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Making Roth Conversions Before Moving to Canada: Key Considerations

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Relocating to Canada from the U.S. presents unique financial planning opportunities and challenges, especially regarding U.S. retirement accounts like IRAs and Roth IRAs. One strategic move often considered is converting a traditional IRA or 401(k)/403(b) to a Roth IRA before establishing Canadian tax residency. Below, we outline the key aspects of this strategy, clarify the Canadian tax filing requirements to maintain Roth IRA tax-free status, and weigh the pros and cons of making such conversions.

Roth IRAs and Moving to Canada

Why Consider a Roth Conversion Before Moving to Canada?

  • Tax Rate Arbitrage: U.S. federal tax rates may be lower than Canadian rates, especially at higher income levels. By converting to a Roth IRA before moving, you pay U.S. tax on the conversion at your current rate, potentially avoiding higher Canadian taxes on future withdrawals.
  • Future Tax-Free Growth: Once in a Roth IRA, investment growth and qualified withdrawals are tax-free in the U.S. and, with proper planning, can remain tax-free in Canada.
  • Estate Planning: Roth IRAs can be passed to heirs with favorable tax treatment, making them attractive for legacy planning.

The Canadian First-Year Tax Filing Requirement

To maintain the tax-free status of your Roth IRA in Canada, you must comply with a specific Canada Revenue Agency (CRA) requirement in your first year as a Canadian resident:

The One-Time Treaty Election

  • Deadline: You must file a one-time election with the CRA by the due date of your first Canadian tax return (generally April 30 of the year following your arrival).
  • What to File: There is no prescribed CRA form. Instead, submit a letter for each Roth IRA account, including:
    • Your name, address, Social Insurance Number, and U.S. Social Security Number
    • The name and address of the Roth IRA trustee/administrator
    • Account number and establishment date
    • Date you became a Canadian resident
    • Roth IRA balance as of your arrival date
    • Statement electing to defer Canadian taxation under Article XVIII(7) of the Canada-U.S. Tax Treaty
  • No Canadian Contributions: After becoming a Canadian resident, you must not make new contributions (including conversions or rollovers from traditional IRAs) to your Roth IRA. Doing so invalidates the election and subjects future growth to Canadian tax.

Pros and Cons of Roth Conversions Before Moving

Pros

  • Potential Tax Savings: If your current U.S. tax rate is lower than the expected Canadian rate, converting before moving can result in substantial tax savings.
  • Tax-Free Growth: With the Treaty election, future growth and qualified withdrawals from the Roth IRA can remain tax-free in both countries.
  • Simplified Cross-Border Planning: Roth IRAs are recognized under the Canada-U.S. Tax Treaty as pensions, allowing for coordinated tax treatment.
  • No Required Minimum Distributions (RMDs): Roth IRAs are not subject to RMDs during the account holder’s lifetime, providing flexibility.

Cons

  • Immediate U.S. Tax Liability: The conversion amount is taxable as ordinary income in the U.S. for the year of conversion, which can result in a significant U.S. tax bill.
  • Potential for Higher Tax if Not Timed Well: If your U.S. tax rate is higher than your anticipated Canadian rate, converting before moving could result in paying more tax than necessary.
  • Potential for Increased Medicare Part B Premium: A Roth conversion increases your income for the year, which may result in higher, income-tested Medicare Part B premiums for a future year.
  • Complex Filing Requirements: Missing the one-time Treaty election deadline can result in annual Canadian taxation of Roth IRA growth.
  • No Further Contributions: Once you are a Canadian resident, you cannot contribute to your Roth IRA without losing tax-free status.

Practical Example

Suppose you have a $300,000 401(k) eligible for rollover and plan to move to Canada next year. By converting to a Roth IRA before moving, you pay U.S. tax on the conversion (e.g., 24% federal, $72,000 total if split over two years and living in a state with no income tax). If you wait and take distributions as a Canadian resident, those withdrawals could be taxed at up to 53.5% in Canada (B.C.), resulting in much higher overall taxation.

Key Takeaways

  • Plan Ahead: Roth conversions before moving to Canada can offer significant tax advantages, but only if carefully timed and executed.
  • File the Treaty Election: To preserve tax-free growth and withdrawals in Canada, file the one-time Treaty election with the CRA by the first-year tax filing deadline and avoid any post-move contributions.
  • Seek Professional Advice: Cross-border tax planning is complex; consult a qualified cross-border tax advisor like the advisors at Cardinal Point to tailor the strategy to your situation.

By understanding these requirements and carefully weighing the pros and cons, you can make informed decisions about your retirement assets as you transition to life in Canada.