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Terry Ritchie on Life and Retirement Traps for Cross-Border Clients

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ThinkAdvisor, an online resource for financial and investment advisors, recently featured Cardinal Point’s Vice President and Private Wealth Manager Terry Ritchie’s insight into cross-border issues in an article in their online publication. With more than 30 years of experience in cross-border wealth management, Terry was able to shed light on a number of traps retirees commonly face when moving from the U.S. to Canada for their golden years.

From dangerous assumptions and differing tax rules to inadequate health coverage and life insurance considerations, these traps can lead to big financial problems if retirees don’t fully understand the implications of their move.

Check out the article here to learn more about:

  • Trap 1: Assuming it’s easy to move wherever you want as a U.S. citizen.
  • Trap 2: Relying on your old retirement savings arrangement regardless of your new home country.
  • Trap 3: Trying to skirt investment restrictions.
  • Trap 4: Leaving gaps in your health coverage.
  • Trap 5: Failing to adjust your life insurance.
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Terry Cardinal Point Wealth

Terry Ritchie featured in The Insurance & Investment Journal article, Managing Cross-Border Clients

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From the Insurance & Investment Journal article:

Managing cross-border clients is a challenging area for advisors that requires thorough knowledge on how to handle life insurance, investments, taxes and pensions while respecting two countries’ rules and regulations.

The Insurance and Investment Journal spoke to U.S-Canada cross-border expert Terry Ritchie, a director at Cardinal Point Wealth Management, who’s specialized in the field for more than 25 years to find some answers. He says if you don’t have knowledge or experience it is very easy to mess things up for your client.

Read the article here

Estate Disputes: Keeping the Peace

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Estate planning issues can create family discord, especially in cases in which there is a sizable inheritance and heirs have disparate circumstances and competing interests.

“You seem to know people,” says Terry Ritchie, director of cross border wealth services with Cardinal Point Capital Management Inc. in Calgary, “but when someone dies and there’s money [involved], their real colours come through.”

Managing delicate family dynamics can be challenging, Ritchie adds, but there is much you can do as a financial advisor to prevent and minimize potential conflict. Ritchie offers the following advice for helping clients keep family peace before and during a wealth transfer:

Encourage open dialogue

Ritchie recommends hosting a family meeting that includes the client and all the beneficiaries of the estate as part of the estate planning process. Heirs who are unable to attend in person can connect by speaker phone or online. The conversation should cover how the wealth transfer will unfold and issues unique to that case that might arise.

As the financial advisor, you are in a position to address family members’ questions about the ins and outs of the wealth transfer. For example, you can field questions that may arise regarding taxes, which can complicate the process, especially if there are cross-border tax issues.

But the level of disclosure you get into — such as the client’s net worth and the distribution of assets — is your client’s call. Ritchie lets his clients decide whether it makes sense for him, as the advisor, to communicate with the family. Once he has the approval to engage the family, he is careful to treat the children equally and be up-front about how he’s helping their parents.

Improve your client knowledge

Expand the scope of your discovery process to include getting to know your clients’ family dynamics. Ritchie usually holds an in-depth conversation with clients about how their children are faring, asking if there are any issues he should be aware of that could complicate the wealth transfer.

For example, Ritchie becomes attuned to the marital status and financial circumstances of his clients’ children, which helps him get a better sense of their motivations. By becoming familiar with your clients’ children, you create an opportunity to continue a relationship with that generation.

“I have a pretty good understanding of the cast of characters I might be dealing with in the future,” Ritchie says. “Many advisors don’t go that deep.”

Take the heat

If your client feels caught in the middle of an intractable sibling rivalry over the inheritance, Ritchie says, help ease the stress by acting as an intermediary.

He has faced situations in which clients’ children want to dictate the terms of how and when the assets will be distributed. In one case, one sibling felt that the wealth was being divided unfairly, because others were receiving a larger portion to include their children.

In such cases, Ritchie will take on the role of “bad cop,” enforcing the client’s expressed wishes and explaining the reasons behind the decision.

When the children prove relentless in pushing for their preferences, he often tells his clients: “Don’t be the bad guy, let me be the bad guy.”

What do I do with my U.S. revocable trust if moving to Canada?

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Affluent individuals living in the United States often use a U.S. revocable living trust (RLT) for estate-planning purposes. Such a trust provides confidentiality and flexibility in how assets are managed, as it eliminates the specter of probate.

A revocable living trust is transparent for U.S. income, gift and estate-tax purposes. The individual who transfers (settles) property to the trust is also its trustee and beneficiary. The trust is considered a U.S. grantor trust, which is ignored for U.S. income tax purposes. All income, losses and expenses are claimed on the individual’s personal U.S. tax return.

Moving to Canada: Canadian tax issues and administrative burdens
For individuals moving to Canada (both Canadian and U.S. citizens), continuing to hold a U.S. RLT will present tax and administrative challenges. Under Canadian tax laws, once the trustee(s) become residents of Canada, the trust will be considered a separate taxable entity and will be treated as a Canadian resident trust. This will then require the trustee(s) to not only file a Canadian Trust return but also to pick up all of the income earned by the trust on their personal Canadian and U.S.  tax returns.

Although foreign tax credits can be used to reduce and/or eliminate double-taxation issues, continuing to hold the U.S. RLT complicates tax filings. Further, the trust would have both a Canadian and U.S. cost basis that would have to be tracked and reported. The Canadian basis would be equal to the value of the assets within the trust on the day the trustee(s) moved to Canada. The U.S. cost basis would be equal to the original value of the assets at the time they were acquired.

In some cases, an exception exists under Canadian tax law that allows the taxpayer to deem all the income and capital gains/losses associated with the trust property as taxable to the taxpayer as an individual, effectively making the trust disregarded for both U.S. and Canadian tax purposes. Under this exception, there would be no double taxation on income earned by the trust during the taxpayer’s lifetime.

Double Taxation at Death
Double taxation issues become a greater concern if the trustee happens to die as a Canadian resident after the trust had been in existence for 21 years. Under this scenario, the trust would form part of the trustee’s estate and, depending on the size of the estate, U.S. estate tax could be payable. In Canada, the trust would also be taxed once the assets were sold on or after the 21st year anniversary of the trust. There would be no foreign tax credits available to offset these two taxes, which could result in double taxation.

Subject to Canadian departure tax
Meanwhile, U.S. citizens temporarily living and working in Canada could be subjected to departure tax on their trust when they return to the United States. U.S. citizens are afforded a five-year period (See article: “Americans Exiting Canada: Understanding the Five-Year Deemed Disposition Rule”) living in Canada in which they are not subjected to Canadian departure tax upon a return to the United States. As stated earlier, because the trust is considered a separate legal entity from a Canadian tax perspective, it would not be granted the same five-year exemption from exit tax because it is not a personally owned asset.

Financial institutions unable to hold or administer trust
An additional complication, unrelated to the tax issues outlined above, is the fact that most U.S.-based financial institutions will not hold a U.S. RLT once the trustee becomes a resident of Canada.

Most U.S.-based financial institutions are not registered and licensed to oversee a taxable (or trust) investment account on behalf of a Canadian resident, even if that individual is a U.S. citizen. Many individuals try to get around this regulation by registering the U.S. RLT to a family or friend’s U.S. address. Not only is it illegal to misrepresent your residency, but it could also create tax issues because the IRS and state will continue to receive tax slips showing you live at a U.S.-based address.

Although it is a great estate-planning tool for those residing in the United States, a RLT presents many tax and administrative challenges once you move to Canada. For those individuals intending to live in Canada for the foreseeable future, it would likely be wise to unwind the trust structure before or soon after arriving in Canada. This would prevent any adverse Canadian income-tax consequences. At Cardinal Point, we assist individuals and families moving from the United States to Canada with their financial, tax and estate-planning needs. If you are moving to Canada and own a U.S. RLT, we can advise you on whether it is in your best interest to keep the entity intact or close it down.

Options for U.S. IRA account holders when living in Canada

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At Cardinal Point, one of the most frequent inquiries we receive is from prospective clients asking what they should do with their U.S. retirement accounts after a move to Canada. These individuals are often caught off-guard by their U.S.-based financial advisor or institution after learning that their investment accounts must go into restricted status or be permanently closed. The reason they are often given is that their U.S.-based advisors and related custodian can no longer maintain accounts registered to a Canadian address.

Many advisors and/or firms in the U.S. – even some of the largest – are not properly registered and licensed to provide investment advice for a client living in Canada (even if the client is a U.S. citizen). In fact, there are few U.S.-based firms that carry the proper licenses and registrations to be able to service taxable, IRA or 401(k) accounts held by Canadian residents. And because of the additional rules and compliance requirements associated with servicing a client physically living outside of the United States, many U.S.-based firms have policies against providing services to non-U.S. residents.

The situation is equally troubling when an individual looks to a Canadian financial advisor to help. Yes, these advisors carry the proper Canadian securities licenses and they can manage accounts domiciled in Canada. But because they are not registered in the United States, Canadian advisors cannot oversee a U.S.-based retirement account. The situation leaves the Canadian resident frustrated and with few options for what to do with their U.S.-based retirement account.

Unfortunately, some advisors have tried to find workarounds that are not only illegal but not in the best interest of the client. Over the years, prospective clients have shared with us the “advice” that they have received from both U.S. and Canadian advisors. In the United States, these suggestions include leaving an old U.S. address on file or using a friend’s or family’s U.S. home address. To the advisor’s compliance officer and firm, it makes it appear as if the client is still residing in the United States. Not only is this illegal under U.S. securities laws and very likely against company policy guidelines, it could also suggest to the U.S. state in which the account is held, that the client is still a tax resident of that state. Given some of the fiscal challenges facing many U.S. states, we have seen state tax authorities use this as a phishing expedition to generate or pursue more tax revenue. In Canada, frequently given advice includes selling out the U.S. retirement account and moving the proceeds to Canada, so that the Canadian-based advisor can manage the assets. Simply following this advice without fully understanding or determining the tax impact of such a move, can be costly and harmful.

So what options are there for Canadian residents with U.S. retirement assets? While it may seem like a no-win situation, there are options available. The first step is to find a qualified Canada-U.S. cross-border advisor that is registered and licensed to provide investment and financial planning advice in both countries. Although there are very few who meet these requirements, these cross-border advisors can not only legally manage your investment and retirement accounts in both countries but can also provide the accompanying financial, tax and estate planning services that are required for those individuals with investment assets and interests in both Canada and the U.S. To take it a step further, when choosing a cross-border financial advisor, make sure that they are bound by the fiduciary standard and not the less strict suitability standard used by most Canada/U.S. investment and bank owned firms. The fiduciary standard is the highest standard of care in the investment industry. As a fiduciary, the advisor must operate in a way that puts the client’s needs ahead of his or her own through a transparent and conflict-free service model.

Because there is no one-size-fits-all approach when it comes to addressing Canada-U.S. cross-border financial planning matters, a fiduciary-bound, cross-border advisor will take the time to properly understand your complete and unique situation. The advisor will then develop a comprehensive Canada/U.S. financial plan including options on how best to address your U.S.-based retirement accounts. In the case of a Canadian resident holding a U.S. retirement account, some of the factors that must be considered include but are not limited to the following: age of the client, likelihood of the client returning to live in the U.S. one day, size of the IRA/401k account, type of IRA (traditional vs. Roth), client tax situation, citizenship, U.S. estate tax exposure, future income needs and residency of beneficiary.

Once a thorough assessment of the client’s situation is completed, the advisor will likely recommend one of the following courses of actions if the individual holds a traditional or rollover IRA*:

  • Close out the IRA and withdraw the funds: Under this scenario, if the owner of the account is a Canadian citizen, there would be a 30% U.S. withholding tax applied to the withdrawal. (This tax can be reduced to 15% if there is a signed IRS W-8BEN form on file. It is important to note that we are finding an increasing number of U.S. institutions that do not honor or understand the role of a W-8BEN form.) Depending on the client’s tax situation, the account owner may be able to recoup some, if not all, of the withholding tax applied through the use of foreign tax credits. If the individual is a U.S. citizen, there is no mandatory withholding tax applied. If the plan owner is under the age of 59 ½, an additional 10% early withdrawal penalty will be assessed on the value of the distribution. The entire amount withdrawn from the IRA account would then be picked up as income for Canadian income tax purposes for Canadian tax residents. If you are a U.S. citizen, the amount would be picked up as income for Canadian and U.S tax purposes. Through the application of foreign tax credits, this form of double taxation could be eliminated. It is important to be very careful when considering redeeming the entire IRA/401k account because the tax treatment tends to not be beneficial in most client situations.
  • Close out the IRA and move the proceeds to an RRSP: If you are not a U.S. citizen or tax resident, under the right circumstances this might be a worthwhile option to consider. Under U.S. tax laws, transfers for an RRSP or RRIF cannot be made into a U.S. IRA. However, Canadian tax law does provide for the transfer of proceeds from a U.S. retirement account to an RRSP. Under Canadian tax rules, there are two provisions under the Income Tax Act that with proper planning, the transfer of IRA or 401(k) proceeds can be made to any existing or new RRSP without compromising one’s RRSP contribution room. That being said, although Canadian tax on the U.S. retirement account distribution can be reduced or eliminated, the U.S. treaty withholding tax of 15% – and the 10% penalty if it applies – cannot be eliminated or reduced. Therefore, if the Canadian wanted to contribute the gross amount from the U.S. retirement asset to a Canadian RRSP, they would have to provide the 15% amount themselves from other financial resources.
  • Leave the IRA account in the U.S.: For many account owners, this course of action makes the most sense given that the Canada-U.S. Tax Treaty allows a Canadian resident with an IRA to leave the account in the U.S. and receive the same tax-deferred treatment the individual would enjoy if still living within the United States. Under this scenario, the plan owner could let the account grow until he or she is required to take out the annual Minimum Required Distributions (RMDs) after turning 72. At that time, a 30% withholding tax would be applied to each annual distribution received by a Canadian citizen (potentially reduced to 15% with a W-8BEN or recovered through the filing of a U.S. tax return and application of treaty benefit). For a U.S. citizen, no withholding requirements are necessary. The plan holder could continue to receive the RMD each subsequent year the same way the individual receives annual Canadian RRIF minimum withdrawals.Any withdrawals or distributions would be picked up as income for Canadian tax purposes (for Canadian residents) or as income for Canadian and U.S. tax purposes (for U.S. citizens or tax residents). Again, foreign tax credits up to a treaty maximum rate of 15% could be applied to eliminate this double taxation for U.S. citizens. There are additional benefits to holding the account in the United States. These include continued currency diversification (USDs), and less expensive investment options, as well as more variety of investment options, than can be found in Canada.

    * For the purpose of this short article, we are not listing the pros and cons of each scenario identified.

Many of the same tax rules outlined above for an IRA account would also apply to a 401(k) account holder who is a resident of Canada. However, we would suggest that the account owner consider “rolling over” the 401(k) account to an IRA account. The key benefit to completing this tax-free rollover is that an IRA account typically allows for more investment options within the plan.

If an individual is an owner of a Roth IRA account, the options are far greater and easier to navigate. This is because any withdrawal received from a Roth IRA after the account owner turns age 59½ is considered tax free for Canadian (if a specific first-year election is made when coming to Canada) and U.S. tax purposes. No withholding taxes are applied either. Like the traditional IRA, the account can grow tax deferred indefinitely for Canadian and U.S. tax purposes. Further, there is no RMD for Roths, meaning the account holder can take out as little or as much as the individual wants once turning 59½ years old.

A thoughtful plan must be put in place after a move to Canada. After all, many of us work hard our entire lives to save for retirement and a cross-border move shouldn’t jeopardize a person’s long-term financial health. When choosing an advisor, take the time to find a qualified individual or firm licensed to provide investment advice in both Canada and the United States. In addition, the advisor must bring a firm understanding of cross-border financial and tax planning matters and, just as importantly, the appropriate Canada-U.S. investment platform to support the recommended course of action.

Cardinal Point is a Canada-U.S. cross-border advisor firm with offices in Canada and the U.S. We specialize in assisting individuals and families with their investment, tax, financial and estate planning needs. We have the unique ability to manage U.S. retirement accounts on behalf of Canadian residents and operate solely under the fiduciary standard. If you wish to discuss the options for your U.S.-based retirement accounts, please feel free to reach out to us. One of our cross-border advisors would be happy to assist you.