Following is a excerpt of a recent e-mail exchange with a U.S. resident who has RRSPs in Canada. To maintain confidentiality I the writers name has been changed and some of the facts have been altered. We will use the name “Shannon” to denote the client.
Shannon: “I’ve been living in the USA for almost 15 years and I’ve had a green card for almost 13 years. I left Canada and did not close out my RRSPs. I’m now married and have a family and will probably not return to Canada to live.
If I cash out my RRSPs what are the penalties and taxes? In addition, I’m not able to make purchases within my RRSP because I’m no longer resident in Canada. Fifteen years ago, I was a much more aggressive investor but not today. Moreover, with what I have lost over the past 20 years of investing I am happier with my real estate investments and count on them for my retirement and not my RRSPs or 401k’s.
Can you tell me what I’m in store for if I choose to cash out of Canada and bring my money to the USA? Thanks for any and all help.”
Tax Admin: Did you step up your RRSP cost base (sell everything and re-acquire) before you left Canada?
Shannon: No, I don’t believe I “stepped up” and sold and re-acquired. I have been able to move them around a bit, but can only still have 80% domestic and 20% foreign, and they are more aggressive than I like. Also, I did sell all of my real estate and possessions in Canada, and only have real estate in the USA.
I’m frustrated because I’m wondering if I missed a window about 13 years ago to sell out of my RRSP’s with only a tax penalty, and not the additional 25% US Resident penalty as well, that’s what a friend told me the penalty to being a US resident is.
I have to say, I’ve spoken with a few banks, and financial planners and they are pretty much clueless on this subject. Again, any help would be very much appreciated. So, with about $130K in Canadian RRSPs, over 25 years of investing in these funds, what will I end up pulling if I cash out now or in the near future. I would bet the tax falls under “other income” which I don’t know the tax rate for.
Am I about to lose over 50% of my RRSPs due to early withdrawal, and paying the US resident penalty.
Tax Admin: I understand your frustration. It is normally difficult to find experts with cross border experience in the U.S. It’s usually easier to find them here in Canada.
What I’m going to do is first discuss the implications of cashing out your RRSP from a Canadian perspective and then deal with the U.S. tax implications. I am in no way a U.S. tax expert and would suggest that you discuss the U.S. tax implications with a CPA. Armed with the data I provide, they should be able to help you a little better.
An RRSP is like an IRA account. Contributions to the account are deducted from current year income and grow inside the account tax deferred. Any amounts withdrawn from the account are included in the income in the year of the withdrawal. This is the treatment if the taxpayer is a resident of Canada.
If a person who is resident in the U.S. and has a Canadian RRSP, the investments can generally continue to grow tax deferred until the plan is closed. If you were to close the plan entirely and move the proceeds to the U.S., you would face a 25% withholding tax in Canada.
The withholding is reduced to 15% if you opt for periodic withdrawals (that is, convert to a RRIF which is a reverse RRSP). On your U.S. return you may then claim the withholding tax as a credit against your U.S. taxes payable. If you can claim the full 25% as a credit, then a full de-registration would probably be your best bet. If not, then I suggest converting the plan to a RRIF and take accelerated periodic payments to draw down the RRIF as quickly as possible. The 15% withholding should be easily claimed as a tax credit on your 1040. The credit system eliminates any double taxation as you receive a credit in the US for the Canadian tax paid.
From a U.S. tax perspective the amounts you receive from the RRSP (or RRIF). You will be entitled to receive tax-free the cost base of your RRSP on the date you became a resident of the U.S. To illustrate how this works, if you made a one-time RRSP contribution of $10,000 in 1990 (and made no other contributions) and became a resident of the U.S. in 1995. You would be able to withdraw up to $10,000 tax free. If on the other hand your RRSP was worth $50,000 just before you left in 1995 and you sold everything and re-acquired them, you would then be able to withdraw tax free up to $50,000. That is referred to as stepping up the cost base.
The remainder above the tax free amount is taxable on your U.S. return.