US Taxation of Canadian Pension

US Taxation of Canadian Pension

US Taxation of Canadian Pension Plans

US Taxation of Canadian Pension Plans: There are various different types of pension plans in Canada. Like many foreign countries, the Canadian Pension system is a 3-Pillar system. There is the government portion, the employment portion and personal investment portion.

Some of the common pension plans, include:

  • CPP: Canadian Pension Plan
  • RPP: Registered Pension Plan
  • RRSP: Registered Retirement Savings Plan
  • RRIF: Registered Retirement Investment Fund (Post-RRSP)

We will summarize the different types of tax treatment of pension plans from Canada.

With the IRS taking an aggressive position on matters involving offshore account compliance and unreported foreign income — understanding the reporting and tax protocols are crucial.

Here is an introduction to the US Taxation of Canadian Pension.

Pillar 1 Canadian Government

Canada Pension Plan (CPP)

In Canada, the CPP is most similar to social security. In accordance with the World Bank Pillar system, CPP is the Pillar administered by the government. It comprises one portion of the Pillar 1 system and is based on the employment/employer contributions similar to U.S. social security. The Pillar 1 also includes:

  • Old Age Security Program (OAS)
  • Guaranteed Income Supplement Program (GIS)
  • Guaranteed Annual Income System (GAINS)

Pillar 2 Employment Pension

The 2nd Pillar refers to employment-pension. The most common is the Registered Pension Plan.

RRP (Registered Pension Plan)

The Registered Pension Plan is an employer/employee pension plan. These types of pension plans are “Registered” with the CRA — Canadian Revenue Agency. Both the employer and the employee can deduct contributions and the growth is tax deferred. There are two classification of RPP, which are Defined Benefit and Money Purchase RPPs.

While the RRP is similar to the RRSP in name, the main difference is that the RRSP are individual retirement plans, while the RPP is an employer plan.

*It also includes employment RRSP and DFSP.

Pillar 3 Individual/Personal Pension

The 3rd Pillar does not require an employer. Rather, it is a personal pension — similar in part to an IRA and 401K.

The main type of investment under Pillar 3 is the RRSP. Since the RRSP is the key component to most retirement plans, we will focus heavily on the RRSP.

What is an RRSP?

An RRSP is a retirement vehicle that is very similar to the U.S. 401K.

Just like a 401K in the U.S., the money you deposit into the Canadian RRSP is pre-taxed and grows tax-free until it is withdrawn.

The goal of the RRSP is the same as the 401K, which is to defer the tax now, during the working years, with the goal of the contributions growing tax-free. Then, when the investment is distributed to the beneficiary at the time of retirement, it is (presumably) taxed at a lower progressive tax rate.

One main difference between the 401K and the RRSP is that the RRSP does not carry the automatic 10% penalty for early withdrawal. The fact that the withdrawal rules for an RRSP are more relaxed had previously impacted how the IRS treated the growth within the fund — and required the annual filing of Form 8891 (see below).

In addition, there are different carry-over rules for unused contribution limits for the RRSP than there are for the 401K.

RRSP US Taxation Rules

In general, the RRSP works similar to the 401K.

Many Canadian & U.S. dual-citizens or permanent residents from Canada (aka U.S. Persons) have an RRSP, and therefore have a U.S. tax and IRS reporting responsibility for their RRSP.

While the IRS has increased enforcement of foreign accounts compliance and unreported foreign income, when it comes to the  RRSP, the IRS has relaxed the rules involving RRSP.

We will summarize the general foreign pension tax rules in accordance with U.S. Canadian Tax Treaty, and reporting rules.

RRSP Under the US/Canada Tax Treaty

When it comes to pensions (and the RRSP is considered a pension), Article 18 of the treaty, provides:

Article 18, Paragraph 1

Pensions and annuities arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State, but the amount of any pension included in income for the purposes of taxation in that other State shall not exceed the amount that would be included in the first-mentioned State if the recipient were a resident thereof.”

What does this Mean?

It means that a U.S. Person with a Canadian RRSP, and who resides in the U.S. may be taxed in the U.S. on the Canadian RRSP, but the amount of pension that is included on the U.S. tax return for tax purposes cannot exceed the amount that would have been includable in Canada.

With a caveat:

“However:

(a) Pensions may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if a resident of the other Contracting State is the beneficial owner of a periodic pension payment, the tax so charged shall not exceed 15 per cent of the gross amount of such payment; and

(b) Annuities may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if a resident of the other Contracting State is the beneficial owner of an annuity payment, the tax so charged shall not exceed 15 per cent of the portion of such payment that is liable to tax in the first-mentioned State.”

Canada May Also Tax the Pension

Pursuant to the above-referenced paragraph, Canada can still tax the pension, but, the total tax rate cannot exceed 15% — so presumably, the U.S. person who paid tax in the U.S. on their RRSP would have a foreign tax credit to apply back to Canada on those taxes.

Article 18, Paragraph 5 Social Security

Social Security is Treated Differently than Pension:

“Pursuant to Paragraph 5, Benefits under the social security legislation in a Contracting State paid to a resident of the other Contracting State or a citizen of the United States shall be taxable only in the first-mentioned State.”

Can U.S. Tax Canadian Social Security?

No.

Unlike the pension, which is generally taxable in the State of residence, Social Security is only taxable in the contracting state (aka the state where the pension was earned). Thus, Canada has t the right to tax a U.S. person with a Canadian Social Security, even if they live in the U.S.

RRSP & Totalization Agreement Treatment

The Totalization Agreement is designed to avoid duplicate social security contributions, but since Canada has its own social security, the RRSP payments do not apply, and are instead covered under the bilateral tax treaty.

For example, if a U.S. Person is employed in Canada, then it would not be fair to require social security payments to both the U.S. and Canada. Not all countries have a totalization agreement. The U.S. has entered into less than 30 totalization agreements worldwide.

As provided by the U.S. and Canadian Totalization Agreement:

“An agreement effective August 1, 1984, between the United States and Canada improves Social Security protection for people who work or have worked in both countries. It also helps protect the benefit rights of people who have earned Canadian Social Security credits based on residence and/or contributions in Canada.”

While you work––If your work is covered by both the U.S. and Canadian Social Security systems, you (and your employer, if you are employed) would normally have to pay Social Security taxes to both countries for the same work. However, the agreement eliminates this double coverage so you pay taxes to only one system (see the section on “Coverage and Social Security taxes” section).

When you apply for benefits––You may have some Social Security credits in both the United States and Canada but not have enough to be eligible for benefits in one country or the other. The agreement makes it easier to qualify for benefits by letting you add together your Social Security credits in both countries. For more details, see the section on”Monthly benefits.”

*Windfall provisions and the totalization agreement may overall impact social security.

Deducting RRSP Payments on a U.S. Tax Return

When a U.S. person pays into RRSP, they may be able to deduct those payments from the table income on their U.S. tax return, if they meet the requirements as established in the 2007 protocol.

2007 Protocol for RRSP

“Contributions made to, or benefits accrued under, a qualifying retirement plan in a Contracting State by or on behalf of an individual who is a resident of the other Contracting State shall be deductible or excludible in computing the individual’s taxable income in that other State, where:

(a) The individual performs services as an employee in the first mentioned state the remuneration from which is taxable in that State and is borne by an employer who is a resident of that State or by a permanent establishment which the employer has in that State; and

(b) The contributions and benefits are attributable to those services and are made or accrued during the period in which the individual performs those services.

This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in the first-mentioned State.”

Paragraph 12 further clarifies:

“For the purposes of United States taxation, the benefits granted under paragraph 10 shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension or retirement plan or other retirement arrangement established in and recognized for tax purposes by the United States, contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of the individual shall be treated as contributions or benefits under a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.”

Form 8891 

Up until 2012, a U.S. person with an RRSP had to make an annual election to avoid immediate taxation of the RRSP growth within the RRSP fund.

The U.S. and Canadian Treaty, Article 29, Paragraph 5 provides:

“A beneficiary of a Canadian registered retirement savings plan may elect, under rules established by the competent authority of the United States, to defer United States taxation with respect to any income accrued in the plan but not distributed by the plan, until such time as a distribution is made from such plan, or any plan substituted therefor.

The provisions of the preceding sentence shall not apply to income which is reasonably attributable to contributions made to the plan by the beneficiary while he was not a resident of Canada.”

Form 8891 was discontinued in 2015, with no retroactivity filing requirement.

RRIF (Registered Retirement Investment Fund)

An RRIF is a Registered Retirement Investment Fund.

It is essentially an add-on or extension of the RRSP. At age 71 the RRSP must close and the owner of the RRSP must take action. Generally, the individual can either take the cash, receive distributions as an annuity or partial annuity, or transfer the money to the RRIF.

Once the money is in an RRIF, no further contributions can be taken, but only minimal distributions must be taken.

Therefore, the RRIF can continue to grow.

TFSA (Tax Free Savings Account)

A TFSA is not a “registered account” and does not receive any tax deferred treatment in the U.S.

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