Roth IRA in Canada: Cross-Border Financial Planning Tips

Video Script

In this video, I’m going to cover the main things you need to know if you have a Roth IRA and are moving to Canada or already living in Canada.

If you haven’t spoken with a cross-border financial advisor, then you might not know some of the common issues that can come up with a Roth IRA in Canada and how to make sure you don’t end up paying extra tax.

Stay to the end for answers to the most common questions about Roth IRAs in Canada as well as how to do a backdoor Roth.

And if you need help right away, you can download our Financial Planning Guide for U.S. Citizens Living in Canada on our website.

You’ll find this free guide at swanwealthcoaching.com/guide

As a Portfolio Manager and Cross-border Financial Advisor, I’ve spoken with hundreds of people with cross-border issues. And I’ve found that there is a lot of confusion around how to deal with a Roth IRA in Canada. So let’s get into it!

The first thing you need to know is that once you become a Canadian resident, make sure you don’t contribute to a Roth IRA because it will “taint” the Roth IRA.

What this means is that your Roth IRA can lose its tax-free status.

If you file the Roth IRA election and don’t contribute while living in Canada, it will continue to grow. When you eventually withdraw money, those withdrawals will be tax-free if they were considered qualified withdrawals in the US.

But if you contribute, it becomes a taxable account in Canada.

It also becomes an accounting nightmare if you contribute to your Roth IRA in Canada because you’ll need to start reporting the earnings from when you became a tax resident. And typically, you won’t have the proper tax slips to do this.

Next, once you are living in Canada, you will need to file a one-time election for each Roth IRA account.

Filing an election simply means you are electing to have an alternative tax treatment on an account.

So for a Roth IRA, you are choosing to have it treated as a pension under the Canada US Treaty, which means you can defer Canadian tax on the plan.

So when you file the one-time election with the Canada Revenue Agency or the CRA, you’ll then be able to have that Roth treated as a Canadian pension and you can defer paying Canadian income tax on the income accruing in your Roth IRA.

In terms of timing, you need to file the one-time election with the CRA by April 30th of the year after you become a Canadian resident.

So if you became a Canadian resident in July, you would need to file this election by April 30th of the following year.

Next, when dealing with a Roth in Canada, some people choose to do a backdoor Roth.

This might be something for you to consider if you’re in a high-income bracket.

A backdoor Roth is a Roth IRA that you fund by doing a conversion from a traditional Roth to a Roth IRA.

But why would you bother doing this?

Withdrawals from a Roth IRA, if qualified, are tax-free. I’ll go over what makes a withdrawal qualified later in this video.

But in general, a Roth IRA is a great tool if you think you will be in a higher income bracket when you take the money out.

When you move to Canada, you will often be in a higher income tax bracket. The tax regime here is higher than in the US.

But with a Roth IRA, you can withdraw tax-free income in retirement. And you also aren’t required to take Required Minimum Distributions (RMDs). In other words, you’re not forced to withdraw a certain amount of money at a particular time, as with some other retirement accounts.

(On Screen: If you are a beneficiary of a Roth IRA, you may need to take Required Minimum Distributions to avoid penalties.)

In addition, if you have a large amount of money saved in an IRA, the amount you’re required to withdraw will be higher in the future. You may be forced to take out more than you need, and this RMD could push you to a higher tax bracket.

Having an IRA and a Roth IRA gives you flexibility. You don’t have RMDs with a Roth IRA as the account owner. And the RMDs for your traditional IRA will be lower if you convert some of that money to a Roth IRA.

So now you might be wondering how to do a backdoor Roth.

I will explain using a simple example. For a more detailed explanation, please check out the full guide I wrote on Roth IRAs in Canada.

So now let’s go over the basics of a backdoor Roth.

First, you have to fund a traditional IRA with before-tax money. This can be from a 401(k) conversion or another IRA account.

Second, you convert a portion of your IRA into a Roth IRA, knowing that whatever amount you convert is taxable income.

When I say converting, this means moving some money from your IRA to a Roth IRA.

You can open a Roth IRA account first, or you can transfer the funds to an existing Roth IRA account.

Also, keep in mind the rules around moving the money.

You have 3 options when it comes to moving the money:

60-DAY INDIRECT ROLLOVER

You can do a 60-day indirect rollover. You’ll receive a cheque for the amount you want to convert from your traditional IRA, and you will need to deposit this money into a Roth IRA within 60 days.

DIRECT TRANSFER WITH THE SAME INSTITUTION

You can open a Roth IRA account with the same financial institution that has your IRA and do a direct transfer from the IRA to the Roth IRA.

DIRECT TRANSFER FROM ONE FINANCIAL INSTITUTION TO ANOTHER

Or you can do a direct transfer from one financial institution to another. You’ll tell the financial institution that has your IRA to send the money directly to the new financial institution that has your Roth IRA.

I usually recommend either option 2 or 3 because it is more direct, and you aren’t at risk of accidentally not transferring within 60 days.

Also, because you are taking money out of an IRA and you haven’t paid tax on it yet, this money is added to your tax return for that year and taxed at your graduated tax rate. So essentially, you are paying tax now to save tax later.

Here’s a simple example:

Let’s say you have a $1,000,000 IRA and want to convert $200,000 to your Roth IRA.

When you convert the $200,000 to your Roth IRA for tax purposes, it would be like you earned an additional $200,000 that year. This would be added to your tax return as earned income. Because of this, you need to speak to your accountant and run the numbers before you do a backdoor Roth.

You may want to fund your Roth IRA over a few years so you don’t push yourself into a higher tax bracket each year.

Also, keep in mind you do not want to do a Backdoor Roth once you are a Canadian resident, or you could face taxation in Canada as well as the US.

For more on Backdoor Roths, you can refer to an article I’ve written about this topic, which we’ll link for you in the description box.

Before I go over the last two tips on how to manage your Roth IRA in Canada, I’d like to invite you to schedule a 15-minute call with one of our SWAN Wealth cross-border experts.

If you’re moving to Canada or already living here, you can go to https://www.swanwealthcoaching.com/calls to schedule a 15-minute call and see how we can help you.

Next, let’s talk about how to take money out of your Roth IRA when you're living in Canada.

If you are worried about paying tax when you take money out of your Roth IRA, you are not alone.

First, make sure you follow the steps I’ve already mentioned, including filing the one-time election and not contributing to the Roth IRA when living in Canada.

Next, when you take money out of your Roth IRA, you’ll need to follow the US rules, which deem your withdrawal a “qualified distribution.”

These rules are simple. You need to be over the age of 59.5, and you have held the Roth IRA with our custody firm for a minimum of 5 years. If you follow these rules, then when you take money out, it is generally tax and penalty-free. That said, I recommend that you speak to a qualified cross-border expert before taking money out. You want to be sure that you’re not going to have a surprise tax hit.

Now, before we wrap up, I’m going to answer some final common questions about Roth IRAs in Canada.

Is a Roth IRA the same as a TFSA?

The short answer is no.

Now for the long answer. They are both funded with after-tax dollars. The investments in both accounts can grow tax free each year. Also you aren’t taxed when you take the money out of these accounts. But a TFSA and Roth IRA have different contribution rules which means who and how much you can contribute. And they have different rules for taxes and penalties.

To contribute to a Roth IRA, you need to have earned income, and if you earn too much, you may not qualify to contribute.

While a TFSA is not based on income at all and instead is a set amount by the government for each year. You qualify for each year you are a permanent resident of Canada and are over the age of 18.

With a Roth IRA, if you take out your earnings before age 59.5 or if you haven’t held the account for at least 5 years, you could face penalties. Also, if you don’t contribute one year, you will not be able to contribute more the following year as the room created doesn’t carry forward.

With a TFSA, you can take out money at any age, and you do not need to have held the account for a specific number of years. In addition, if you don’t contribute one year, that room can be carried forward to give you more room the following year. So you don’t miss out.

Also, if you take money out of your TFSA, you can put it back in the following year, so the room isn’t lost.

For example, if you took out $10,000 as you had a surprise expense, you can add the $10,000 back the next year. One important thing to remember with a TFSA is that you don’t want to over-contribute, as you can be hit with a 1% penalty per month on overcontributions.

Can a Canadian citizen have an IRA?

Yes, a Canadian citizen can have an IRA. If you’re asking this question, you probably have either worked in the US and contributed to an IRA or you have inherited an IRA as a beneficiary.

In both cases, you can keep your IRA. Where you may be limited is finding an advisor who can help you manage your IRA and offer advice on investments and strategies for when to take money out if you are living in Canada. This is because US financial institutions cannot help non-residents of the US.

In this case, it would be best to work with a cross-border advisor. They can offer a solution and have assets managed from Canada or the US.

Is there a Roth 401k in Canada?

No, there is no Roth 401(k) in Canada.

The closest account is a TFSA because like a Roth 401(k) is funded with after-tax dollars and investment income and capital gains are generally allowed to grow tax-free.

A Roth 401(k) and TFSA have different rules around contributing, taking money out, taxes and penalties. So be aware of these rules before investing. In addition, a TFSA is not considered a tax-free account by the IRS. This means as a US citizen living in Canada, you may want to understand the rules before investing in this, but it can still be beneficial.

Finally, remember that taxes are generally higher in Canada than in the US, so you will want to make sure you follow the rules, so your Roth IRA isn’t taxed in Canada. A surprise tax hit is one thing everyone prefers to avoid. And as long as you do your planning well in advance, you can avoid this.

Now, if you’re living in Canada but have investments in the US, I recommend you start working with a cross-border advisor.

There are so many things that can go wrong when you don’t have the right information.