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Personal Finance Across Borders I – Retirement Accounts

Something that I would like to learn more about is how personal finance issues work in the U.S.  For example, how do their retirement 401k and roth IRA/traditional IRA systems work?    How do they compare to an RRSP and TFSA?  How about their mortgages and real estate system? 

With the help of The Money Writers, Generation X Finance in particular, I was able to put something together in comparing retirement accounts across the border.  This is part 1 of perhaps many posts about the personal finance comparison between the giant neighboring countries.

I think that the best way to represent the comparison is through a table matrix.  That way, we can see how their benefits/downfalls compare side by side. 

The contenders for Canada are:  RRSPs and TFSA's.  For the U.S, we have the 401k, Roth IRA and Traditional IRA.

  RRSP TFSA 401k Roth IRA Traditional IRA
Contributions Pre Tax? Yes  No  Yes  No Yes 
Contribution Limit 18% of prev yrs earned income. Max $20k for 2008. $5k / year   $15.5k / yr with $5k extra when > 50 yrs old $5k with $1k extra > 50 yrs old  $5k with $1k extra > 50 yrs old
Withdrawal Age Anytime  Anytime  >59.5 yrs old or additional 10% tax levied. Anytime*  >59.5 yrs old or additional 10% tax levied.
Mandatory Withdrawal Age 71 None  70.5  70.5  70.5 
Tax on Withdrawal Taxed as income  None  Taxed as Income, 10% penalty for early withdrawal. None* Taxed as Income, 10% penalty for early withdrawal.
Tax Free Growth? Yes  Yes Yes  Yes  Yes 
Option to be self directed in discount brokerage? Yes Yes? No** Yes Yes

*  Withdrawals from a Roth IRA have a few stipulations.  Contributions can be withdrawn at anytime without any penalties or tax.  The growth on the contributions however, must be in the account for at least 5 years AND the account holder must be older than 59.5 yrs in order for the withdrawals to be tax free.  They can also be withdrawn for qualifying purchases like first home purchase or disability.

** Generally speaking, you can't place a 401k account under a self directed discount brokerage like E*Trade.  However, there are some situations where some of the 401k money can be placed in a self directed account.

By the looks of the table, it seems that our RRSP system is very similar to the 401k, and the TFSA is the same idea as the Roth IRA.  The traditional IRA though is a hybrid between an RRSP and TFSA.  I may be biased, but it looks to me that Canadian retirement accounts have a slight advantage over our friends south of the border.  Their mortgage/real estate tax system however, seems to have a big advantage over Canada.  This will be discussed in another article.

Note that this article is the bare bones basics of all the accounts listed above as there were a substantial amount of details that were not included.

Photo credit: PinkMoose

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 20 comments… add one }
  • Four Pillars May 8, 2008, 7:46 am

    Good stuff.

    For the record I have three part series on the same topic (just so you don’t think I’m copying you). :) I compare RRSP to 401k, Roth IRA to TFSA and RESP to 529.

    The Canadian retirement system is simpler and more flexible. Personally I like more flexibility but some people probably benefit from things like the 10% penalty for early 401k withdrawal since it might make them less likely to dip into their 401k.

    Mike

  • Cannon_fodder May 8, 2008, 9:03 am

    I believe that the advantage of deducting mortgage interest in the US actually inflates the housing prices.

    What we have seen in North America is as interest rates rise, housing affordability goes down. It slows down, and even reverses, the rise in housing prices.

    If on July 1 the government immediately implemented the ability to deduct mortgage interest, that would make housing affordable to a group of Canadians that otherwise could not and in turn put more expensive homes within the reach of current homeowners. The demand would go up and so would the prices. Eventually, in my opinion, equilibrium would be reached and the net result would be similar affordability rates that we see today meaning the house prices would rise commensurately.

    • FrugalTrader May 8, 2008, 9:23 am

      Great point CF, imagine the home prices in Vancouver if mortgages were automatically tax deductible. :)
      On the other hand, there are some states that have very low average housing prices. For example, i’ve read that texas has an average home price in the $130’s. Low housing prices in addition to a tax ded mortgage = gold.

  • Dividendgrowth May 8, 2008, 11:33 am

    WOw, the canadian system is indeed more flexible.. So if I start contributing to a retirement account at the age of 15 from my high-school job and I am lucky enough to have invested before a strong bull market, I could retire by the time I graduate from college in Canada..

  • Telly May 8, 2008, 12:35 pm

    One pretty substantial difference between an RRSP and a 401k that I think you might want to add is that, in Canada, our RRSP contribution limits carry over. In the US 401k, it’s use it or lose it. I think that’s partially the reason that Americans tend to use their 401k’s to a much larger extent than Canadian use an RRSP.

    Also, wrt to cannon-fodder’s comment, although mortgage deductibility is available to all home owners in the US, a large number of home owners in the lower to middle income range do not take the deduction as the standard deduction is more beneficial. It’s really the higher earners that benefit most from the mortgage deductibility issue (and they generally have the larger mortgages). So while I agree that mortgage interest deductibility would “put more expensive homes within the reach of current homeowners”, it may not necessarily “make housing affordable to a group of Canadians that otherwise could not” although I’m not sure how Canada would treat this (as we do not use a “standard deduction” and we also do not file jointly for spouses).

  • Telly May 8, 2008, 12:39 pm

    Also, I don’t know the exact details, but I do believe there is a way to access 401k money prior to age 70.5 without penalty (besides borrowing, buying a home, etc). It seems if you withdraw it in smaller increments you can avoid the 10% penalty but again, I don’t have all the details on this. Perhaps one of your US readers can fill us in.

  • FrugalTrader May 8, 2008, 1:25 pm

    Telly, some excellent points. So as a Canadian working in the U.S, do you have a 401k account? If so, how does that work with Canadian taxation?

  • Telly May 8, 2008, 1:49 pm

    Yes, I have both a 401k and an RRSP account. Up until this year, any contributions I made to my 401k were taxable as income in Canada (not in the US), but from what I understand (and it hasn’t been cleared up entirely), the amendments to the US – Canada Tax Treaty indicate that any contributions I make to a 401k will be tax deferred in Canada as well. Growth has always been deferred.

    I’m a big fan of the 401k as the mutual funds options in my plan are great (including Vanguard index funds) and the fees are significantly lower than comparable funds or even ETFs in Canada. I also have a trading account which I am able to keep 50% of all 401k money in (the others have to remain in select but good funds). I do own some individual US stocks in that account and don’t have to worry about taxation.

    I keep all our US holdings in the 401k (in USD) and our Canadian holdings in my and my husbands RRSPs (CAD) so it works out rather well. International holdings are spread out between the two in both currencies.

    Wow…not sure if you wanted all that info but there you have it! :)

    • FrugalTrader May 8, 2008, 1:57 pm

      Telly, I was under the impression that under most circumstances, 401k money cannot be placed into a self directed brokerage account. Do you have special circumstances? Or is this common?

  • Telly May 8, 2008, 3:49 pm

    I’m not sure how common it is but, in my particular plan, 50% of my 401k can be tranferred to a self-directed brokerage. A friend of mine that also commutes to work in the US is allowed to keep his entire 401k in a self-directed account (and does). For me, I believe there was a $100 fee to set up the account and trading fees are $12.95.

    Again, I’m not sure how common it is but it’s likley dependent on the particular company you work for rather than any special circumstances. Just like in Canada, some companies have better defined contribution plans, pensions, etc than others.

  • Paolo May 8, 2008, 5:27 pm

    Note that the RRSP contribution limit is reduced by the prior year’s pensions adjustment too. So your contribution limit is also affected by hom much went into your pension plan. Good point by Telly about carrying forward your limits.

  • Finance Monk May 8, 2008, 10:32 pm

    There’s a new option that’s starting to gain acceptance in the US – Roth 401ks.

    They’re like 401ks but are fully taxable at the beginning, but are never taxed again (grow tax free and withdrawals are tax free). My company started offering it last month. The same deposit limits (15,500/20,500) apply as a traditional 401k and unfortunately the limits are for both combined.

    Unfortunately most companies have pretty limited, high-fee choices in their 401k banks… but whenever you switch jobs you can transfer your entire balance to a self-directed brokerage (like vanguard). So there’s more freedom than it appears initially.

  • Gates VP May 11, 2008, 2:36 am

    Hey FT;

    Thanks for the great run-down. I moved to the US in January, so I now have an RRSP and 401k (amongst a small mess of other accounts) and I’m still learning the details. Right now my company matches 25% up to 6% of gross. So I just invested the 6% for the match and I put other money into the savings until I get to sit down with an accountant and figure out the details (like how much income tax I’ll be paying the Canadian government next year).

    My personal preference is for the Canadian RRSP system (and the Canadian Tax system). The 401k was really just a piece of tax law that was added for a few large US companies with lobbying budgets. As companies dropped pension plans and discovered 401ks there was a mass rush, but the rules around the 401k were never designed for the role they’re currently serving. Throw in IRA and the Roth IRA and the Roth 401k and it’s really just a mess.

    I honestly believe that they should just get rid of the 401k move to a model more like the RRSP/TFSA and the people I’ve spoken with seem to agree. The system is not user-friendly.

    Then again, I’m not looking forward to tax-time either. You know how taxes are pretty simple in Canada? You start on page 1, fill in the little boxes and add up the numbers. If a Canadian accountant told me that he could save me an extra $400 on my return, I’d call BS, b/c there’s not really much there.

    Well, by all accounts, this is not the case in the US. You have two options here: standard deductions (i.e.: return equal to last year’s averages, fill in income and taxes paid, your check is in the mail) or itemized. Anecdotal comparisons between my tax return experience and those of the “itemizers” seem to be pretty grim. Here, if somebody tells you they can save you $400 on your return, they actually mean it. Just keep your receipts.

    *sigh* tax time is going to be “fun”!

  • Tom May 14, 2008, 12:13 am

    Just a thought for maybe a future article: I read about that when you retire, if you move your principal residence to the USA, your RRSP withdrawals are only taxed at 25%.. if this is true, you could hit your desired retirement age, move to the ‘states, then withdraw your entire RRSP as a lump sum, then a couple years later move back to Canada with your entire amount now outside your RRSP tax free (with the exception of 25%), and still qualify for CPP, OAS -> all those government goodies.. Am I missing something here, or is this something that people consider doing? If anything, it could at least shave a few years off before you retire if you planned it properly..

  • DAvid May 14, 2008, 1:29 am

    Seems an expensive way to try to avoid a few dollars in taxes. You could withdraw some $80,000 of income from an RSP before crossing the 25% tax rate. With that income, you’d likely not see much OAS…..

    I’d look for other ways to reduce taxes, such as investing in appropriate dividend paying stocks or similar.

    DAvid

  • Telly May 14, 2008, 9:15 am

    DAvid makes a good point. Also, moving your principal residence to the US does not make you a non-resident of Canada. You must break ties to Canada, which means no universal health care and the loss various other privledges (and quite honestly, with the cost of US health care, you may just break even or worse on this deal).

    One last thing, becoming a US resident is not an easy task and is something I would not rely on just to save a few bucks.

  • Telly May 14, 2008, 9:20 am

    Gates VP,

    There’s a great board for info on US / Canadian taxes that I’ve found VERY useful (I file both my US and Canadian taxes on my own). You might want to check it out as it’s actually most useful during “down” times. A fellow that goes by “nelsona” is really knowledgeable in this area but be sure to read over old posts 1st…he can get kind of grouchy when questions are repeated. :)

    http://forums.serbinski.com/viewforum.php?f=2&sid=b118410ee5bf3bfa438116d3a8fe30bb

  • Four Pillars May 14, 2008, 9:45 am

    I think Tom’s idea would be more expensive for most people. Assuming you only withdraw reasonable amounts from your rrsp each year (which most people do), your average tax rate will probably be less than 25%.

    Mike

  • ATL Canadian October 18, 2008, 2:32 am

    1. There is no mandatory withdrawal age for Roth IRAs.
    2. Rule 72(t) allows early distributions of retirement funds via at least 5 “substantially equal periodic payments”.
    3. In Canada, the Smith Manoeuvre is used to simulate the tax deductibility of loan interest available for US mortgages.

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