401(k) Rollover to an IRA

Do you have a 401(k) from a previous employer? Have you considered rolling over your 401(k) into an IRA? Here are a few elements to review before making your decision:

  • Investments in both your 401(k) and IRA continue to grow tax-deferred for both Canadian and U.S. tax purposes if the transfer is executed properly in consultation with your tax professional and your former employer.
  • Holdings in your 401(k) can remain in U.S. currency if desired while having the ability to hold Canadian currency and other foreign currencies in your IRA.
  • An IRA can expand investment options in market-traded securities with access to Canadian and other foreign securities. Many 401(k) plans have limited investment options.
  • Flexibility to withdraw as much or as little from the IRA before the Required Beginning Date (like an RRIF).
  • Consolidation of various U.S. plans into one IRA account and simplification of required minimum distribution (RMD) calculations.
  • Assets can be consolidated with one financial advisor who can take into account overall asset allocations and investment objectives.
  • A financial advisor can provide investment advice and retirement planning services in the context of Canadian tax residency.
  • Potentially lower fees depending on investment choices and portfolio management in your IRA compared to your 401(k).
  • Early penalty-free withdrawals available from your IRA for first-time home purchases ($10,000 lifetime limit).
  • Effective January 1, 2020, the age limit for traditional IRA contributions was eliminated. Individuals must still have compensation income to contribute.
  • Flexibility to name any person, group, or entity as beneficiary (subject to custodian review).

Disadvantages of rolling over your 401K to an IRA when moving to Canada

  • There will be a loss of net unrealized appreciation (NUA) capital gains treatment on employer stock if a U.S. taxpayer rolls their employer stock into an IRA. Growth will become ordinary income for U.S. tax purposes. You should consider withdrawing stock before moving to Canada.
  • If you are subject to an expatriation tax as a covered expatriate, the IRA value is includable in expatriation income as a specified tax-deferred account.
  • Retirement distributions from an IRA are not eligible pension income for Canadian pension splitting and the pension credit.
  • There is no option to withdraw lump sums before the age 59½ without penalty if separated from employment at or after the age of 55.
  • An IRA rollover completed in the same year as a back door Roth IRA conversion will increase the taxable income of the Roth conversion because the calculation measures the IRA value at the end of the year.
  • No automatic cash-out rules for your IRA.

REMINDER - Attributes applicable to both 401(k) plans and IRAs:

Generally, withdrawals before age 59½ from both 401(k) plans and IRAs are subject to a 10% penalty tax in addition to regular U.S. income tax. Exceptions are available: (https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions).

Required minimum distributions for both IRAs and 401(k) plans must begin at age 73 for individuals born after December 31, 1950, unless the employee is still working past 73 for the U.S. employer providing the plan.

Survivor spouse beneficiaries can inherit the 401(k) or IRA account and continue to defer tax on the account growth over their remaining life expectancy until withdrawn.

Children and other non-spouse designated beneficiaries can inherit and continue tax-deferred growth of the 401(k) or IRA account for up to 10 more years after the account holder’s death, even if they live in Canada. Check with your 401(k) plan provider if there are limitations on non-spouse beneficiaries.

Upon death, the account value of your 401(k) or IRA is not included in the deceased’s Canadian terminal income tax return (unlike RRIF or RRSP). The beneficiary pays taxes on the withdrawals.

Generally, no special Canadian tax election forms are required to let the 401(k) or IRA account grow tax deferred.

The ability to convert to a Roth IRA remains intact if the account holder decides to move back to the U.S.

Generally, the 401(k) or IRA account is protected from creditors and bankruptcy claims.

A 15% non-resident withholding tax applies to periodic payments and 30% applies to lump sum distributions (collapse entire account) for non-U.S. persons living in Canada.

U.S. retirement plans, including 401(k) and IRA accounts, are U.S. situs assets exposed to U.S. estate tax if the deceased taxpayer’s net worth is high enough to generate a U.S. estate tax liability in the year of death.

When a 401(k) or IRA plan holder dies with a home address outside the U.S. or has an estate administrator outside the U.S., the financial institution may require clearance from the IRS (transfer certificate) before releasing the inherited account to the beneficiary. The executor may have to file estate disclosures or an estate tax return to obtain the transfer certificate from the IRS if the plan value exceeds $60,000.