is only 10% regardless of the amount of the distribution so long as it is between the minimum and the maximum amounts.
But I have a question: my understanding is that RSP distributions are only taxable in the United States to the extent that income was earned on the RSP since becoming a resident for tax purposes in the United States (cost basis).
Hi Nabil,
Thanks for the queestion. I would strongly consider talking to your tax planner about this question. I work closely with a cross-border CPA and his interpretation is the full amount is taxable, unless you did a deemed distribution upon coming to the U.S. However, I know of other tax preparers interpretation is that only the amount earned in the U.S. is taxable in the U.S. I have a hard time justifying why only the gains in the U.S. are taxable in the U.S. CPP/OAS and other pensions earned in Canada are fully taxed here in the U.S. so I don’t see why RRSPs are different. However, I do know of people that use this “cost basis” tax strategy and never have had a problem.
Thanks,
Bryan
The article says withholding is either 15% or 25%, and that is consistent with what I’ve been able to find. Can you explain why you only have 10% withheld. Are you filing a non-resident return in Canada to get that rate?
Hello Bryan
Thank you for this informative article. Question that another reader asked previously. When we arrived in the US two decades ago my tax preparer (enrolled agent) asked me to provide a list of all our RRSP contributions as of date we became US residents and sent this information in with our US return the first year of filing. He said these contributions would be considered ‘post tax’ and only earnings from that date would be subject to federal US taxation when distributions are made. Can you comment on this?
Hi Sonya, Yes, I have heard of this before but I’d defer to your tax preparer. In my opinion, if you paid taxes on the RRSP when you came to the states, you only have to pay taxes on the growth since you have been to the states. However, I have heard Cross-Border CPAs have differening views on this subject.
Thanks,
Bryan
Sonya,
In what State is your CPA? If in Michigan, I would like to consult with him.
Thanks,
Vera
Hi, Yes, they are in Michigan and Windsor. Here is their website: https://taxmco.com
This information is extremely helpful and the best I’ve found on the internet so far. My only remaining question is whether i actually need to file a 2020 Tax return with Revenue Canada if the RRSP distribution was my only source of Canadian income in 2020, and 25% was already withheld from the distribution at source by RBC.
Thank you so much!
Hi Jason,
I’m glad you find the info helpful. Most of my clients do not file a Canadian tax return as the tax withholding is sufficient. However, if your income is low it is possible that you can get a lower withholding if you do file a return. Like I mentioned, that is fairly rare.
Thanks,
Bryan
Hi Bryan,
If I file a Canadian return and my only income in Canada is from the Distribution, say less than 10K, can I not get the full 25% withholding back from Revenue Canada? Am a US citizen and resident with RRSP.
Thx for your response.
Ashok
Hi Ashok, you may be able to get the full 25% back. It depends on your overall income, both in the US and Canada.
Thanks,
Bryan
The foreign tax credit is limited by your “average” tax rate, so you would need an average tax rate of 25% in the US to get credit (on your US tax return) for all the withholding you paid to Canada. You must be a very high earner in the US to be taxed that highly.
Great article! Thanks for the clear explanations. I understand now that as a US resident, I will be subject to the 25% foreign tax withholding to Canada when my RRSP is distributed, and I will also have to report that as income to the IRS on my annual tax return. Will I have to file an income tax return to Canada and pay income tax on that distribution as well? Other than the RRSP account, I have severed financial and living ties with Canada and haven’t had to pay income tax up there in years.
Hi, thanks for the question. No, if you are not living in Canada while withdrawing your RRSP, you shouldn’t have to file income taxes there. Canada withholds the 25% and this satisfies your tax obligation. However, you can file taxes if you think your tax rate will be lower and want to get a lower tax withholding on the RRSP withdrawals. However, most of my clients don’t file Canadian taxes.
Thanks,
Bryan
Hi Bryan, Great article that sums things up nicely.
I am 63 and in early retirment with “NIL” income since we are spending savings. We have about C$320K/US$232K in RRSPs that I have been holding for 20+ years. I wasn’t going to delay starting my Social Security for a few years. I was going to do some Roth conversions during my NIL income years, but it seems that that now might be a perfect time to pull that RRSP money back to the US since the fractional ratio you mention would be almost 1 (equal on top and bottom) and I would be able to maximize the foreign tax credit. The benefit is that I get the cash for current living costs and can further delay Social Security. Thoughts?
I note another person refers to the idea that money deposited prior to moving to the US is non-taxable since that money was never subject to US taxes in the first place. I could convert the RRSP to a RRIF and take withdrawls at 15%but when I have US pension earnings, my fraction will eat down the credit and on gut-feel, it seems like it could be a lot of extra work for potentially little benefit.
Hi Brian,
I don’t know a ton about your situation but for most of our clients we are focusing on Roth conversions right now and delaying RRSP withdrawals. The reasons are the low U.S. tax rates and the low exchange rate if moving CAD to USD.
Thanks,
Bryan
Brian, you are right that the income ratio will be almost 1, However, the foreign tax credit is not a refundable credit. Let’s just use $200k (US) to make the math easier. Canada will take $50k off the top which satisfies your tax liability to Canada. However, if you have $200k of income, your federal tax bill in the US would be about $30k (using calcxml.com). You wouldn’t owe the US any money, but you would have paid $20k more than if you had US source income of that amount. You can carry over the foreign tax credit to future years (or past years if you want to amend returns), but it’s unlikely you will over get that $20k back. You would need an “average” tax rate of 25% to get the entire foreign tax credit. I’m in a similar situation and plan to convert to RRIF at some point and then take the maximum each year until it gets drawn down to a small amount.
Brian, I assumed married filing jointly. If it was single, the tax bill would be about $40k, but still paying $10k more than necessary. If you assume that the taxable portion was $200k, then you would have more than $50k withheld by Canada, which makes it even worse.
Is the only avenue to have “periodic withdrawals” from RRSP to convert to RRIF? Our accountant has explained to us that we should let our bank (BMO) know that we will do periodic withdrawals and that they only need to withhold 15%, rather than 25%. BMO seems to think RRIF is the only way to do this. We have 10 years (year 10 about to drop off) of FTCs to use, so we would like to start the withdrawals, but can’t quite figure out how to execute it. The accountant tells us to ask the bank. The bank tells us to ask the accountant. It is like a circular reference at this point. Can you advise on our options? We don’t want to accumulate more FTCs or have to file for a refund from Canada.
Hi DC, Yes, I believe in theory that you can take periodic withdrawals from an RRSP and the withholding should be 25%, but that’s not typically how I see it work. In order to get the 15% withholding, you will probably have to convert it to a RRIF. It seems like every custodian is different in respect to the 15% withholding. Some are able to convert and withdraw the same year and have 15% withheld. However, I usually see people have to wait the next year which it appears that BMO is doing. You’d have to be in a pretty high U.S. tax bracket (average rate over 15%) to get much benefit of the FTC from 10 years back.
If you don’t convert to RRIF, then periodic withdrawals, while possible, are not required. Therefore, you can take out less than the threshold for 15% withholding this year, and then next year, you don’t take out anything. How do they know that the withdrawal you make this year is the first of a series of periodic withdrawals? For the financial institution dealing with a US resident, they want a one and done solution, so converting to RRIF makes it easier for them to justify only withholding 15%. My plan is to convert, then take out the maximum allowed each year (to remain at 15% withholding) so that I can take advantage of the foreign tax credit. I’ve used TurboTax to model adding an RRSP distribution with 25% withholding, and I get very little of the foreign tax credit, which means that I get double-taxed.
Great article. I have a question about doing full early lump withdrawal of sizeable RRSP, if one expects not to return to Canada and has ability to adjust US source income the same year as transfer (and how that impacts FTC)
Moved to US for work, have RRSPs (~$340k US), but no longer CAD tax residents + not likely living there again (could live in another US state or foreign country without tax treaty, though, hence the thought to simplify). Had not thought to do this lump transfer because it would bump income up when done. But spouse being offered income deferral program at work so I was thinking maybe that means we bring RRSP $$$ stateside and lower their source income at work to compensate, so as not to have huge income spike.
However, based on your article and the FTC formula you quote, if we defer then I think we would not benefit from full FTC value and thus pay some extra tax than required due to not being able to apply full FTC…is this correct?
Say we withdraw the $340k RRSPs, Canada charges non-resident tax of $85k (25% x $340k), and then we either defer some US source income (Option 1) or not (Option 2):
Option 1, Defer:
$110k US source income = US$450k total worldwide income (76% foreign sources [$340/$450]). ~$88k US fed tax on $450k income, and FTC cannot offset more than $66k [76% x $88k], thus $88k + ($85-66) = $107k total tax.
Option 2, no deferral:
$360k US source income = US$700k total worldwide income (49% foreign sources [$340/$700]). ~$175k US fed tax on $700k income, and FTC cannot offset more than $85k [49% x $175k], thus $175k + ($85-85) = $175k total tax and Canada tax fully offset.
Hi JB,
I appreciate the question. Probably a little too much complexity to get into via a quick blog reply. I haven’t verified your numbers so I assume they are correct. In option 2, you are essentially paying 27% for $250,000 of U.S. income ($68k more in taxes/$250,000 of income). Yes, you are using more of your FTCs, but is it worth it to pay that much more on taxes? If you can defer the taxes into future years at lower tax rates, you are probably better off doing that. If your income remains high when the money is deferred and you are paying more than 27% on this money in the future, you are probably better with Option 2.
I just did this same scenario with a client and we calculated that recognizing some additional U.S. income resulted in using more FTC and an overall pretty low effective tax rate on the conversion, but we stayed in the 24% tax bracket. your calculation may not be as favorable. Also, depending on your state, you may have a large state tax bill as a result of this withdrawal.
Thanks,
Bryan
I agree with Bryan’s comment that cashing out the entire amount might be too aggressive because you end up higher than the 24% bracket. However, if you did reduce down to $110k US source income (your option 1), you could get about $240k out of the RRSP and still stay in the 24% marginal bracket. That should get you a complete credit of the foreign withholding. Even if you can only get down to $170k US source income, then you could empty the RRSP over two years.
I’m glad JB posted this option. With the top of the 24% bracket at about $340k, if you can get taxable income under 75% of that ($255k), then you’ll be able to get the complete foreign tax credit and still stay in the 24% bracket. The lower TCJA tax brackets are still there for 2024 and 2025, so JB might be able to get the entire amount “stateside” with a reasonable tax bill.
I apologize for not getting the brackets correct. The $340k was MFJ 24% for 2022, it’s up to $364k for 2023, so $91k is the rough threshold to be able to take all of the foreign tax credit. It will, of course, increase for 2024, so $95-100k will be the threshold for 2024.
I got to this article bit late bit is very informative. My basic question is that not total RRSP withdrawal should be taxed in US as there is Adjusted cost basis to this. As an example, I invested 20K (in equivalent US$ in 2015) in Canadian RRSP and it grew to 30K (in today’s US$) now in 2024. I will only be taxed at (30-20) 10K in US as 20K was my cost. In Canada, it is taxed as full income as it was tax deferred there but in US it should only be net capital gain that should be taxed that too long term capital gain if held for more than a year. Am I missing something…
Hi,
Yes, I have seen some people only include the account gain in the U.S. as income on the U.S. tax return. The cross-border CPA which I work closely with will include all of the income on the U.S. tax return and not just the gain. I trust his guidance so typically will make that recommendation as well. However, Canada will withhold money on the full withdrawal. I’ve never seen anyone include RRSP withdrawals as capital gains though on the tax return.
Thanks,
Bryan
Thanks,
Bryan
As returning US citizens and residents we lived a long time in Canada and substantial funds in RRIFs. These funds are being managed at significant cost to us by Canadian bank. Our accountants consistently filed US IRS returns (including FBAR) with Form 1116, resulting in substantial Foreign Tax Credit (FTC) over past 10 y. Q1. Can these FTC be used to offset US tax on funds withdrawn from RRIF’s (after 25% CAD withholding tax)? Q2. The funds invested into RRSPs (then converted to RRIFs) were mine, just tax deferred, so why should we have to list any RRIF withdrawals as essentially income on US tax returns? I am fully prepared to pay US tax on gains made within RRSP/RRIFs (after Canadian tax deduction), but double taxation (on original withdrawal by Canada and on same amount by US) seems wrong, wrong.
Sidney
Hi Sidney,
Thanks for the questions. Yes, you can use FTC to offset Canadian income on your U.S. tax return. However, it can’t offset any U.S. income. For most people, the 25% withholding is higher than your U.S. effective tax rate. As a result you keep gaining a larger FTC each year. As a U.S. citizen you unfortunately must declare worldwide income. I agree it doesn’t seem fair.
Thanks,
Bryan
If you want to only claim part of the distribution as income, you have to have good records of what the basis was when you moved to the US. You also have to calculate the taxable portion using publication 939 (general rule for pensions and annuities), and that doesn’t seem terribly easy to follow. If the basis is small, then it won’t make a lot of difference and the bookkeeping would be much easier.
Yes, I agree that you will only pay US income tax on the $10k gain. However, you will pay $7500 (25% of $30k) to Revenue Canada to satisfy your tax obligation to them, and you will get very little of that back in the form of a FTC on your US return. The tax treaty considers RRSP like a pension or IRA, so it’s income and not capital gains.
Let’s say you have $200k of income (MFJ, total including the RRSP distribution). Dinkytown’s tax estimator gives a tax bill of $32.5k (average tax rate 16.25%) and a marginal rate of 22%. That means the RRSP withdrawal increased your taxes by $2200. The largest FTC you can have is $32.5k x (10/200), or $1625. The extra $5875 can be carried forward, but it will be very hard to use. Therefore, you paid $2200 more in taxes (22% marginal bracket) to the US, minus $1625 FTC, plus $7500 to Canada, for a grand total of $8075 in extra taxes, or a 80.1% marginal tax on that extra income.
If your income is lower, it’s even worse. You have to get up to a really high income to even get close to claiming the entire FTC. The bottom line is that it’s really hard to make the math work at a 25% withholding to Canada. With your basis being a large part of the balance, it’s even harder. If you convert to RRIF and take out the maximum amount each year (maximum of 10% or double the required minimum), then a reduced withholding makes the double taxation less or perhaps even go away (depending on income level).