Canadian Tax Treatment of Roth Individual Retirement Arrangement (Roth IRA)

Introduction To Roth IRA

A Roth Individual Retirement Arrangement (“Roth IRA”) is an individual retirement plan available in the United States. Similar to a Canadian tax-free savings account (TFSA), for US income tax purposes, contributions made to a Roth IRA are not deductible from income but gains and earnings are income tax exempt. There are also no contribution age restrictions or no required minimum distribution for Roth IRAs.

The allowable contribution to a Roth IRA in 2022 is capped at $6,000 US Dollars for those below the age of 50 and $7,000 US Dollars for those above the age of 50. In addition, the contribution room to which an individual is entitled also depends on his or her income in 2022. For example, if you are filing as a single person in the United States and your 2022 income is over $144,000 US Dollars, you cannot make any contributions to your Roth IRA. If you’re making less than that and you’re 45 years old, you will be able to contribute $6,000 US Dollars to your Roth IRA.

Income accrued in a Roth IRA is generally subject to Canadian income tax unless a Canada-US Tax Treaty Article XVIII Election is filed to defer Canadian taxation. If you are a Canadian tax resident who owns a Roth IRA, you should file a Canada-US Tax Treaty Article XVIII Election and avoid making any additional contributions to your Roth IRA after you have become a Canadian tax resident. To plan your contribution to and distribution from your Roth IRAs for tax purposes, please contact our experienced tax lawyers in Toronto.

Legal Characterization

The Canada-US Tax Treaty, formally known as the Convention Between Canada and the United States of America, provides in Article XVIII that a distribution from a Roth IRA to a Canadian tax resident is not taxable in Canada to the extent that the payment would not be taxable if the individual taxpayer were a US tax resident and the Roth IRA qualifies as a pension.

A Canadian tax resident who owns a Roth IRA must determine the legal characterization of his or her Roth IRA and applicability of the Article XVIII election relief. There are three legal characterizations for Roth IRAs: Custodial Account, Trust, Annuity or Endowment Contract. Different legal characterizations may result in different Canadian tax treatments.

Roth IRA Custodial Account

A Roth IRA that is a Custodial Account can be a savings or investment account (other than a trust account) at a financial institution, brokerage firm, or mutual fund company. If you have a Custodial Account Roth IRA, you are considered to own the assets held in your savings or investment account by the custodian. The nature of the income and gains derived from this type of Roth IRAs determines the Canadian income tax treatment. For example, interest paid out by a Roth IRA bank account on a monthly basis will be taxable in Canada pursuant to paragraph 12(1)(c) of the Income Tax Act.

Roth IRA Trust

If your Roth IRA is a trust, the Canadian Revenue Agency (CRA) would generally expect that it qualifies as an exempt foreign trust, pursuant to subsection 94 (1) of the Income Tax Act. In such case, assuming that you are the sole beneficiary, you will be required to include the trust’s foreign accrual property income in taxable income. However, the taxation of a Roth IRA is based on relevant facts and the CRA may find it to be a non-resident trust and subject it to full Canadian taxation.

Roth IRA Annuity Or Endowment Contract

An Annuity Contract is a written agreement between an insurance company and an individual to provide the beneficiary of the contract a lifelong income. An Endowment Contract is a similar type of agreement that is designed to pay a lump sum on maturity to the beneficiary. The taxation in Canada of such Roth IRAs is specific to the terms of the particular contract. You should consult with our experienced Canadian tax lawyers to determine how your Roth IRAs will be taxed.

Article XVIII Election

Canadian tax residents cannot transfer a Roth IRA to a Registered Retirement Savings Plan (RRSP) or a Tax Free Saving Account (TFSA). Instead, the Canada-US Tax Treaty allows Canadian tax residents to file a one-time irrevocable election for each Roth IRA that they own. The election allows taxpayers to defer taxation in Canada for any accrued but undistributed income in a Roth IRA. Consequently, a distribution from a Roth IRA to a Canadian tax resident is not taxable in Canada to the extent that the Roth IRA qualifies as a pension and the payment would not have been taxable in the United States if the individual is a US resident.

The Canada-US Tax Treaty Article XVIII Election should be filed on or before a taxpayer’s income tax filing due date for the year he or she becomes a Canadian tax resident. Once an election is made, there is no requirement to make subsequent elections for following tax years.

Avoiding Canadian Contribution

After an individual has become a Canadian tax resident, any additional contributions made to his or her Roth IRA directly or indirectly will be considered a Canadian Contribution. Effectively, a Canadian Contribution splits a Roth IRA into two parts. The first part, consisting of the balance in the Roth IRA before any Canadian Contribution has bene made, will continue to be considered a pension and remain tax exempt in Canada. The second part, including all income accrued in the Roth IRA after Canadian Contribution, will be subject to Canadian taxation.

Pro Tax Tips – Minimize Your Tax Obligations!

It is important to stop contributing to your Roth IRA after you have become a Canadian tax resident. Otherwise, proportional to your Canadian Contribution, part of the Roth IRA will be subject to Canadian Income Tax when it is distributed. Additionally, you should take the opportunity to file the Article XVIII election to defer your taxes.

For more advice on Roth IRA Tax Treatment, contact our expert Canadian tax lawyers.

FAQ

Will The Distributions From My Roth IRAs Be Taxable In Canada?

Whether the distributions from your Roth IRAs will be taxable in Canada depends on two factors: legal characterization of your Roth IRAs and contribution made after you have become a Canadian tax resident. If your Roth IRAs distributions would not be taxed in the US if you were a US tax resident, then it is unlikely to be taxable in Canada. However, any contributions made to your Roth IRAs after you’ve become a Canadian tax resident will make the distribution from your Roth IRAs partly taxable.

Do I Need To Close My Roth IRAs To Minimize My Tax Obligations?

To minimize your tax obligations, you do not need to close your Roth IRAs. However, you should avoid making contributions once you’ve become a Canadian tax resident.