You’ve worked hard for your retirement income. If you’ve decided to retire in Canada and are approaching the age of 71, you may find that a bit of year end tax planning may save you a lot.
What is an RRSP?
A Canadian Registered Retirement Savings Plan (RRSP) is a Canadian government-approved way of allowing Canadians to save for retirement on a tax deferred basis. It’s very similar to a U.S. Individual Retirement Account (IRA).
RRSP Benefits
Saving in an RRSP for retirement is generally a good thing. It’s one of the few instances in which you get to “have your cake and eat it too!” How? When you make an eligible contribution to an RRSP, you get the benefit of an immediate tax deduction on your Canadian income tax return. In addition, the assets held in an RRSP continue to grow tax free, until you hit the mandatory withdrawal age. Failed to contribute to an RRSP one year? No worries, the contribution room and even the deduction limit can be used in a subsequent year.
Tips for Canadians in Retirement
Because RRSPs are merely a method of deferring and not avoiding taxes altogether, it’s important to plan for withdrawals. If you do nothing to your RRSP by the end of the year you reach the mandatory withdrawal age of 71, you would have effectively cancelled or removed the “tax-shield” protecting your hard-earned funds.
From the beginning of the year after the year you turn 71, the fair market value of the assets in your RRSP are included on your income tax return as taxable income. If you’ve grown an RRSP over, say 40 years, including that amount in taxable income in a single year could significantly diminish your retirement savings.
RRSP Options in Retirement
To avoid a big tax hit on your Canadian return, consider these options:
- Contribute some, or all of your RRSP to a Registered Retirement Income Fund (RRIF) or Life Income Fund (LIF). This will allow you to defer taxes on all or a portion of your RRSP balance.
- Assess the benefits of pension income splitting up to half of the RRSP income with your spouse. This may allow you to lower your effective tax rate and your final tax bill.
- Make your contributions to your RRSP by December 31 of the year you turn 71. This may allow you to maintain the tax deferred status of some additional earnings if the RRSP is later converted to a RRIF or LIF.
- If you have unused RRSP contribution room or earned income in a previous year, you may continue to contribute to your spouse’s RRSP until the year they turn 71. This will allow you to continue to defer tax on some of your family’s earnings.
RRSPs on a U.S. Tax Return
Unlike Canadian Tax-Free Savings Accounts (TFSAs) and Registered Education Savings Plans (RESPs), a Canadian RRSP generally enjoys the same tax-deferred status on a U.S. income tax return.
But don’t relax just yet! While it may be possible to defer paying U.S. taxes on a Canadian RRSP, the U.S. reporting requirements are unavoidable. The U.S. requires a number of information returns to be filed by U.S. filers if account balances exceed certain thresholds. So while you may not need to pay tax on some of that income in the U.S., to avoid a hefty fine, it is important that U.S. filers carefully consider their Foreign Bank Account Reporting (FBAR) and Financial Account Tax Compliance Act (FATCA) obligations.
Planning a Move to the U.S.?
If you are planning a move to the U.S., RRSP planning is also beneficial. Two features of an RRSP suggest that maximizing contributions prior leaving Canada may be beneficial. The amounts eligible to be contributed to an RRSP is based on the “earned income” in a previous year. As such, you may have RRSP contribution room in your departure year. Because the amounts held in an RRSP are generally tax deferred in both Canada and the U.S., it may be beneficial to maximize your contributions to your RRSP before you leave.
Got US tax and Canadian tax compliance issues? Contact Cross-Border Financial Professional Corporation – When Perspectives Matter!
Karlene J. Mulraine, EA, CPA, CA, CPA (NH) is the President of Cross-Border Financial Professional Corporation. Follow us on Linkedin and Twitter, or hang out on Facebook.
The views expressed in this article are those of the author and should not be relied on to make decisions. Consider discussing your specific circumstances with an appropriate specialist.