This article was originally published on Feburary 4 2020 by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc.
In an article published in early December, we discussed the inevitability of death and taxes and complications that can arise when a Canadian resident who holds a U.S. individual retirement account (IRA) passes away. In particular, we looked at the tax-treatment options available to a Canadian resident who is a beneficiary of this IRA.
To recap, the least punitive option is to have the IRA account legally transferred to the Canadian beneficiary within the required timeline. Payments made to the beneficiary are subject to a 15 per cent U.S. withholding tax and must be reported on their Canadian income tax return. Any Canadian taxes can be offset by claiming the U.S. withholding tax as a foreign tax credit.
As of last November, this legal transfer made it possible to “stretch” the IRA payments over a long period of time. For example, if a child was the beneficiary, the IRA could be extended over many years since the payments would be calculated based on the projected lifetime of the beneficiary. stretching payments depletes the IRA at a slower rate and allows more time for the balance to grow on a tax-deferred basis.
On Dec. 20, 2019, U.S. President Donald Trump signed into law the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The purported intention of the SECURE Act is to provide greater access to tax-advantaged accounts and decrease the chances of outliving one’s assets.
For example, the law makes it easier for small businesses to provide retirement plans to their employees (including part-time employees). In addition, the requirement to start taking distributions from an IRA at age 70.5 has been pushed to 72 and IRA contributions can continue to be made in any year that income has been earned regardless of age. Under the prior law, contributions could not be made past the age of 70.5.
Unfortunately, ringing in this new Act means a sad farewell to the stretch provisions on IRAs and 401(k)s. Effective Jan. 1, the maximum time period for distributions to non-spousal beneficiaries is now limited to 10 years after the death of the original account holder. Removing this provision will result in larger payments and higher taxes for the beneficiary.
There are some exceptions to the 10-year rule:
- Spousal and disabled or chronically ill beneficiaries are exempt.
- Beneficiaries who are less than 10 years older than the deceased are exempt.
- Beneficiaries who are minor children of the original account owner can continue to receive payments based on their life expectancy until they reach the age of majority. At the age of majority, the account must be paid out in full within the 10-year period.
Whether or not the beneficiary meets criteria for an exemption, it is critical to plan both the timing and amount of distributions in order to minimize taxes paid on IRA distributions. If the IRA is inherited by a beneficiary who is in a high-income tax bracket in Canada, the IRA distribution will also be taxed at that high bracket. Also, for beneficiaries not currently in a high tax bracket, large IRA distributions may push them into one, further disrupting prior tax planning.
Canadian resident IRA beneficiaries have additional considerations around whether or not to draw funds directly from the IRA or roll them into a Canadian RRSP. Unlike IRAs, which cannot be split between spouses, RRSP distributions can be split and may result in tax savings if this lowers the tax
brackets for both spouses.
If you are a professional adviser to someone who owns or is the designated beneficiary of an IRA account, it is important to review tax planning with your client to ensure that the implications of the SECURE Act don’t adversely affect retirement income. This is particularly important when an IRA is left to a Canadian beneficiary, as there is limited time to act in the beneficiary’s best interest.
Under this new Act, there is homework to do in determining the optimal method for withdrawing funds and leaving beneficiaries truly secure. Death and taxes may be inevitable, but financially burdening one’s heirs doesn’t have to be.
This is part two of a two-part series. Read part one: Dying in Canada when owning a U.S. individual retirement account.
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