Hello, everyone! This is Mohammad Akif of Akif CPA. I am a Texas CPA. I’m also a chartered accountant in Ontario and today we’ll be discussing what is the equivalent on the American side of a Canadian RRSP account and also comparing those accounts with the RRSP in terms of deductions, contribution limits, carry forward options, withdrawal options, and how retirement works with each of these.
So, let’s first talk about the equivalency, meaning that we know what an RRSP is an how it works, so what is similar on the U.S. side?
RRSP, of course, is a retirement account designed for tax-free growth and claiming tax purposes. All the contributions you make and any growth when you see good returns in the accounts also grow pre-tax. You only pay taxes at the time of withdrawal.
On the U.S. side, in terms of equivalency, we have a couple of options:
- IRA – available to anyone (not the Roth IRA. That’s important to remember)
- Solo 401(k) – for self employed individuals
- Group 401(k) – offered through your employer, sometimes with a contribution match
The IRA and the 401(k)s are also similar in that you can have tax-free contributions, meaning that this is money that you haven’t paid taxes on and you will not pay taxes on the growth in them. You pay taxes when you withdraw and take distributions.
So, the equivalency is of the group RRSP on the Canadian side is the American IRA, Solo 401(k), or Group 401(k) through your employer.
Comparison: RRSP vs. IRA and 401(k)
Let’s compare the RRSP account versus the IRA account or the 401(k) account.
The RRSP contribution amounts are based on the earnings that you have on the previous year. There’s a room that’s calculated by the CRA. You will have that limit on your notice and it will tell you how much contribution limit you have from previous year combined with the current year. So, in terms of the RRSP contribution amounts, these are from year to year based on your earnings and the contribution limits do carry forward.
That’s one big difference between the RRSP and the IRA and 401k account.
Contribution Allowances, Limitations, and Differences
With the RRSP, any room in the contribution you don’t take in one year rolls over to the next year, where you can contribute any amount you didn’t use in th previous year. So, in a year, you could be making a $10,000 contribution the other you could be making $50,000 contribution if you have room.
The IRAs, however, do have limitations in terms of maximum contribution amounts you can make in a year, and if you do not use all of that contribution room, you cannot make up for it. For the IRA, there are also income limits based on how you are filing—single, married filing single, or married filing jointly.
401(k)s are usually run by an employer. So, if you are an employee earning W2 wages, you will likely have a 401(k) option through your employer. You will have a higher contribution limit than with the IRA—typically $10-20,000 per year more depending on your income limits, so that’s one big difference. And, contributions made to a 401(k) are tax deductible, and the growth is also tax-free. Since contributions are tax-deductible, these will lower your taxable income.
From year-to-year, any amount in the contribution limit for an IRA or 401(k) that does not get used does not carry forward into the next year. Where you might be used to having room with your RRSP, yearly contributions in the U.S. are a use it or lose it situation. (There are catch up contribution allowances for those who meet certain age requirements).
Withdrawal Allowances, Limitations, and Differences
The U.S. has an early withdrawal penalty if you withdraw money from your IRA or 401(k) before age 59 and 1/2. That is a 10% penalty on top of the federal taxes or the state taxes.
On the Canadian side, where you will just pay our regular ordinary income tax based on the vital amount that you have taken out, that is not the case. But, be aware that there are early withdrawal penalties if you are under 59 and 1/2 in age. This is a 10% penalty plus the federal taxes on the withdrawal amount. So, it can get expensive.
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