Canadian and US Retirement Accounts –
Navigating US Retirement Accounts as a Canadian
Retirement accounts are an
incentive to enable workers to put money aside and plan ahead for their
retirement whilst at the same time allowing for a lower tax bracket and some
flexibility. In this article, I will discuss the Canadian System and the
American System, highlighting the benefits of each.
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by master1305 on Freepik
Canadian System
The Canadian system has mainly
two funds, the Registered Retirement Savings Plan [RRSP] and Tax-Free Savings
Account [TFSA], each providing different benefits and levels of flexibility.
RRSP
The RRSP is a retirement account
where a percentage of your salary is put aside using pre-tax money into this
account. Currently, the maximum annual RRSP contribution for 2023 is $31,560 CAD. The employer at times
matches this amount and it is a good rule of thumb to match the highest your
employer would match you. This action results in lowering your overall tax
bracket for the year. For example, if you make $80,000 CAD a year and you
contribute 5% to your RRSP; that means your new total salary is $76,000 CAD
which will be taxed.
Early Withdrawal Penalty
Withdrawals without penalty at
maturation start at the age of 71. Early withdrawals have bracketed penalties:
·
Withdrawal
$5,000 CAD- $10,000 CAD à
10% Penalty (5% in Quebec)
·
Withdrawal
$5,0001 CAD - $15,000 CAD à
20% Penalty (10% in Quebec)
·
Withdrawal
over $15,000 CAD à
30% Penalty (15% in Quebec)
·
Withdrawals
for non-residents of Canada à
25% Penalty.
It should be noted that using
that money causes you to lose that contribution room.
Retirement
At the point you reach the age of
71 (end of that calendar year), you have access to the money and can make
withdrawals that are taxed at income but a much lesser tax bracket. There are different methods to withdrawing
the cash. It is best to sit with a
financial advisor prior to making a decision.
HBO and RRSP
The Home Buyer’s Plan [HBO]
is a program offered by the government of Canada that allows you to withdraw up
to $35,000 ($70,000 for a couple) from the RRSP Tax-Free in the year of
withdrawal to buy a house. This amount will help Canadians put a down-payment
on a house and for HBO qualification, must be spent within 90 days of
withdrawal. You have 15 years to pay back this loan, in addition to the annual
contribution you choose to make.
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by wirestock on Freepik
TFSA
As for the TFSA, this is a magical flexible account that allows you to invest
post-tax dollars and allow them to compound over time. In other words, you
cannot get a tax deductible with this account. However, any money you make over
this will not be taxed and you have the luxury of using this cash for any
purpose at any time. The maximum annual contribution for 2023 is $6,500.
What happens if you have contributed once you
have ceased being a Canadian Resident (The date you moved out of the country)?
|
Year 2022 |
|||
|
Month |
Status |
Amount |
Amount Taxed |
|
April |
Left the country |
||
|
May |
No Contributions |
||
|
June |
Contributed amount |
$500 |
$505.00 |
|
July |
No Contributions |
$505.00 |
$510.05 |
|
August |
No Contributions |
$510.05 |
$515.15 |
|
September |
No Contributions |
$515.15 |
$520.30 |
|
October |
No Contributions |
$520.30 |
$525.51 |
|
November |
No Contributions |
$525.51 |
$530.76 |
|
December |
500 removed |
($500.00) |
$30.76 |
|
Amount Owed as Taxes |
$30.76 |
||
To avoid further complications, remove that cash from your funds and fill RC-243
and RC-243 Schedule B for that tax year. Please note some banks
have automatic contributions from your chequing account to your retirement fund
to remove the monthly rebate fee so make sure to call and cancel automatic
deposits.
The table below shows a summary
comparison between Canadian Registered Retirement Account (RRSP) and Canadian
Tax-Free Savings Account (TFSA):
|
|
RRSP |
|
Max Annual Contribution |
$31,560 CAD for 2023 |
|
Fund Roll-Over |
If
you change employers, fund can be moved to another RRSP |
|
Maturity Age |
71 |
|
Home Buyer’s Plan |
Can
withdraw up to $35,000 CAD ($70,000 CAD if couple) that must be paid back
within 15 years. |
|
Leave Employer |
Nothing changes. RRSP is a
non-owned employer account |
|
|
TFSA |
|
Max Annual Contribution |
$6,500 for year 2023 |
|
Flexibility |
Can
access at any time for any reason. No penalties |
US Retirement Funds
IRA, Roth IRA and 401K are
retirement funds you can use to plan ahead for retirement. They differ slightly
with different perks which are important to understand to know where is the
best bang for your buck.
401K
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401K is a workplace retirement
plan that deducts a portion of your salary pre-tax and sets it aside for future
investments. This amount is usually matched by the employer either a full match
or a partial match and some are vested contributions. Vested means you get the
employer’s contribution upon completing an assigned work duration with the
company. The maximum annual contribution for 2023 is $22,500 for those under
age 50, with an additional $7,500 for those aged 50 or older.
This action of putting money
aside allows you to reduce your overall taxes by taxing you at a lower income
bracket, similar to the RRSP account explained earlier. At the age of 59.5 or
if you became disabled or unable to work, you are able to start withdrawing the
cash penalty free. If you try to withdraw this cash prior to reaching this age
or conditions set, a 10% penalty tax will be applied to the amount. There are
exceptions to the rule, such as taking a loan against your 401k.
Penalty-free Exemptions:
You are able to take a loan from your 401K penalty-free for the following exemptions:
·
Down-payment
for a first homebuyer only
·
You owe the
Internal Revenue Service (IRS)
·
Permanent
Disability
·
Active Duty
·
Court-ordered
withdrawal to pay previous spouse or dependent
·
Medical debt
that outweighs a percentage of your AGI (Adjusted Gross Income)
Taking a Loan against your 401K
Similar to an RRSP, one can choose to take a loan from their 401K, up to 50% of its value. The maximum amount allowed is $50,000. The perk here is this does not affect one’s credit score or disqualify you from getting a mortgage. However, this amount is tax and penalty-exempt and needs to be paid back with interest. Not only that, but you are unable to make pre-tax contributions until you pay back in full the loan amount in post-tax money – depending on your plan. In the meantime, you are paying post-tax money that will be taxed again at retirement and losing on any 401K employer match contributions. It should also be noted that the interest paid back does not make up for the compound interest gains from the withdrawn cash.
This method is best used for
smaller loans with a short-turn around.
401K repayments are generally
completed within 5 years. Please note that not all 401K plan sponsors offer
loans within the 401K fund.
What happens if you leave your employer?
Should you leave your employer,
you have to pay back the outstanding amount quicker than the 5-year plan
outlined above. You have until the due date of their federal income tax return
to pay it back in full with interest. Otherwise, the remaining amount will be
subject to taxable disbursement and penalties for those under 59.5 years old.
What is a Hardship
Withdrawal Instead?
If you are making a decent-size
withdrawal for a house purchase, you can do a hardship withdrawal instead. This
will incur income tax and a 10% penalty for any amount greater than $10,000.
Roth IRA
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Roth IRA is post-tax
contributions that are allowed to grow and be withdrawn tax-free until
retirement. You can withdraw this money at the time you are 59.5 years old and
the account has been active for 5 years. For 2023, contribution are at $6,500
for those under 50 years old and $7,500 for those 50 years or older.
Should you access the grown funds
prior to reaching 59.5 years or the 5-year rule, you will be paying income tax
and a 10% penalty. This is known as Non-Qualified Roth Distributions. However,
the originally contributed amount (post-tax) can be withdrawn at any time
tax-free since it has already been taxed. Any profit accrued to it will be
taxed with a penalty if taken out early.
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by rawpixel.comon Freepik
Once the 5-year period is
satisfied, earnings can be taken out after exhausting the original
contributions. Qualified Roth Distributions include the following:
Penalty-free and tax-free:
·
Buying a
House/ Remodelling/ Renovating
[LK1] A total of $10,000
(lifetime limit) can be taken out tax-free and penalty-free for a first time
homebuyer. This term is loosely defined as someone who has not owned a
principal residence within the last 3 years from the purchase date.
·
Permanent
disability
·
Made by a
beneficiary or your estate after your death
Penalty-free
·
Unreimbursed
Medical Bills
o
Should your
medical bills be greater than 7.5% of your adjusted gross income (AGI),
·
Health
Insurance Premiums
o
In the case
of unemployment, paying health care premiums can be challenging. The IRS allows
funds to be taken out tax-free and penalty-free!
·
Permanent
Disability
·
Inherited
Roth IRAs
·
Education
o
Education
nowadays is as expensive as ever. You can tap into Tapping into your ROTH IRA
reserve can be done for educational purposes for yourself, your offspring or
grandson/granddaughter whilst avoiding the 10% penalty fee. These include
tuition, books, supplies and room and board.
The table below summarizes Roth
IRA Withdrawal Rules:
|
Age |
5 Year Rule Met? |
Taxes and Penalties
on Withdrawals |
Qualified Exceptions |
|
59 ½ or older |
Y |
Tax-free and penalty-free. |
N/A |
|
N |
Penalty-free but Taxed on earnings |
N/A |
|
|
Younger than 59 ½ |
Y |
Tax and 10% penalty on earnings. |
· First-time home
purchase |
|
·
Made to a beneficiary or your estate after your death |
|||
|
· Due to a disability |
|||
|
N |
Tax and 10% penalty on earnings. |
·
First-time home purchase |
|
|
· Unreimbursed medical
bills |
|||
|
·
Health insurance premiums while unemployed |
|||
|
· Due to a disability |
|||
|
·
Qualified education expenses |
|||
|
· Childbirth or
adoption expenses |
Roth 401
This is similar to a Roth IRA in regards to terms, except its contribution is only deducted from your salary where the employer can match that contribution. This can be rolled-over to a normal Roth IRA and qualifies under the start date for the 5-year rule for Roth IRA, explained under Roth IRA.
The table below shows a summary
comparison between US Employer Matched 401K and US Roth IRA:
|
|
401K |
|
Max Annual Contribution |
$22,500 for those under age
50 / An additional $7,500 for those aged 50 or older. |
|
Fund Roll-Over |
401K
is a type of fund created for Employer’s match. It must be rolled over to
another employer’s 401K or rolled over to an IRA |
|
Maturity Age |
59.5 or disabled/unable to
work |
|
Home Buyer’s Plan |
Can
withdraw up to $50,000 or 50% of 401K amount, whichever is less |
|
Leave Employer |
Must pay back remainder
amount before tax filing season or may incur taxation and penalty |
|
|
Roth IRA/ Roth 401K |
|
Max Annual Contribution |
$6,500 for those under age
50 / $7,500 for those aged 50 or older. |
|
Flexibility |
·
Can
only access contributions without penalty. ·
Any
investments cannot be accessed without penalty and taxes. ·
There
is a 5-Year Rule. Eligible expenses can be used to withdraw the money without
penalty such as first-time home buyer, medical expenses etc.. |
The table below shows a summary comparison between Canadian Registered
Retirement Account (RRSP), US Employer Matched 401K, Canadian Tax-Free Savings
Account (TFSA) and US Roth IRA:
|
|
RRSP |
401K |
|
Max Annual Contribution |
$31,560 CAD for 2023 |
$22,500 for those under age
50 / An additional $7,500 for those aged 50 or older. |
|
Fund Roll-Over |
If
you change employers, fund can be moved to another RRSP |
401K
is a type of fund created for Employer’s match. It must be rolled over to
another employer’s 401K or rolled over to an IRA |
|
Maturity Age |
71 |
59.5 or disabled/unable to
work |
|
Home Buyer’s Plan |
Can
withdraw up to $35,000 CAD ($70,000 CAD if couple) that must be paid back
within 15 years. |
Can
withdraw up to $50,000 or 50% of 401K amount, whichever is less |
|
Leave Employer |
Nothing changes. RRSP is a
non-owned employer account |
Must pay back remainder
amount before tax filing season or may incur taxation and penalty |
|
|
TFSA |
Roth IRA/ Roth 401K |
|
Max Annual Contribution |
$6,500 for year 2023 |
$6,500 for those under age
50 / $7,500 for those aged 50 or older. |
|
Flexibility |
Can
access at any time for any reason. No penalties |
·
Can
only access contributions without penalty. ·
Any
investments cannot be accessed without penalty and taxes. ·
There
is a 5-Year Rule. Eligible expenses can be used to withdraw the money without
penalty such as first-time home buyer, medical expenses etc.. |
Please note I am not a financial advisor but a curious inhabitant of the world. Contact a financial advisor for better understanding and best banking practices.
