American Living in Canada: Tax and Investing Pitfalls to Avoid
Tiffany Woodfield, Senior Financial Advisor, Associate Portfolio Manager, CRPC®, CIM®, TEP®
Summary of Key Points
Avoid moving an IRA into an RRSP, as IRAs offer more beneficiary flexibility and can reduce overall taxes by spreading withdrawals over time.
Do not contribute to a Roth IRA while a Canadian resident, as this can eliminate its tax-deferred status without a CRA one-time election.
Avoid PFICs, such as Canadian mutual funds and ETFs, because they create complex US tax reporting and higher compliance costs.
If you are a US person, do not work with a Canadian-only investment advisor, as they may create US tax issues and fail to provide the required Canada and US tax slips.
Avoid having a US-based executor while resident in Canada, as this may result in your estate being treated as a foreign trust and taxed twice.
Video Script
In this video, you’re going to discover the main financial planning pitfalls to avoid if you’re a US citizen living in Canada.
From tax planning to investing, it’s important to take care of your finances the right way, so you don’t overpay your taxes or get a surprise tax hit!
Stay to the end to find out my five quick tips on how to avoid overpaying tax.
And if you need help right away, download our Financial Planning Guide for US Citizens Living in Canada. You’ll find this free guide at swanwealthcoaching.com/guide
As a Cross-Border Financial Advisor, I help my clients in the US and Canada optimize their investments so they can live a work-optional lifestyle.
Over the years, I’ve seen far too many clients come to me after they’ve already made costly mistakes. So in this video, I want to help you prevent the most common and costly mistakes. The first mistake many people make is withdrawing and contributing their IRA into an RRSP.
Why you shouldn’t do this?
First, an IRA may often be considered to be a superior retirement account to an RRSP because you have more flexibility. There are more options around who you can name as successor beneficiaries, and you can keep the tax deferral status.
Let me explain this with an example:
With an RRSP, when the last surviving spouse or common-law partner passes away,* the RRSP is collapsed. The total amount in the RRSP is added to the deceased person’s income tax return in the year of death.
So if you have $500,000 in an RRSP and are the last surviving spouse when you pass away, this $500,000 dollars would be taxed at the highest marginal tax rate, leaving a much smaller inheritance for your loved ones.
With an IRA, when the holder dies, the IRA can go to a named beneficiary even if it is not their spouse.
For example, you could leave your IRA to a child or other loved one. By opening an inherited IRA, they can continue to benefit from the tax deferral of the IRA for up to 10 years. In this way, they can continue to allow the account to grow before being taxed.
This significantly helps reduce the tax rate than if it all came out at once. This is because if the money comes out all at once and the value of the holder’s IRA is $500,000 then it is as if the individual earned $500,000 in one year and this would likely push you into the highest tax bracket. If you spread out the income and took out smaller amounts you could keep your income in a lower tax bracket.
Using the same IRA example, you could name 5 different beneficiaries, each with $100,000. Each person could choose when to take the money out or allow it to grow for up to 10 years.
As you can see an IRA allows flexibility and potentially access to lower graduated tax rates.
The other major consideration if you are still thinking of transferring your IRA into an RRSP is that doing so is complicated and very rarely tax-neutral. Which means you are at risk of paying more tax. If you consider this please speak to your cross-border accountant ahead of time.
The next big mistake I see is people contributing to a ROTH IRA after becoming Canadian residents.
If you contribute to a ROTH IRA as a Canadian resident, it essentially taints the Roth IRA, and you can lose the tax-deferred status for Canadian taxes.
As a result, you may end up paying tax on your Roth IRA in Canada, which defeats the purpose of why you set up the Roth IRA in the first place!
And remember that if you have a Roth IRA, you must file a one-time treaty election with CRA when you file your first tax return as a Canadian resident to keep your tax-deferred status.
Next, a major pitfall is accidentally investing in PFICs.
PFIC stands for passive foreign investment company. Some of the most common PFICs you may inadvertently invest in are Canadian mutual funds, Canadian ETFs and Canadian money market funds.
These are investments that are registered outside of the US and have passive income.
I don’t recommend that my US citizen clients invest in Canadian mutual funds, Canadian ETFs, or anything considered a PFIC because it creates a nightmare for US citizens and their accountants. The tax compliance for PFICs is complex and you’ll pay more to your accountant for tax preparation, and you may also pay more in tax. So it is usually best to avoid PFICs if you’re a US Citizen living in Canada.
I have seen this costly mistake many times. But you can prevent it by working with a cross-border accountant and a cross-border financial advisor. When you have a cross-border team, they understand the implications of a PFIC. You still have access to a variety of investments as a US Citizen in Canada.
Other investments will not cause these complications and will help you reach your financial goals with less stress at tax time.
The next mistake many US Citizens in Canada make is working with a Canadian-only investment advisor.
This can be problematic because Canadian-only investment advisors don’t know the complexities that a US person living in Canada faces. They may unknowingly invest you in things that end up creating massive accounting headaches, such as Canadian mutual funds.
In addition, if you’re working with a Canadian-only investment advisor, you will not get all the correct investment tax reporting slips.
Your accountant will have to do more work to calculate and prepare your US tax return.
It is much easier to work with a cross-border wealth management firm. You can confirm if you will get a full set of slips for preparing your Canadian tax return and a full set of slips for preparing your US tax return. This alone will reduce your costs and help prevent mistakes.
No matter who you work with, make sure they are cross-border experts!
I have a few more tips for you, but if you’ve been watching this video thinking that you need to get advice right away, please click the link below to schedule a call with a SWAN Wealth advisor so we can help you avoid some of these major pitfalls.
Next, you might not have a complete estate plan yet, but if you do, make sure that you do not have a US resident as the executor of your will.
Here’s why this can be a problem:
An executor has control and management of the assets in your will. It is not where the assets are always located but rather where the decision maker of the estate lives. So if the decision maker lives in the US the Canadian Revenue Agency may see the estate as a foreign trust and you could be at risk of double taxation.
On a related note, you should also update your will for the province where you live.
Failing to do this can be a serious problem because each province has its own laws on how to deal with property after death.
The next major pitfall I see often is US Citizens leaving taxable investment accounts in the US even though they’re living in Canada.
You move across the border and are happily living your life. But every April, you start to dread tax time. You dislike it, even more, when you get an expensive bill from your accountant.
You say to yourself at least you are onside with the IRS. But what you don’t realize is that it can be easier when you have your taxable accounts in Canada.
Having taxable investments in the US while living in Canada is complex because you are dealing with two different systems for calculating capital gains, two different costs for your investments — one when you purchased in the US and one when you became a Canadian tax resident — and two different currencies.
Lastly, I have some quick tips to guide you through the process of optimizing your finances before you move to Canada.
I won’t go into each tip in detail, so you may want to find more information about each of these topics on the SWAN Wealth Blog.
QUICK TIPS:
> Before you give up your green card, get tax advice from a cross-border accountant.
> Always update your will for the province you live and for any other provinces, states, or countries where you hold assets because each jurisdiction has its own estate laws.
> Work with an investment advisor that can produce two complete sets of tax receipts/statements- those for Canada and those for the USA. This way, your accountant has less work at tax time, and you save money.
> If you need to set up a trust in Canada, be aware that the taxation rules for trusts in Canada and the US are different.
>When you are a US person working in Canada, the impact of a high salary is crucial to consider because you may have been used to paying less tax in the US. Canada does have a higher tax regime than the US.
You will want to invest in things that do not add to your income but are treated tax favourably and don’t cause additional penalties with the IRS. You want to keep in mind how much you’ll have in your pocket after tax.
You may also want to consider what you can invest in that could be moved to the US if you decide to move back. For advanced planning like this, you’ll want to work with a cross-border financial advisor.