Transferring U.S. Based Retirement Plans to an RRSP

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1 Tax Planning Transferring U.S. Based Retirement Plans to an RRSP A strategy worth considering if you are planning to remain in Canada during retirement If you spent time working in the United States (U.S.), you may have accumulated funds in a U.S.-based retirement plan such as a 401(k), a traditional Individual Retirement Account (IRA) or another U.S. retirement plan. If you are settling in Canada, you may be wondering whether you can consolidate your retirement accounts. Under certain conditions, Canadian tax rules allow residents of Canada to contribute benefits withdrawn from certain U.S.-based retirement plans to a Registered Retirement Savings Plan (RRSP) without using RRSP contribution room. It may be possible to implement this strategy on a tax-deferred basis by claiming a foreign tax credit on your Canadian income tax return to recoup the U.S. income tax resulting from the withdrawal. The rules and considerations regarding moving U.S.-based retirement plan assets to an RRSP can be fairly complex. It is essential for you to seek the advice of a tax professional who is familiar with the process before taking any action. Prior to implementing any strategies contained in this article individuals should consult with a qualified tax advisor, accountant, legal professional or other professional to discuss implications specific to their situation. Eligibility to transfer funds to your RRSP The Canadian Income Tax Act (Act) contains special provisions that allow you to contribute 100% of the gross amount withdrawn from certain types of foreign pension plans (e.g. 401(k)) or foreign

2 2 Tax Planning retirement arrangements (e.g. traditional IRA) to your RRSP without using or requiring RRSP contribution room, provided certain conditions are met. The following is a list of requirements to consider when determining if you qualify to transfer your U.S.-based retirement plan to an RRSP: n The contribution to your RRSP must take place by December 31 of the calendar year in which you turn 71. n You must be a resident of Canada at the time of the contribution to your RRSP. n The withdrawal from the foreign plan must be received as a lump sum payment. n If you are withdrawing a benefit from a foreign pension plan such as a 401(k) plan, the benefit withdrawn must relate to services rendered while you were a non-resident of Canada. If you made contributions to a 401(k) plan for services rendered in a period when you were a resident of Canada (for example, if you lived near the border and commuted to the U.S. to work on a daily basis), speak to your tax advisor about transferring the 401(k) plan assets to a traditional IRA before making the withdrawal. n If you are withdrawing a benefit from a foreign retirement arrangement such as a traditional IRA, contributions that were made to the plan by you, your spouse or your former spouse will qualify for transfer. If you inherited the foreign plan from someone other than your spouse, the withdrawal will not qualify for contribution to your RRSP under these provisions. Although most IRAs are funded solely by the plan holder, certain company-sponsored IRAs include contributions made directly to the plan by an employer. In such cases, the employer contributions to your IRA are generally not eligible for contribution to your RRSP under these provisions. However, you can use your unused RRSP contribution room, if any, to contribute ineligible amounts to your RRSP. n Roth IRAs are not considered foreign pension plans, nor are they considered foreign retirement arrangements. Therefore, withdrawals from these plans do not qualify for a contribution to your RRSP under these provisions. Consider these points before collapsing your U.S. retirement plan In addition to the list of requirements just mentioned, the following items should be considered before deciding whether a transfer of a U.S.-based retirement plan to your RRSP makes sense for your situation: n The gross amount of withdrawal from your U.S.-based retirement plan will be treated as taxable income, and the U.S. will impose tax on the withdrawal. You may be able to claim a foreign tax credit on your Canadian income tax return to recover the U.S. tax paid. The ability to claim a full foreign tax credit depends on the amount of U.S. tax paid and on your net income (apart from the U.S. retirement plan income) reported on your Canadian tax return in the year of the withdrawal. Ensuring that you have a strategy in place to allow yourself to claim a full foreign tax credit is a key issue that should be discussed with a professional tax advisor. Excess foreign tax credits on your Canadian tax return cannot be refunded or carried forward for use in a future year. Therefore, in certain cases, it may not make sense for you to transfer the funds, or you may wish to execute this strategy by making more than one lump sum withdrawal in order to recover the entire foreign tax credit. If you are not able to claim a full foreign tax credit, this could result in double taxation of the U.S.-based plan benefits as the benefits may be taxed once by the U.S. when the withdrawal is made and again in Canada when you withdraw the funds from your RRSP. n In order to offset the income inclusion resulting from the withdrawal, you will need to make an RRSP contribution equal to the gross value of the withdrawal from your U.S.- based plan. You will need to have access to funds equal to the amount of U.S. withholding tax to make a full RRSP contribution. You may wish to consider borrowing the funds if you do not have them available. If you are able to recover the full foreign tax credit on your Canadian tax return, the borrowed funds will be needed on a temporary basis only until your Canadian tax return has been filed and assessed. n In addition to the U.S. tax withheld on the withdrawal, if you are required to file a U.S. income tax return, there may be an additional tax liability due. Any amounts payable are due to be paid by the April 15 U.S. tax return deadline, which may cause a short term cash flow issue until your Canadian tax return is filed and assessed.

3 Transferring U.S. Based Retirement Plans to an RRSP 3 n If you are under age 59½, you should consider whether waiting to collapse your U.S. retirement plan until you can avoid the non-refundable 10% early withdrawal penalty makes sense. However, for Canadians (non- U.S. citizens/green card holders) in certain circumstances, it may be more important to reduce the U.S. estate tax exposure and incur the penalty. For example, if you are terminally ill and your exposure to U.S. estate tax is greater than what the penalty for early withdrawal would be, you may consider implementing this strategy sooner. Basic process for completing a transfer Once you and your tax advisor have determined this strategy makes sense for you, the following is a general description of the steps to follow along with the corresponding Canadian and U.S. tax reporting: 1. Instruct your U.S. plan administrator to collapse your qualifying U.S. plan and to mail you a cheque for the net proceeds. If you are a U.S. citizen/green card holder, the withdrawal may be subject to U.S. withholding tax of 10% 20%. The withdrawal must be reported on a U.S. resident income tax return (Form 1040) and will be subject to U.S. tax at graduated tax rates. A lump sum withdrawal by a Canadian (non-u.s. citizen/green card holder) is subject to a 30% U.S. non-resident withholding tax, although some U.S. plan administrators may withhold tax at a lower rate. If the benefits withdrawn relate to services performed in the U.S., the withdrawal may be considered effectively connected with a U.S. trade or business. This may require you to report the gross amount of the withdrawal on a U.S. non-resident income tax return (Form 1040NR), subjecting the withdrawal to tax at U.S. graduated tax rates. Therefore, irrespective of the initial amount of tax withheld from your withdrawal, your ultimate U.S. tax liability may depend on the tax liability calculated on your U.S. 1040NR non-resident tax return. Note: If you are under age 59½ when the withdrawal is made, you may be subject to a non-refundable 10% early withdrawal penalty. The penalty is reported on your U.S. tax return and added to your income tax liability. The U.S. plan administrator is not responsible for withholding this early withdrawal penalty on withdrawal. 2. Contribute an amount equal to the value of the gross withdrawal to your RRSP. The Canadian-dollar equivalent of the gross amount withdrawn (the full amount before withholding tax) should be contributed to your RRSP to take full advantage of this strategy. You must make this contribution by the end of the regular RRSP contribution deadline (during the year of the withdrawal or 60 days after the end of that year at the latest). You will receive an RRSP contribution receipt. 3. Report the withdrawal and RRSP contribution on your Canadian income tax return. The gross withdrawal from your U.S. plan (converted into Canadian dollars using the foreign exchange rate in effect on the date of the withdrawal) should be reported as taxable income on your Canadian income tax return. In addition, the contribution to your RRSP should be reported as a deduction to offset the amount included in your taxable income. In order to indicate to Canada Revenue Agency (CRA) that you are using special provisions to allow you to contribute the amount to your RRSP without using RRSP contribution room, you must report the RRSP contribution on line 11 of Schedule 7 on your Canadian tax return. The amount of the withdrawal included on your Canadian tax return is considered U.S. source income. To recover part or all of your U.S. tax liability (excluding the 10% nonrefundable penalty), claim a foreign tax credit to reduce your ultimate Canadian tax liability. Transferring foreign retirement plans from countries other than the U.S. to your RRSP. It may be possible to transfer pension funds from a country other than the U.S. using these provisions. Although Canada allows for the transfer, the foreign country may have restrictions on the plan withdrawals. The foreign plan administrator should be contacted for information on the country s specific requirements. Your ability to contribute to your RRSP amounts that qualify under Canadian tax rules does not create an obligation for a foreign plan administrator to release funds to you. Benefits of contributing U.S. pension plan assets to your RRSP There are many potential benefits to consolidating your retirement plans in Canada, particularly if you expect to be spending most of your time in Canada when you draw income from these plans.

4 4 Tax Planning Some of the key benefits: Simplifying the management of your retirement portfolio and income sources Ensuring that the overall asset allocation of your portfolio is on target, tax-planning opportunities are optimized and specific investment decisions have been made and implemented in a timely manner are all easier tasks when your portfolio is held in as few accounts and financial institutions as possible. Managing your exposure to foreign currency risk When money is withdrawn from your U.S.-based retirement plan, it will be paid to you in U.S. currency. It is very difficult, if not impossible, to predict if Canadian currency will increase or decrease in value relative to the U.S. dollar, particularly over a long period of time. While it is possible for you to benefit from fluctuating foreign exchange rates, it is also possible to suffer a loss in your purchasing power if exchange rates move in the opposite direction. Because of this risk, most prudent financial advisors will generally agree that it is best to take whatever steps they can to match the currency of their future income sources with the currency of their future expenses. To do otherwise would expose them needlessly to foreign exchange risk and could have a negative impact on their cash flow during retirement. Reducing or eliminating your exposure to U.S. estate tax Many Canadians who own U.S. assets are unaware that they may face U.S. estate tax at death even if they are not a U.S. resident, citizen or green card holder. For the purposes of U.S. estate tax, assets held in a U.S.-based retirement plan are considered to be situated within the United States, regardless of how these funds are invested. Assets held in an RRSP in Canada, on the other hand, are not considered to be situated in the U.S. (with the exception of certain U.S. securities). You may be able to reduce or eliminate your exposure to U.S. estate tax by transferring your U.S.-based retirement plan to an RRSP in Canada. If you are a U.S. citizen or green card holder residing in Canada, there is no distinction between assets situated within the U.S. and those situated elsewhere for the purpose of calculating exposure to U.S. estate tax. Therefore, transferring your U.S.-based retirement plan to an RRSP in Canada will not help you reduce your exposure to U.S. estate tax. Increasing your choice of investment options Canadian financial institutions offer a wider range of investments products that typically appeal to Canadian investors than U.S. financial institutions. In addition, Canadian provincial securities commissions may impose restrictions on the trading activities of non-resident investment advisors, including those based in the U.S. Depending on the type of plan that you hold, you may have a limited ability to make changes to your portfolio. In most cases, transferring your U.S.- based retirement plan to an RRSP in Canada will provide you with more choice and greater flexibility to adjust your investment holdings as your needs change. Obtaining local service and advice with a Canadian perspective At the time of writing of this special report, very few financial institutions within the United States were demonstrating an ability to provide advice regarding how a U.S.-based retirement account fits in the context of a Canadian resident s overall retirement plan. Also, providing customized advice to you can be more challenging by telephone and . For most residents of Canada, dealing with a local financial advisor who specializes in retirement planning for Canadians is generally preferable. Where it is not possible or practical to transfer your U.S.-based retirement plan to an RRSP in Canada, RBC is one of the few Canadian financial institutions that has advisors with Canadian retirement planning experience in certain key locations in the U.S. Conclusion While there are many compelling reasons to transfer a U.S.-based retirement plan to an RRSP in Canada, there are many issues to consider and tax implications to be aware of before proceeding. Clearly, there is no one strategy that is right for everyone. Advice from a professional who is experienced in these matters is highly recommended. In some cases, it may be best to simply leave the U.S. plan in place and receive an income stream from it when you retire. Your RBC advisor is available to answer your general questions and can work with you and your professional tax advisor to help you make the best decision for you and your family.

5 If you have questions on any of the issues in this article, please speak with your advisor. The material in this Fact Sheet is intended as a general source of information only, and should not be construed as offering specific tax, legal, financial or investment advice. Every effort has been made to ensure that the material is correct at time of publication, but we cannot guarantee its accuracy or completeness. Interest rates, market conditions, tax rulings and other investment factors are subject to rapid change. Individuals should consult with their personal tax advisor, accountant or legal professional before taking any action based upon the information contained in this Fact Sheet. Financial planning services and investment advice are provided by Royal Mutual Funds Inc. (RMFI). RMFI, RBC Global Asset Management Inc., Royal Bank of Canada, Royal Trust Corporation of Canada and The Royal Trust Company are separate corporate entities which are affiliated. RMFI is licensed as a financial services firm in the province of Quebec. Registered trademarks of Royal Bank of Canada. RBC and Royal Bank are registered trademarks of Royal Bank of Canada Royal Bank of Canada. VPS (02/2011)