Is Your 401(k) Taxable in Canada?
Tiffany Woodfield, Senior Financial Advisor, Associate Portfolio Manager, CRPC®, CIM®, TEP®
Summary of Key Points
A regular 401(k) is a US account; the IRS taxes withdrawals first, and Canada may tax second, with US tax potentially claimed as a foreign tax credit.
US withholding applies to 401(k) withdrawals; rates depend on whether you are a US person or a non-US person, and whether payments are lump sum or periodic.
Canadian residents must report worldwide income and can use US tax paid on a 401(k) as a foreign tax credit to help avoid double taxation.
When moving to Canada, you can leave a 401(k) in the US or work with a dual-licensed advisor to roll it into an IRA for ongoing management.
401(k) contributions may be deductible in Canada in limited cases, including short-term Canadian residency or daily commuting to the US for work.
Video Script
In this video, I’m going to go over whether your 401(k) is taxable in Canada. I am a cross-border financial advisor and you would need to speak to your accountant first before you make any decisions.
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.
Stay to the end to find out if your 401k contributions are deductible in Canada and how to avoid double taxation.
I’m Tiffany Woodfield, a Cross-Border Financial Advisor and the co-founder of SWAN Wealth Management. I work with US and Canadian clients every day, and over the years, I’ve seen how much stress the question of taxes can cause dual citizens. I always recommend you also consult with a cross-border accountant and this video was reviewed by a cross-border accountant.
If you’ve moved so that you can enjoy your next adventure or pursue a career opportunity, the last thing you want is to be worried about the IRS.
So let’s get into it!
First, is a 401k 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 US, the IRS 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.
When you live in Canada and take money from 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, your final 401(k) tax rate will be your graduated tax rate in the US.
As a Canadian resident, non-US person, you will have US tax withheld on your 401(k) income. Your US withholding rate is based on whether the withdrawals are periodic or lump sum.
The US withholding rate is based on whether the withdrawals are periodic or lump sum. The tax rate for a lump sum is generally 30%; for periodic payments, the withholding rate may be reduced to 15% under the Canada-US tax treaty.
So how do you avoid double taxation as a Canadian resident?
As a Canadian resident, you will 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.
Next, does it make sense to keep your 401k in the US if you move to Canada?
Let’s say you’ve worked in the US most of your career, and you have a large 401k.
You don’t want to lose huge chunk of your retirement investments by liquidating your 401k.
So you have two options:
1) You could leave the 401k in the US and do nothing.
2) You could find a dual-licensed financial advisor who can manage your 401K for you.
The problem with option number one is that brokerage firms are usually not allowed to hold non-resident accounts. You could receive a letter from your brokerage firm stating that you have 30-60 days to either liquidate your account or find another advisor.
If you work with a financial advisor in who is dual licensed they can roll over your 401k to an IRA and have it managed to your needs and risk profile while living in Canada. If you were to move back to the US, it could still be managed.
Next, are your 401k contributions deductible in Canada?
There are two situations when they may be deductible.
1) 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 may be able to use the 401(k) deduction to offset income for work completed in Canada.
2) 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.
If you find this information helpful and want to read more about this topic including whether IRA withdrawals are taxable, check out the article I wrote about this on the SWAN Wealth Blog.
Finally, if you’re planning on moving across the border and have assets you want to protect, I recommend you schedule a call with a cross-border advisor well in advance.
The biggest and most costly mistakes happen when people don’t plan in advance.