Taking the Commuted Value of a Canadian Pension Before Moving to the US: The LIRA, the Excess, and the Treaty

Canadians leaving a defined benefit pension plan before retirement can usually choose between a deferred monthly pension and a lump-sum commuted value. For someone moving to the US, the commuted value looks attractive: take the money, transfer it to a locked-in account, and manage it from the US. The mechanics are more involved. Only part of the commuted value can be transferred tax-free, the locked-in account has its own rules, and the US side has to treat the transfer as a rollover rather than a distribution.

Key takeaways

• The commuted value can be transferred to a locked-in retirement account (LIRA or locked-in RRSP) tax-free only up to the maximum transfer value set by the Income Tax Regulations; the excess is paid in cash and fully taxable in Canada in the year received.
• If you are still a Canadian resident when the transfer happens, the excess is taxed at your marginal rate. If you have already become a non-resident, it is subject to 25% Part XIII withholding as a lump-sum pension payment.
• Under the treaty, a LIRA is treated like an RRSP: US tax on the growth is deferred under Article XVIII, and the transfer from the pension plan to the LIRA is a rollover, not a US taxable event.
• Most provinces allow a non-resident to unlock a LIRA in full after two years of non-residence, on CRA confirmation of non-resident status; the unlocked withdrawal is a lump sum subject to 25% Canadian withholding and US tax with a foreign tax credit.
• Periodic payments from a LIF (the payout vehicle) qualify for the treaty's 15% withholding rate within the periodic limit.

The commuted value transfer

When a member leaves a defined benefit plan, the plan calculates the lump-sum present value of the accrued pension. The Income Tax Regulations cap the amount that can be transferred tax-free to a LIRA based on the member's age and the annual pension amount. In a low-interest-rate environment commuted values are large and the excess over the cap can be substantial, sometimes a third of the total.

The excess is paid in cash and is fully taxable. If the member has RRSP contribution room, part of the excess can be sheltered by contributing it to an RRSP. Timing matters: excess paid while the member is still a Canadian resident is taxed at marginal rates on the T1; excess paid after departure is a lump-sum pension payment to a non-resident subject to 25% Part XIII withholding, and it is also US-taxable if the member is a US resident when it is received.

The US treatment

The treaty's Article XVIII and the IRS's administrative position (Rev. Proc. 2014-55) treat Canadian registered retirement plans, including LIRAs and locked-in RRSPs, as eligible for deferral of US tax on the accrued income until distribution. The transfer of commuted value from the pension plan to the LIRA is a plan-to-plan rollover and is not a US taxable event. The cash excess is different: if received after the member has become a US resident, it is a pension distribution taxable in the US in the year received, with a foreign tax credit for the Canadian withholding.

The sequencing recommendation follows: complete the commuted value transfer and receive the excess while still a Canadian resident, so the excess is taxed once in Canada at marginal rates and the US has no claim on it.

Unlocking as a non-resident

Pension legislation is provincial (or federal for federally regulated employers), and most jurisdictions permit a LIRA holder who has been a non-resident of Canada for at least two years to unlock the full balance on providing CRA confirmation of non-resident status. The unlocked amount is a lump-sum RRSP withdrawal: 25% Part XIII withholding in Canada, US tax on the full amount with a foreign tax credit, and no further Canadian filing. The alternative is to convert to a LIF and draw periodic payments at the 15% treaty rate.

Worked example

A 52-year-old Ontario engineer leaves a defined benefit plan with a $900,000 commuted value on May 1, moves to Texas on June 30, and has $60,000 of RRSP room.

• Transfer. The maximum transfer value is $620,000; that amount goes to a LIRA tax-free.
• Excess. $280,000 paid in cash on May 15 while still an Ontario resident. $60,000 contributed to the RRSP; $220,000 taxable on the departure-year T1 at marginal rates, roughly $110,000 of tax.
• US. The LIRA is deferred under the treaty. The excess was received before US residency began and is not US taxable.
• Later. After two years in Texas, the engineer can unlock the LIRA (25% Canadian withholding, US tax with FTC) or convert to a LIF and draw periodically at 15%.

Reverse the timing (excess received August 1 after arriving in Texas): 25% Canadian withholding, US tax on $280,000 at up to 37% with a foreign tax credit for the Canadian 25%, and the RRSP contribution is no longer available.

Official sources

"You have to transfer certain payments directly. To make sure that these funds are transferred on a tax-deferred basis, you must ask the payer to transfer the funds directly." — Canada Revenue Agency, Transferring a lump-sum payment, https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/transferring.html

"Pensions may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if a resident of the other Contracting State is the beneficial owner of a periodic pension payment, the tax so charged shall not exceed 15 per cent of the gross amount of such payment." — Canada-United States Tax Convention, Article XVIII(2)(a), https://www.canada.ca/en/department-finance/programs/tax-policy/tax-treaties/country/united-states-america-convention-consolidated-1980-1983-1984-1995-1997.html

Practitioner note

The commuted value decision is a timing decision. The transfer and the excess should be completed while the member is still a Canadian resident, so the excess is taxed once at Canadian marginal rates and the US has no claim. Done after arrival, the same excess is taxed in both countries with a credit that rarely covers it fully.

See also: Planning a move? See the Canada-to-Florida guide and browse every corridor by city, province, and state.

Next step

Fairlight prepares the commuted value analysis, the departure-year Canadian return, and the first-year US return with the LIRA treaty position. See cross-border pricing or book a call.