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Cross-border issues complicate financial planning
In Quebec, Paul, who is 44, and, Marianne, 42, have built their careers on art.
Their lives are those of creative people who struggle with the art of complying with the taxes of two countries, for Paul is a U.S. citizen, resident in Canada for a decade. A tenured professor of sculpture, he brings home $4,800 a month. Marianne, a self-employed painter and Canadian citizen, has a fluctuating take-home income of $1,800 a month. “We are lucky to have a comfortable life, smart enough to know that we should be able to continue it if we can just plan correctly, and dumb enough not to be able to do it,” Marianne says.
We are lucky to have a comfortable life, smart enough to know that we should be able to continue it if we can just plan correctly, and dumb enough not to be able to do it
Family Finance asked financial planner Caroline Nalbantoglu, head of CNal Financial Planning in Montreal, to work with Paul and Marianne.
“The issue is how they can be smart with their savings,” the planner says. “There are a lot of complications, however. Paul, as a U.S. citizen, must report income to the Internal Revenue Service and bank accounts to the U.S. Treasury.
But there are ways we can help them to comply with U.S. rules and build family assets.”
They should begin by eliminating irrational allocations.
They have $64,000 in cash earning almost nothing which could pay down a $14,338 line of credit that costs them 4% interest a year secured by their fully paid house.
Then, given that they have invested very little in their children’s RESPs, which have a current balance of $3,847, they can make use of the 20% Canada Education Savings Grant and the 10% Quebec education grant, both on the first $2,500 of annual contributions. They have the saving capacity to make a $5,000 contribution for each child for the next couple of years, the planner says.
Paul and Marianne will be able to fill RESP space for their two children, ages 8 and 4, and capture the grants. Thereafter, they can contribute $2,500 a year to each child’s RESP until age 18. If they begin to make catchup contributions of $10,000 a year this year and next, $7,500 in year 3 and $5,000 a year thereafter, by the time the elder child is ready for university, each child should have $66,000 for university.
That’s assuming a 3% annual return after inflation and full contributions of the lesser of $500 per child per year or 20% of contributions from the Canada Education Savings Grant plus half that again from the Quebec Education Saving Grant. Annual contributions will not be subject to U.S. gift tax rules, the planner says.
Most residents of Canada can use tax-free savings accounts but U.S. tax law does not accord the same treatment, that is, elimination of tax while money is in the accounts. Paul cannot use a TFSA as efficiently as Marianne. She can make use of a TFSA and should do so, Ms. Nalbantoglu says.
Paul can expect a defined-benefit pension from his university. He can contribute and have a higher pension at retirement or not contribute and have more RRSP room. The difference is the pension adjustment, a tax rule that ensures that those with company pension plans do not get to double their pension contributions.
If Paul starts contributing to his pension plan, his annual payout at age 65 would be $92,793. If he remains in the non-contributory plan, however, his age 65 pension would be $56,830 a year. The present value of the difference, using a 5% discount rate and a life expectancy of 85, is $448,178. Paul would have to save that much to make up the difference.
If Paul were to remain in the current non-contributory plan and have $12,000 in RRSP room every year and to fill that space from now to age 65 and if he were to obtain a 5% return, he would accumulate $428,630. The difference over two decades is relatively small. But he would be the manager of the RRSP and could lose as well as gain.
The higher DB plan at age 65 is guaranteed and Paul will not have to worry about outliving his assets. Moreover, pension plans have competent management and much lower fees than mutual funds.
Taking the pension plan route, which is probably best in his case, Paul will have to pony up $500 a month to the plan via a payroll contribution.
Paul has an individual retirement account in the U.S. with a balance of $36,950. He would like to transfer the account to Canada, but that is not easily done. He should seek advice from a tax specialist or just leave the money in the IRA, then take it after age 59½ without penalty, Ms. Nalbantoglu suggests.
At retirement, the couple can count on Paul’s Quebec Pension Plan benefit of about $8,288 a year, $56,830 from his employer’s pension plan based on current salary, $5,580 from what will be $186,000 of various registered and non-registered investments, including Paul’s U.S.
IRA, all growing at 3% a year after inflation and, at age 67, two OAS benefits, $6,540 a year for Marianne and $5,428 for Paul, who will have been a resident of Canada for 33 years out of the 40 required for full benefits.
The total, $82,666 a year, would rise with salary increases that Paul may receive. With pension splitting and an average 20% income tax, the couple will have $5,511 a month to spend, a little more than their present spending net of savings. All figures are in 2012 dollars.
“There is no easy way out of cross-border complications,” Ms. Nalbantoglu says. “Paul’s strategy has to be compliance. But Marianne can make most investments free of U.S. complexities.”