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Terry Ritchie on Unraveling Cross-Border Financial Planning

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Terry Ritchie

Snap Projections, a financial planning software company, recently featured Cardinal Point’s Partner and Director of Cross Border Wealth Services, Terry Ritchie, on their Growing Your Financial Advisory Practice podcast. Given Terry’s more than 30 years of experience in cross-border financial, investment, tax, and estate planning, it’s no surprise that Snap Projections chose to tap into his insight for this primer directed at financial planners who want to serve US-Canada clients.

From the factors driving clients to move between Canada and the US (hint: politics, healthcare, family, and lifestyle all play a role) to the intricacies of visas, green cards, and US income tax, the podcast highlights Terry’s wealth of knowledge and passion for cross-border work.

Here’s everything discussed in the one-hour episode:

  • Why people move between Canada and the US.
  • Why Terry thinks cross-border work matters.
  • What you MUST know about visas and green cards.
  • Important elements of US income tax.
  • Limitations on Canadians who invest in the US.
  • Estate planning for cross-border clients.
  • The biggest cross-border planning mistake advisors make.
  • How to grow a financial planning career you really love.

Cardinal Point Wealth Management Featured in ETF.com

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Terry Ritchie, Director of Cross-Border Wealth Services, and Matt Carvalho, CIO, recently sat down with Lara Crigger at ETF.com and discussed some of the tricky aspects of moving abroad.

Terry-Matt-Cardinal-Point-Wealth

When your expenses are in a different currency from your income, currency hedges and dollar-cost-averaging are normal ways to deal with uncertainties in global markets.

But there are also many other financial issues to consider, such as immigration and social security:

“You can’t just cross the border and say, ‘I live here now; I’m going to work here and get free health care’. There’s a process,”, says Ritchie and points out that the job of financial planners is to take a big-picture view. For tax and financial regulatory reasons, you may have to change some of the ETFs or mutual funds held via 401(k)s – or else face some onerous tax implications and heavy paperwork.

It all has to be part of a comprehensive financial plan, catered to the specific individuals moving and their conditions.

Read more at ETF.com

Why Invest Internationally?

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Diversification is the most important concept in investing, but also perhaps the least exciting. If anyone knew for sure exactly which one company or country would have the highest return in the coming year, there would be no reason to hold anything else. But while being able to predict markets with any certainty sounds great in theory, in practice nobody has been able to consistently outsmart the market. So what do you do if you can’t know for sure if Pepsi or Coke, or the US or Canada will be the best performer in the coming year? You diversify. This is especially important when it comes to financial planning.

While we may plan to retire in one country or have our peak earnings years in another, having broad-based global diversification can help you over the long run, even though in any give year or time period it can feel like it’s not benefiting you.

Stock Market Returns 2003-2006 Let’s take an example of a Canadian investor who had a CAD account and was watching returns in the early 2000s. Between the start of 2003 and the end of 2006, the Canadian market far outpaced the US. You can see from the chart on the left that the annualized returns (in CAD) for Canadian markets was nearly triple the returns for US markets over that period.

Besides Emerging Markets, it would have been hard to see much reason to allocate any investments outside of Canada. And in fact, that’s much of what the Canadian and US investing media was telling you at the time- dump your US stocks, and buy Canadian and Emerging Markets! Yet moving to those markets solely and out of the US and International Developed markets would have been particularly painful shortly after in 2008, when  Canadian and Emerging Markets holdings would have underperformed compared to US markets, when viewed in CAD.

Stock Market Returns 2015-2017 More recently, if we look at 2015-2017, Canada has delivered just half the performance of the US on an annualized basis, and well below the returns experienced in  International Developed and Emerging Markets.

As we can see on the chart below, the order of returns by region each year is essentially random. Trying to guess in advance each year which country or market segment will outperform will likely lead to simply buying what’s been hot in the last year and will often result in  disappointment. One area might do well for a number of years, as Emerging Markets did in the early 2000s, only to fall hard in 2008. US stocks did much better than Canadian stocks for 6 of the previous 7 calendar years, but underperformed significantly in 2016, and have experienced steeper declines this October.

Returns by Region
Diversification blog chart
*2018 YTD is Jan 1 – Oct 27

Instead of guessing which country or region is going to outperform next, astute investors can realize many benefits by spreading their assets across the group of global stocks. Doing so  allows you to capture the returns of whichever market is doing best in that time period, and ensures you’re never exposed to just one market or currency. As you can see on the chart, a blended exposure to the different regions means you can reduce your year to year volatility, and this is before the introduction of bonds or other asset classes that may move differently than stocks.

Over the last 15+ years, each region we looked at had strongly positive returns. Standard deviation measures how much those investments went up or down over the years, with  Emerging Markets being the most volatile. The Sharpe Ratio measures how efficient each investment was by comparing the magnitude of the returns  to the amount of volatility experienced. US stocks looked pretty good during this time period, but they don’t beat the blend when it comes to reward per unit of risk.

US stocks 15years

Looking back to the chart of annual returns above, we can’t know what region will have the strongest returns over the coming week, month or year. Yet, when we look at the blended result, which made no predictions at all but simply followed a long-term asset allocation between the four regions, we saw the lowest volatility and a healthy return , resulting in the highest Sharpe ratio.  This indicates that the blended portfolio is a  more efficient stock allocation than holding any one region individually. This blog looked at these regions from the Canadian Dollar point of view, but the results and theory are similar from the US Dollar perspective.

The downside of diversification is that you will never be the best performer. There will always be some particular stock or area of the market that will do better than the whole of your portfolio. But by having a globally diversified portfolio, you’re likely going to be capturing some of those gains. At some points, like 2008 or recently in 2018, all markets may see losses, however diversification ensures that you’re not taking unnecessary risk by having all of your exposure in any one company, sector, or country.

Thinking back to the financial plan that is crucial to the ability to meet long term goals, the long-term growth rates assumed are already factoring in ups and downs along the way. Nowhere in a prudent investment plan is the need to try and predict or out guess markets, but key to the plan is being able to capture those market rates of return wherever and whenever they do occur.

Source: Morningstar Direct 2018. Canada returns represented by S&P/TSX 60 TR CAD, US returns represented by S&P 500 TR CAD, International Developed represented by MSCI EAFE NR CAD, Emerging Markets represented by MSCI EM GR CAD. Blended mix represents 33% in Canada, 33% in US, 23% in Intl Developed and 10% in Emerging Markets, rebalanced annually. Indexes are unmanaged baskets of securities that are not available for direct investment by investors. Index performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. All investments involve risk, including the loss of principal and cannot be guaranteed against loss by a bank, custodian, or any other financial institution

Don’t Settle: Choose wisely when selecting a cross-border wealth management firm

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Your whole life you have done things correctly: worked hard, saved and prudently invested your money. Then one day, out of the blue, you receive a letter from your U.S. investment management firm saying they no longer want to work with you because you reside outside of the U.S. Worse yet, they give you 90 days to transfer out your account or risk having your holdings liquidated. Whether it is a taxable or tax-deferred investment account, a forced liquidation and closure of your account can have  severe tax consequences. Furthermore, it can have a devastating effect on your long term retirement and savings goals. While the above scenario sounds  dire, it does not mean you should make a rushed decision and simply partner with the first firm that confirms they can take over the management of your account(s). Instead, take the opportunity to rethink what advisory firm would best serve your long-term interests as a non-resident. In other words, seek out a true cross-border wealth management firm that can not only deliver on the investment management piece but also provide ongoing value added cross-border financial, tax and estate planning solutions. The last thing you want to do is work with another firm that does not specialize in working with non-residents of the U.S., only to find out down the road you are once again being terminated from their platform.

So what characteristics should you be looking for in a true cross-border wealth management firm? The following checklist is a good starting point for selecting a company that’s right for you:

Cross-border platform – Make sure the firm and its advisors are legally licensed and registered in the jurisdiction you reside. Confirm they are not restricted on how your investment account can be managed based on your non-resident status.

Fiduciary vs. Suitability – It is important to confirm that the firm’s advisors operate under the fiduciary standard of care, which is a legal requirement that an advisor act in the best interest of his or her client. The fiduciary standard helps eliminate conflicts of interest. In contrast, the less stringent suitability standard adheres to a rule in which recommended investments must merely be “suitable” for but not necessarily in the best interest of a client. Most large investment brokerages, banks and wire houses operate under the suitability standard.

Fee-only – Finding an advisory firm that is fee-based and is not compensated by commissions, trading fees or financial products can eliminate conflict of interests between the advisor and the client.

Business Model – You cannot be all things to all people. Advisors who claim they work with four or five different categories of clients (retirees, small business owners, professionals, divorcees, expats, etc.) fall back into that “generalist” category. If you want to be an expert in what you do, focus on your niche. A financial firm with a business model of working exclusively with cross-border clients is typically better suited to handle expats or non-residents of the U.S.

Credentials, Experience and Education – Just because an advisor has a certain credential, doesn’t mean that they are an expert. That being said, when looking to partner with a cross-border financial advisory firm, make sure to review the bios of the individuals working at the company.  Have they been working with cross-border clientele for a long time? Do they have education or credentials in certain areas that focus on assisting cross-border clientele?

Cross-border Team – When building and preserving wealth, you’re only as strong as your weakest link. In other words, you may find a firm that can deliver on the investment management piece, but can they provide the ongoing cross-border or expat financial, tax and estate planning services you require? Look for a cross-border team that has dedicated portfolio managers who specialize in managing money for expats, and has international or cross-border tax experts and cross-border financial planners. All of these individuals have unique skill-sets that complement one another. Finding a firm that can provide comprehensive cross-border financial planning services in an integrated and coordinated fashion ensures no stone is left unturned when reviewing your situation.

Understanding of Tax – Understanding the tax rules and regulations of the jurisdiction in which you reside is extremely important when providing investment management services to non-residents. Further, if you are a U.S. citizen living abroad, you must also ensure the investment management strategy is tax managed based on U.S. tax rules. For example, the Passive Foreign Investment Companies (PFICs) rules will impact almost all foreign-traded mutual funds and ETFs. Ensuring you are not subjected to the punitive tax rules associated with holding a PFIC is critical. Make sure the firm you choose has a strong understanding of tax rules impacting non-residents and expats.

While no one wants to be faced with a surprise “move your investment account or else” deadline, don’t feel pressured to move your account to the first firm you speak to. Do your homework. Look to partner with a true cross-border wealth management firm that is positioned to provide long term value in addressing your unique and ongoing cross-border financial planning requirements.

Income Tax Implications of RRSP Withdrawals as a Non-Resident of Canada

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A large number of the clients that we work with are those that move from Canada to the United States. In these cases, we spend quite a bit of time making our clients aware of the income tax implications of leaving Canada and establishing tax residency in the U.S. We have written many publications on this topic, including a recent article, “Moving from Canada to the United States: What You Need to Know.”

For many of these people transitioning from Canada to the U.S., some of their larger financial assets are held within their registered plans (RRSPs, LIRAs, RRIFs, etc.). Given that our firm is properly registered and licensed in both Canada and the U.S., we can provide ongoing financial planning, tax and investment management for our clients who choose to leave their registered assets in Canada.

By leaving these assets in Canada, continued tax deferral in Canada and most U.S. states will continue. The State of California, however, has a different set of tax rules that relate to registered plans that remain in Canada. See our article, “California Residents: Does Your Financial Advisor Tax-Manage Your RRSPs?”

As we develop our clients’ comprehensive Canada/U.S. financial plans, discussions and decisions with respect to taking distributions from their RRSPs for future lifestyle or retirement planning purposes are reviewed. For the vast majority of our clients, RRSPs continue to be managed by us through our Canadian institutional custodian until clients retire or are required to convert their RRSP to a RRIF.

However, what if one was looking to take a distribution from their RRSP as a non-resident of Canada prior to retirement, i.e. for the down payment on a new U.S. home or to meet current lifestyle requirements?

Let’s first review the tax impact of de-registering a Canadian RRSP before becoming a U.S. tax resident. As a resident of Canada, distributions from an RRSP are be subject to ordinary income tax rates depending on the province of tax residency. The bank or custodian holding the RRSP would be obligated to withhold tax upon the RRSP distribution at the following rates:

Withdrawal Amount % Federal Tax Withheld
From $0 to $5,000 10% (5% in Quebec)
From $5,001 to $15,000 20% (10% in Quebec)
Greater than $15,000 30% (15% in Quebec)

The withholding tax rates above would only be applied for those individuals who would still be considered tax residents of Canada. If one were to become a U.S. tax resident or non-resident of Canada, the Canadian withholding tax imposed on distributions would be 25%. Under Article XVIII(2) of the Canada-U.S. Tax Treaty, distributions from RRSPs/RRIFs can be reduced to 15% under certain and very specific guidelines. This would generally only be the case if one was to convert their RRSP to a RRIF and take periodic distributions from the RRIF. Under the Canada-U.S. Tax Treaty, this would include payments out of a RRIF where the total amount paid in the current year does not exceed twice the “minimum amount” and 10% of the value of the RRIF at the beginning of the tax year. The “minimum amount” is determined by a percentage factor based on the RRIF holder’s age at the beginning of the tax year.

Some Canadian financial advisors and individuals believe that the above table of withholding tax rates would be applied irrespective of Canadian and U.S. tax residency, which is incorrect. If the departure planning is done properly, then the Canadian institution should have the correct U.S. address on record and the tax residency indicated as a non-resident of Canada. This would generally be acknowledged by the bank or custodian via the completion of CRA Form NR301 and IRS W-9 form at the time the account becomes tagged as a non-resident of Canada account. Therefore, a 25% Canadian withholding tax would apply for lump-sum distributions.

If the individual or advisor still maintains a Canadian address on the account while claiming to no longer be a tax resident of Canada, they are opening themselves up for a number of issues. For example, the ability of an advisor to properly and legally manage registered accounts can be problematic, and so can the indication to CRA that Canadian residency is maintained (though the use of a Canadian address) when a previously filed Canadian tax return indicates a date of departure from Canada.

In some unique situations, former residents of Canada might be able to file a Canadian income tax return as a non-resident under Section 217. Filing a return under this election allows a non-resident to file a Canadian tax return if it would be beneficial for them to do so. In this case, the non-resident taxpayer would be able to claim the same deductions and credits as that of a traditional Canadian taxpayer. There are limited reasons for a non-resident to make this election. One reason is when an individual has a non-working spouse in the U.S. with, for example, $50,000 in their RRSP. In this case, the individual could withdraw the RRSP tax free over five  years without paying any Canadian income tax. Conversely, if the non-working spouse withdrew the $50,000 in a lump sum, there would be a 25% withholding tax imposed at the time of distribution.

As part of our comprehensive wealth management process, and based on our clients’ specific financial planning objectives, we can provide an RRSP distribution analysis to review the options available and the related Canada and U.S. income tax results. Further, because we manage our investment and retirement accounts on a Canada/U.S. tax-effective basis (we understand tax!), we can ensure that withholding tax paid in Canada can be recovered over time through proper portfolio and tax management.