
Many US tax and financial advisors are recommending that their clients consider converting their traditional individual retirement account (IRA) or other eligible accounts to a Roth IRA (known as a “Roth conversion”). This article looks at the pluses and minuses, the logistics, and the Canadian tax implications.
First: An overview of US tax treatment
A traditional IRA in the US is similar to an RRSP in Canada in that contributions are tax-deductible, earnings accumulate tax-free, and distributions are fully taxable in the year withdrawn. If an individual is under the age of 59½, there may be an additional 10% penalty tax for early withdrawals unless an exception is available. Additionally, distributions must start by April 1 following the year in which an individual turns 72.
By comparison, a Roth IRA is similar to a TFSA in that contributions are not tax-deductible, earnings accumulate tax-free, and contributions can be withdrawn at any time without incurring US tax or penalties. Moreover, an individual can withdraw earnings from the plan tax-free even if they are over the age of 59½ when they do so and if they make the withdrawal no earlier than at least five years after their first contribution to any Roth IRA. There are limits on the amount that can be contributed to the plan each year.
Lastly, a 401(k) plan in the US is similar to an RPP in Canada.
Pros and cons
While a Roth conversion is not for everyone, there are many reasons why an American individual might consider making one. For example, if they:
- Are temporarily in a lower tax bracket;
- Anticipate being in a higher tax bracket during their retirement years as a result of the taxable distributions from their retirement accounts; these distributions, called required minimum distributions or RMDs, are to begin after the individual’s 73rd birthday;
- Want to leave the account to grow tax-free until tax-free withdrawals are made;
- Intend to use the Roth IRA as an estate-planning tool, as Roth IRAs may be passed to beneficiaries tax-free; and/or
- Are looking for a “backdoor” way to contribute to a Roth IRA because their income level otherwise prohibits them from doing so.
The downside of doing a Roth conversion, however, is that amounts withdrawn from a traditional IRA and contributed to a Roth IRA are treated as a taxable distribution and subject to US income tax at the time of withdrawal. Therefore, it is recommended that individuals execute the conversion over several years, as doing it all at once could result in moving them to a higher marginal tax bracket.
Further, if an individual has not reached the age of 59½ at the time of withdrawal and they withdraw funds from the IRA to pay conversion-related taxes, they could potentially face a 10% early withdrawal penalty. Finally, the Roth IRA funds cannot be withdrawn for five years if the taxpayer wants to withdraw the converted funds penalty-free.
How it’s done
Converting all or part of a traditional IRA to a Roth IRA can be accomplished in one of three ways:
- Taking a distribution from a traditional IRA and depositing it into a Roth IRA within 60 days;
- Directing a financial institution to transfer funds from a traditional IRA to a Roth IRA held at the same financial institution; or
- Making a trustee-to-trustee transfer, where a financial institution that holds the traditional IRA is directed to transfer the funds to a Roth IRA at another financial institution.
Whichever of these methods is used, the taxpayer will have to report the conversion1 to the Internal Revenue Service when they file their tax return for the year.
Canadian tax implications
Anyone can convert their IRA to a Roth IRA, but is a Roth conversion recommended for US taxpayers who become residents of Canada?
Once an individual becomes a Canadian tax resident, the income they’ve accrued in a Roth IRA is subject to Canadian income tax annually unless relief is provided under the Canada – United States Convention with Respect to Taxes on Income and on Capital (the “Treaty”). Under the Treaty and Canada’s Income Tax Act (ITA), Canadian residents can enjoy continued tax deferral of their IRA and similar retirement accounts—just as they would if they were still residing in the US—as long as each account is viewed as a pension2 under the Treaty.
Another consideration is the withdrawal of funds. Once funds are withdrawn from an IRA, they will be subject to US income tax and included in income for Canadian tax purposes. However, it may be possible to offset some or all of this US tax in Canada by claiming a foreign tax credit against the Canadian tax payable on the withdrawal.
In accordance with the Treaty, a Roth IRA will qualify as a pension, and Canada will respect the tax deferral of the Roth IRA, provided two conditions are satisfied:
- The taxpayer made the contributions to the Roth IRA while they were a US resident and a non-resident of Canada; and
- The taxpayer files a one-time irrevocable election3 to continue the tax deferral in Canada.
Once an election is made,4 it is valid for the current and all subsequent taxation years. The taxpayer must file the election by the filing due date5 of their personal tax return for the year in which they become a Canadian tax resident.
The Treaty does not protect a Roth IRA from Canadian taxation where a contribution is made to the Roth IRA by or on behalf of an individual while the individual is a resident of Canada (a “Canadian Contribution”). If a Canadian Contribution is made to the Roth IRA, a portion of the Roth IRA will cease to be considered a pension for Treaty purposes,6 as the election will only be valid up to the time of the Canadian Contribution. If a valid election is made, income accrued up to the time of the Canadian Contribution will continue to be eligible for deferral, but all subsequent income earned or accrued in the Roth IRA will be subject to Canadian taxation.
Notably, Canadian tax residents who hold assets outside of Canada may also have foreign reporting obligations;7 however, where an individual has filed a valid Treaty election and has not made a Canadian Contribution, they are not required to file foreign reporting information returns.
It’s also important to note that although both the United States and Canada8 view transfers from a 401(k) plan to an IRA as occurring on a tax-free basis, no such tax-free rollover is available for transfers from an IRA to a Roth IRA. Therefore, if the Roth IRA conversion is done while an individual is a Canadian tax resident, the conversion amount will be subject to US tax and included in Canadian taxable income9 as foreign pension income that is eligible for a foreign tax credit for the US tax paid. This may result in a significantly higher total worldwide tax liability, as Canadian tax rates are higher than US tax rates. For this reason, it is generally recommended that a Roth conversion only be made before an individual becomes a tax resident of Canada.
Final thoughts
Any individual who is considering making a Roth conversion while they’re a tax resident of Canada should consult with a qualified tax advisor first to ensure that they understand the full impact of this strategy.
Lawrence (Larry) Bell, CPA, CA, is a senior manager in tax with the personal advisory services – global mobility and rewards practice of EY in Vancouver.
This article was originally published in the July/August 2025 issue of CPABC in Focus.
Footnotes
1 Conversions are reported on Form 8606: Nondeductible IRAs: Part II; see irs.gov.
2 Treaty Article XVIII:3 defines a pension under the Treaty.
3 Treaty Article XVIII:7.
4 The election is made in the form of a letter, as there is no prescribed form for this election. A separate election needs to be filed for each Roth IRA account owned by the individual.
5 Generally, April 30 of the year following the year in which they become a Canadian tax resident. If this filing deadline is missed, a taxpayer should contact the Canada Revenue Agency’s Competent Authority Services Division, as a late-filed election may be allowed provided no Canadian Contribution has been made.
6 Treaty Article XVIII:3 discusses the impact of Canadian Contributions.
7 Canada’s Form T1135 Foreign Income Verification Statement is required if the cost amount of a taxpayer’s total foreign property exceeds C$100,000.
8 Canada Revenue Agency document no. 2011-0407461E5 (Tax on 401(k) Transfer to IRA and IRA Withdrawal), June 19, 2012. See taxinterpretations.com.
9 ITA subsection 56(12).