Canadian Tax on U.S. Retirement Plans

Canadian Tax on U.S. Retirement Plans

Pursuant to Article XVIII of Canada-U.S. tax treaty, pensions and annuities from U.S. sources paid to Canadian residents are subject to tax by U.S., but the tax is limited to 15% of the gross amount (if a periodic pension payment) or of the taxable amount (if an annuity). U.S. pensions and annuities paid to Canadian residents may be taxed by Canada, but the amount of any pension included in income for Canadian tax purposes may not be more than the amount that would be included in income in the U.S. if the recipient were a U.S. resident.

What is pension?

The term pension is defined in the treaty and includes any  payment under a pension or other retirement arrangement, Armed Forces retirement pay, war veterans pensions and allowances, and payments under a sickness, accident, or disability plan. It includes pensions paid by private employers and the government for services rendered.

Pensions also include payments from individual retirement arrangements (IRAs) in the United States, registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs) in Canada.

Pensions do not include social security benefits.

Specific pension plans and their treatment:

In the U.S. common type of retirement plans are IRA, 401(k), and Roth IRA. 

When employers want to give employees a way to save for retirement, they may offer a 401(k). They may also offer employees a Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) or, if the company has fewer than 101 employees, a SIMPLE IRA.  

Individuals can open a Roth or traditional IRA by themselves, but a 401(k) can only be obtained when offered by an employer.

Traditional IRA is very similar to RRSP and Roth IRA is similar to TFSA in Canada. 

For those who are self-employed, they can offer themselves a 401(k) plan. 

 

 

Pension Plan 
Traditional IRA/401(k), SEP IRA/Simple IRA

Income earned with a traditional IRA or 401(k) by a resident of Canada is only taxable when amounts are withdrawn.

A lump-Sum withdrawal out of a traditional IRA which is taxable in Canada will be eligible for tax free transfer to Canadian registered pension plan (RPP), RRSP or any other registered plan. This transfer will not impact your RRSP contribution room. 

As 401(k) is an employer sponsored plan, the employer contributions in these plans cannot be transferred on a tax free rollover to RPP, RRSP. However, if an unused RRSP contribution room is available, then up to that amount can be transferred tax-free.

Doing a transfer from U.S. plan to Canadian RRSP

Be aware of 10% early withdrawal penalty if you are under the age of 59.5. The U.S. withholding tax paid can be claimed on your Canadian income tax return as a foreign tax credit against other sources of income from the U.S.

There will be a 15% withholding tax in the U.S. on this transfer (generally, it is 30% but reduced to 15% due to the treaty)

 

Eligibility criteria

To transfer funds from U.S. plan to Canadian plan on a tax-free basis, the following criteria is required to be met. 

  1. The transfer of funds must be made with 60 days after the end of the calendar year in which the withdrawal is made to your RRSP
  2. The amount transferred to your RRSP must be related to a work time when you were not a resident of Canada for tax purposes.
  3. The withdrawal from your U.S. retirement plan must be a lump sum, not periodic payments.

Contributions to these plans 

It is deductible in the U.S. but not generally deductible in Canada. There are few exceptions that were introduced in Fifth Protocol  of Canada-US tax treaty. It is discussed below.

Fifth Protocol relevant to pensions

Article XVIII (Pensions and Annuities) of the Convention shall be amended by adding the following paragraphs:

8. Contributions made to, or benefits accrued under, a qualifying retirement plan in a Contracting State (U.S.) by or on behalf of an individual shall be deductible or excludible in computing the individual’s taxable income in the other Contracting State (Canada), and contributions made to the plan by the individual’s employer shall be allowed as a deduction in computing the employer’s profits in that other State (Canada), where:

(a) The individual performs services as an employee in that other State (Canada) the remuneration from which is taxable in that other State (Canada);

(b) The individual was participating in the plan (or another similar plan for which this plan was substituted) immediately before the individual began performing the services in that other State (Canada);

(c) The individual was not a resident of that other State (Canada) immediately before the individual began performing the services in that other State (Canada);

(d) The individual has performed services in that other State (Canada) for the same employer (or a related employer) for no more than 60 of the 120 months preceding the individual’s current taxation year;

(e) The contributions and benefits are attributable to the services performed by the individual in that other State (Canada) , and are made or accrued during the period in which the individual performs those services; and

(f) With respect to contributions and benefits that are attributable to services performed during a period in the individual’s current taxation year, no contributions in respect of the period are made by or on behalf of the individual to, and no services performed in that other State (Canada) during the period are otherwise taken into account for purposes of determining the individual’s entitlement to benefits under, any plan that would be a qualifying retirement plan in that other State (Canada) if paragraph 15 of this Article were read without reference to subparagraphs (b) and (c) of that paragraph.

This paragraph shall apply only to the extent that the contributions or benefits would qualify for tax relief in the first-mentioned State (U.S). if the individual was a resident of and performed the services in that State (U.S.).

9. For the purposes of United States taxation, the benefits granted under paragraph 8 to a citizen of the United States shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

10. Contributions made to, or benefits accrued under, a qualifying retirement plan in a Contracting State (U.S.) by or on behalf of an individual who is a resident of the other Contracting State (Canada) shall be deductible or excludible in computing the individual’s taxable income in that other State (Canada), where:

(a) The individual performs services as an employee in the first-mentioned state (U.S.) the remuneration from which is taxable in that State (U.S.) and is borne by an employer who is a resident of that State (U.S.) or by a permanent establishment which the employer has in that State (U.S.); and

(b) The contributions and benefits are attributable to those services and are made or accrued during the period in which the individual performs those services.

This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in the first-mentioned State (U.S.).

11. For the purposes of Canadian taxation, the amount of contributions otherwise allowed as a deduction under paragraph 10 to an individual for a taxation year shall not exceed the individual’s deduction limit under the law of Canada for the year for contributions to registered retirement savings plans remaining after taking into account the amount of contributions to registered retirement savings plans deducted by the individual under the law of Canada for the year. The amount deducted by an individual under paragraph 10 for a taxation year shall be taken into account in computing the individual’s deduction limit under the law of Canada for subsequent taxation years for contributions to registered retirement savings plans.

12. For the purposes of United States taxation, the benefits granted under paragraph 10 shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States. For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension or retirement plan or other retirement arrangement established in and recognized for tax purposes by the United States, contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of the individual shall be treated as contributions or benefits under a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

13. Contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of a citizen of the United States who is a resident of Canada shall be deductible or excludible in computing the citizen’s taxable income in the United States, where:

(a) The citizen performs services as an employee in Canada the remuneration from which is taxable in Canada and is borne by an employer who is a resident of Canada or by a permanent establishment which the employer has in Canada; and

(b) The contributions and benefits are attributable to those services and are made or accrued during the period in which the citizen performs those services.

This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in Canada.

14. The benefits granted under paragraph 13 shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States. For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension or retirement plan or other retirement arrangement established in and recognized for tax purposes by the United States, contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of the individual shall be treated as contributions or benefits under a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

15. For purposes of paragraphs 8 to 14, a qualifying retirement plan in a Contracting State means a trust, company, organization or other arrangement:

(a) That is a resident of that State, generally exempt from income taxation in that State and operated primarily to provide pension or retirement benefits;

(b) That is not an individual arrangement in respect of which the individual’s employer has no involvement; and

(c) Which the competent authority of the other Contracting State agrees generally corresponds to a pension or retirement plan established in and recognized for tax purposes by that other State.

16. For purposes of this Article, a distribution from a pension or retirement plan that is reasonably attributable to a contribution or benefit for which a benefit was allowed pursuant to paragraph 8, 10 or 13 shall be deemed to arise in the Contracting State in which the plan is established.

17. Paragraphs 8 to 16 apply, with such modifications as the circumstances require, as though the relationship between a partnership that carries on a business, and an individual who is a member of the partnership, were that of employer and employee.

 

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