Moving to the States? Know your RRIF rules
RRIFs become an important issue if you move to the United States and take up residence, as some retired Canadians choose to do. Actually, the tax laws are quite generous when it comes to your registered plans, but you need to understand how they work.
When you become a U.S. resident, the value of your RRIF is considered capital, and is therefore not taxable. Any income earned within the plan after you become a U.S. resident may continue to compound tax-free. You become liable for U.S. taxes once you start making withdrawals from the plan, but only on those amounts that relate to income earned in your RRIF after you become a U.S. resident, plus any unrealized capital gains. It therefore makes sense to take any capital gains in your RRIF before you leave Canada, thereby reducing the U.S. tax for which you’ll be liable. If you’ve lost money in your RRIF to the extent that the plan’s value is less than it was at the time you became a U.S. resident, you’ll face no U.S. tax at all.
Periodic payments from a RRIF or annuity are subject to a 15 percent withholding tax in Canada once you leave the country. When you become a non-resident, the Canada Customs andevenue Agency will regard the withholdings as your full payment. This means you’ll pay tax at a much lower rate than would have been the case had you stayed in Canada. Of course, some tax may be assessed in the U.S., but it will only be payable on a portion of your withdrawals, as we’ve seen. Plus, you should be able to claim a credit for your Canadian withholdings against your U.S. taxes payable.
These rules make it advantageous to keep your RRIF if you decide to move to the States. Your investments will continue to grow, tax-sheltered, just as if you’d stayed in Canada. To be eligible for this tax break, you must make a declaration to the U.S. Internal Revenue Service (IRS) that you wish to use this provision of the U.S./Canada Tax Treaty. This requires a special election, which is made with the first U.S. tax return you file. You’ll be required to supply detailed financial information about your RRIF at that time.
Pension income may also qualify for a tax break if you move to the U.S. Employee and employer contributions made to the plan on your behalf prior to taking up U.S. residency are considered capital, and therefore won’t be taxed. However, pension payments originating from Canada are also subject to withholding tax if you become a non-resident. The standard rate is 25 percent. As well, several other types of Canadian income may also have tax withheld at source if you leave. These include most interest payments, dividends, rents, CPP, and OAS.
Until recently, RRIF investors faced a real problem when they moved to the United States. A couple of old rules, enforced by the U.S. Securities and Exchange Commission (SEC), meant that Canadians who were U.S. residents could not manage the investments in their Canadian accounts. Canadian brokers and financial planners were prohibited from taking orders from U.S. residents, even though the registered plans remained here, and securities that were not registered with U.S. regulators (in effect, the majority of our RRIF holdings), could not be offered for sale in the U.S. Fortunately, saner heads prevailed and, in June 2000, U.S. regulators passed rules exempting Canadian dealers and securities from the rules. However, at this time, corresponding rules have not been adopted by all the states, so if you live in the U.S., be sure to check on the rules governing your RRIF here at home before you take any action in your plans.
In addition to keeping abreast of the legislation, there is another side of RRIF investing that needs careful consideration if you decide to leave Canada for good. Should you run the risk of leaving your registered assets in Canadian dollars and perhaps seeing the loonie fall in relation to U.S. dollars?
The best way to avoid this is to switch a large proportion of your investments into U.S.-dominated securities. You can convert Canadian-dollar securities into U.S.-dominated assets quite easily, even in registered plans. The foreign-content limitations and the rule that says you cannot hold foreign currency in a registered plan are not the impediments they may seem to be at first glance.
U.S. dollar-denominated bonds from Canadian issuers such as the federal and provincial governments are considered to be 100 percent Canadian content for RRIF purposes. So are mutual funds that invest in these securities. Some financial institutions issue U.S.-dollar term deposits and GICs, which are considered Canadian content for RRIFs. As well, some Canadian stocks are denominated in U.S. dollars and pay dividends in that currency. Ask your broker for a list.
In the case of non-registered investments, there are no barriers of any kind in switching to a U.S. dollar–based portfolio. It’s simply a matter of selecting which securities you want to move. U.S. equities, as a group, tend to outperform Canadian stocks, so that could be a plus if you want to maintain a growth component in your portfolio.
You won’t be able to protect yourself in currency terms in cases where your income originates in Canadian dollars — OAS, CPP, an employer pension plan, and the like. In these cases, you’ll have to accept a degree of currency risk, although you may wish to convert your funds to U.S. dollars as soon as they’re received in order to minimize the downside in the event the loonie should dive.
Adapted from Gordon Pape’s 2001 Buyer’s Guide to RRIFs and LIFs, published by Prentice Hall Canada