RESPs and TFSAs for US Citizens Living in Canada

Are TFSAs and RESPs US Tax Traps? 

The headlines tell us (Canadian residents over the age of 18) why we should contribute to a Tax-Free Savings Account (TFSA) every year. They also tell us how to support a child’s future education by opening a Registered Education Savings Plan (RESP).

As attractive as TFSAs and RESPs are for Canadian residents, they may not be beneficial for a US person (US citizen or green card holder) living in Canada.

What is the Tax Treatment?

Unlike RRSPs and RRIFs, there are no provisions in the Canada-US Income Tax Treaty that recognize the tax-exempt status of a TFSA or tax-deferred status of an RESP.

While funds held in a TFSA are not taxable on withdrawal (in Canada or the US), the benefit of earning tax-free income in Canada is lost to a US person as the income is taxed annually in the US.

When a US person opens a RESP, the income earned within the plan must be reported on the subscriber’s annual US tax return even where the plan is for the benefit of a child who may not be a US person. When the funds are withdrawn by the Canadian-resident beneficiary to fund post-secondary education, the income earned within the plan becomes taxable in Canada to the beneficiary, resulting in double taxation.

What are the True Costs?

TFSAs and RESPs are likely characterized as trusts for US tax purposes, which creates annual US reporting requirements (i.e. Form 3520, “Annual Return to Report Transactions with Foreign Trusts and Receipt of Foreign Gifts”, and Form 3520-A, “Annual Information Return of a Foreign Trust”). Penalties of up to US$10,000 per year may apply for non-compliance with the US filing requirements.

When the US tax on income earned within a TFSA or RESP is added to annual plan fees and Form 3520 and 3520-A preparation costs, the costs can often exceed the earnings within the plan.

US persons with a TFSA may consider closing the account and transferring the assets to a non-registered account, if the US income tax and administrative costs of filing exceed earnings in the account. An RESP may be transferred to a non-US spouse or grandparent.

Contact your DMCL advisor about your circumstances and to understand the tax impact of owning these plans.