Is Your 401(k) Taxable in Canada?

Written by Tiffany Woodfield, CRPC®, CIM® Dual-Licensed Financial Advisor
Reviewed by Mia Bent, CPA, CA, U.S. Tax Advisor mia@miabentcpa.com

When you first think about moving from the USA to Canada, you might begin wondering if your 401(k) is taxable in Canada. That’s what we’re going to cover in this article.

Many of my clients are US citizens or ex-pats living in the US and planning on returning to Canada. When we speak for the first time, the issue of a surprise tax hit often comes up. Nobody wants to get a big tax bill that they weren’t expecting. That’s where proper tax and cross-border financial planning come in.

While you will need to speak with a cross-border accountant to get advice on your specific move, this blog will give you some general guidance.

Are 401(k) accounts taxable in Canada?

The short answer is yes, but the long answer is maybe. *

Because a regular 401(k) is a US account set up using money earned in the USA, the US has the first right to tax that income when you take the money out, and Canada has the second right to tax.

The tax you pay in the US may act as a foreign tax credit on your Canadian return. This reduces the tax you owe in Canada on that same income and helps to avoid double taxation.

The second consideration is what rate will you be taxed at?

When you live in Canada and take money out of your 401(k), the US will withhold money to pay your US taxes. However your final tax rate is based on whether you are a US citizen/green card holder or a non-US person.

As a US person, you are required to file a US tax return annually to report your worldwide income. That means your final 401(k) tax rate will be your graduated tax rate in the US.

As a Canadian resident, non-US person (who is not required to file a US tax return), you will have US tax withheld on your 401(k) income instead. Your US withholding rate is based on whether the withdrawals are periodic or lump sum. The rate for a lump sum is generally 30%; for periodic payments, the withholding rate is reduced to 15% under the Canada-US tax treaty.

As a Canadian resident, you will also need to report your worldwide income on your Canadian tax return. You can use the tax paid to the US as a foreign tax credit on your Canadian return to avoid double taxation.

This is where working with a cross-border accountant who understands the complexities of foreign tax credits is very important.

*Canadian Tax on US Retirement Plans.

Can you keep your 401k account if you move to Canada?

Let’s use an example. Jessica is a retired hospital manager living in Seattle. She wants to move back to Canada but doesn’t want to lose a huge chunk of her retirement investments by liquidating her 401(k).

Here are Jessica’s options:

1) She could leave the 401(k) in the US when she moves to Canada.

The issue here is that the brokerage compliance departments are enforcing the rules around not holding nonresident accounts. Jessica could receive a letter stating she has 30-60 days to either liquidate her account or find another advisor. This creates unnecessary stress.

2) The second option is to find a dual-licensed financial advisor who could manage her account whether she lives in Canada or the US.

For this option, Jessica could roll over her 401(k) to an IRA and have it managed to her needs and risk profile while living in Canada. If she decides to move back to the US, she can still stay with the same advisor.

Is my 401k deductible in Canada?

In a narrow set of circumstances set out by CRA, your 401(k) contributions may be deductible on your Canadian tax return. It is important to speak to your cross border accountant before making 401(k) contributions as a Canadian resident, because if you make a 401(k) contribution and it is not tax deductible on your Canadian return, you could find yourself in a double tax situation. You should also be aware that tax deductible 401(k) contributions do use up your RRSP deduction room* and contributions to an IRA are not deductible in Canada.

*RRSPs and Other Registered Plans for Retirement - Canada.ca

When can you deduct 401(k) contributions in Canada?

There are two situations where you may be able to use 401(k) deductions in Canada:

Workers on a short-term assignment in Canada. If you come to Canada for 5 years or less and were already contributing to a company 401(k) plan before coming to Canada, then you can use the 401(k) deduction to offset income for work completed in Canada. But you can’t double up on deductions, meaning you can’t also contribute to a Canadian plan.
Cross border commuters. If you commute to work daily in the US, are paid by a US employer, and are taxed in the US, then 401(k) deductions are permitted during this period of service.

Are IRA distributions taxable in Canada?

Similar to 401(k) withdrawals, if you are not a US person and are living in Canada when you take an IRA withdrawal, that income is taxed first in the US in the form of withholding tax. That same income is then taxed on your Canadian return and you will receive a foreign tax credit for the US tax withheld.

For both 401(k) income and IRA income, Canada will only allow a foreign tax credit up to the treaty withholding rate. Therefore, if you are not a US person and are residing in Canada, it is important that you provide your advisor with a W-8BEN form* to let them know that you are eligible for the reduced 15% treaty withholding rate on periodic pension income. Lump sum withdrawals are still subject to the 30% withholding rate.

* A W-8BEN is a form used to inform the administrator responsible for taking withholding tax that you are a resident of a treaty country and that reduced treaty withholding rates should apply.

If you are a US person living in Canada, your IRA income will be taxed at the US graduated tax rates when you file your US tax return and you can then claim that US tax paid as a foreign tax credit when you report the same income on your Canadian return.

For both 401(k) income and IRA income, Canada will only allow a foreign tax credit up to the treaty withholding rate (currently 15% on period pension income). If you are a US citizen residing in Canada and your US graduated tax rate on periodic pension income exceeds 15%, there is a special treaty provision that will allow you to claim the excess US tax paid above 15% as a credit on your US return instead, effectively reducing your US tax on that income down to the treaty withholding rate and eliminating double tax.

Since these foreign tax credits can be complex, it is important to work with a cross border accountant who understands how the treaty provisions apply to both your US and Canadian tax returns.

Should Canadians Working in the US Contribute to a 401(k)?

Canadians working in the US for a US employer can contribute to a 401(k). The first question you need to consider whether you live in Canada or the US is does your employer match your 401(k) contributions. Because employers often offer an employer match, it may make sense to contribute.

The second consideration is whether you are living and working in the US or residing in Canada but commuting to the US. In the second scenario, as a Canadian resident you are also eligible to contribute to your RRSP. Doing this reduces your Canadian tax. Just keep in mind that your RRSP deduction room is used up by 401(k) contributions deducted on your Canadian return

If you are in a situation where your 401(k) contributions are not deductible on your Canadian return, it may still make sense to contribute to a 401(k) if you can benefit instead from employer matching. As each person’s situation is unique, it is advisable to consult with your cross border accountant to determine whether this would be beneficial for you.

Summary of Key Points:

As a Canadian resident receiving 401(k) distributions, you will be subject to US withholding tax and you will have to report the income (distribution) on your Canadian tax return. Foreign tax credits help you avoid double taxation. Your final US tax rate depends on whether you are a US person or a US non-resident alien.
You can keep your 401(k) when you move to Canada. One option is to roll over your 401(k) to an IRA and have it managed with a dual-licensed financial advisor.
Your 401(k) contributions may be deductible in Canada, depending on your situation. You should consult with your cross-border tax accountant on this matter.
IRA distributions are reported as income in the US and Canada, but foreign tax credits help avoid double taxation.
Depending on their circumstances, Canadians working in the US should consider contributing to a 401(k).

Next Steps

If you’re planning a cross-border move or you’ve already moved from the US to Canada and need help simplifying and optimizing your finances, then please get in touch. At SWAN Wealth, we specialize in cross-border financial planning and wealth management. We would be happy to ensure that you’re onside with the IRS while protecting your investments and retirement assets.

About the Author

Tiffany Woodfield is a dual-licensed financial advisor and the co-founder of SWAN Wealth Management, along with her husband, John Woodfield. Tiffany specializes in advising clients who live both in Canada and the United States and need to simplify their cross-border financial plan, move their assets across the border, and optimize their investments so they can minimize their tax burden. Together Tiffany and John Woodfield help their clients simplify their cross-border finances and create long-term revenue streams that will keep their assets safe whether they live in Canada or the US.

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