Author: John McCord CFP® CIM®, CRPC®, TEP, Vice President, PortfolIo Manager, Partner, Cardinal Point Wealth Management
The strong U.S. dollar has presented new challenges for individuals and families relocating from Canada to the United States. As many know, the Canadian dollar has remained relatively stable for nearly a decade. It’s now valued at .73 against the U.S. dollar. This stands in contrast to the summer of 2014 when it reached a high of .94.
In the past, when the currency values were closely aligned, many individuals planning a move to the U.S. opted to convert their bank and non-registered taxable investment accounts to U.S. dollars. After all, it's typically prudent to hold a meaningful amount of local currency within one’s country of residency. In addition, transferring funds to the U.S. often simplifies tax and foreign account reporting. Doing so can also enhance investment options, tax efficiency and financial planning.
However, the current exchange rate of the Canadian dollar presents complications, as many people are hesitant to convert their funds at such a significant discount to the U.S. dollar. There are three basic options available to those who prefer not to convert their Canadian dollar taxable investment accounts to U.S. dollars.
Option 1: Leave your Canadian investment accounts in Canada.
Most Canadian financial advisors are not authorized to provide investment and financial planning advice to U.S. residents. A financial advisor must always be licensed in the jurisdiction where a client resides, irrespective of their citizenship status or the location of their assets. Therefore, upon becoming a U.S. resident, updating your mailing address to your new U.S. address will likely result in one of three scenarios:
Your advisor may inform you that they are no longer able to provide investment advisory services to you and that you must work with someone in the U.S.
Your advisor may explain that you can maintain your accounts on their Canadian platform, but they will be frozen, and no further trading or rebalancing can occur.
Your advisor may clarify that they are registered in the United States and can continue overseeing all investment management services for your accounts.
It's important to reiterate that most Canadian advisors are not registered in the United States, making options 1 and 2 the most likely scenarios. If your advisor fits the third scenario, ensure that their services and expertise extend beyond merely providing investment management.
The following considerations are important for those who choose to leave Canadian non-registered accounts in Canada.
Drawbacks of Canadian Funds:
Canadian-traded mutual funds are typically not registered for sale to U.S. residents. Furthermore, Canadian traded mutual funds and ETFs are likely categorized as Passive Foreign Investment Companies or PFICs, subjecting their earnings and dividends to the highest marginal tax rates on U.S. income tax returns. Holding these securities can also lead to additional and more costly U.S. tax filing requirements.
Accounting Hurdles:
Canadian custodians have a reputation for doing a poor job of complying with U.S. tax reporting requirements. For example, many do not prepare and submit annual U.S. 1099 tax reports showing dividends, interest, and long term versus short term capital gains. That noted, 1099 reports are required by law if you are a U.S. resident. Furthermore, many of the tax reporting forms Canadian custodians provide to U.S. resident clients are denominated in Canadian dollars. That means that you or your accountant must convert all taxable and reportable transactions to U.S. dollars before filing your U.S. tax returns. This additional work can increase the likelihood of errors and lead to significantly more time consuming and expensive accounting and tax preparation.
The Conversion Window:
If converting your funds to U.S. dollars once the exchange rate improves is still your goal, make sure your investment strategy is flexible enough to accommodate a future currency conversion. For example, you don’t want to be locked into investment products that must be held for a certain period of time. If they are locked when exchange rates improve, you may miss the opportunity to take advantage and convert because your funds aren’t accessible. Also, it’s important that your investment accounts are not allocated within volatile or speculative securities that are subject to sharp market swings. It would be unfortunate if exchange rates become attractive but the value of your Canadian dollar investment holdings are significantly lower due to poor market performance and downside volatility.
Tax-Aware Investing:
Make sure your advisor is managing your accounts under an investment mandate that reflects your U.S. tax residency. As previously mentioned, U.S. residents are subject to long-term and short-term capital gains tax rates. If you sell an asset that has been held for one year or less, any profit is considered a short-term capital gain, and is taxed at your ordinary income rate which is up to 40.8%. If you sell an asset held longer than one year, any profit will be considered to be a long-term capital gain and is typically taxed at the considerably lower rates of 15% or 20%. But in Canada, there is no such thing as long-term or short-term capital gains. Canada has just one capital gains rate, and most Canadian portfolio managers are trained to oversee client accounts while applying that rate. Also, there are different types of investment securities, such as Canadian preferred shares, that are often attractive investments from a Canadian tax standpoint but not from a U.S. tax standpoint. It’s sensible for tax residents of the U.S. to invest in securities that distribute qualified dividends that are taxed at a more favorable rate than ordinary dividends. For these reasons and others, it’s in your best interest to confirm that a Canadian money manager or advisor has deep experience in working with U.S. tax residents. It is also important to understand whether they can strategically manage portfolios and be compliant with U.S. tax rules.
Reporting Requirements:
As a U.S. resident, you will be subjected to extra foreign account reporting requirements by the Internal Revenue Service. The accounts that you leave behind are domiciled outside of the United States and the IRS may require you to report specific information about them on a form called the FinCEN Report 114. Additionally, you may have to file an IRS Form 8938 called the Statement of Specified Foreign Financial Assets as part of your Form 1040 filing. These increased reporting requirements are time consuming and will likely lead to substantially higher tax preparation costs.
Leaving Canadian dollar taxable or non-registered accounts in Canada can be viable under limited scenarios for U.S. residents, but it's far from ideal considering the issues above.
Option 2: Move your Canadian Investment Account to the U.S.
Moving your Canadian dollar investment accounts to the United States will simplify financial and estate planning initiatives and often streamlines U.S. tax reporting. However, you will still face challenges. For one, most U.S. based financial advisors will automatically want you to convert your Canadian dollar accounts to U.S. dollar accounts, which obviously contradicts your goal of maintaining your holdings in Canadian dollars. The main reason why U.S. based advisors make this recommendation is that their firm, or its custodian, does not offer multi-currency accounts. The U.S. dollar is the only currency option that they can provide for your investments. It’s rare for U.S. investment firms to offer Canadian dollar denominated accounts because there is little demand for them in the United States.
Another critical consideration is that investment advisors who do offer multi-currency accounts may not know the Canadian investment market well enough to construct a proper investment portfolio. The act of opening a Canadian dollar denominated account for a client is possible in limited circumstances. That noted, it’s quite a different matter for a financial advisor or portfolio manager to have the knowledge, experience, and extensive training necessary to build and oversee Canadian investment portfolios that include Canadian traded securities.
All too often, clients are left holding their Canadian dollar investment accounts in cash, simply because they cannot find a qualified financial professional based in the United States to expertly invest those assets.
Option 3: Partner with an experienced and properly registered Canada-U.S. Cross-Border Advisor
The sophistication of financial planning is enhanced when cross-border complexities are present. Individuals and families with cross-border requirements should review their situation with a multidisciplinary team who has access to a platform with which to address their unique needs. For example, when moving to, and or living in the United States, there are often a host of cross-border planning hurdles to work through. A true cross-border advisor will help construct an integrated Canada-U.S. cross-border financial plan that addresses issues such as tax and estate planning in addition to the management of investment assets.
It’s critically important to align yourself with a firm that is comprised of seasoned professionals who have earned both Canadian and U.S. credentials and designations. These include but aren’t limited to Canadian CFPs, U.S. CFPs, Canadian CPAs, U.S. CPAs, and Chartered Financial Analysts licensed in both Canada and the U.S.
For the above reasons, the optimal solution is to partner with a legally registered advisor that can provide investment management and financial planning services in both Canada and the United States, without any restrictions or limitations. Doing so integrates investment accounts in both countries, helps provide compliant U.S. tax reporting on Canadian-dollar investment assets, allows for multi-currency investment accounts, helps facilitate foreign exchange, and includes comprehensive cross-border investment, tax, retirement, and estate planning expertise. This is the only structure that truly caters to Canadians and Americans navigating Canadian and U.S. cross-border complexities.
Cardinal Point is legally registered to provide investment management and financial planning services in both Canada and the United States, without any restrictions or limitations. For clients who have investment accounts in both countries (RRSPs, IRAs, 401ks, Trusts, Non-Registered accounts, etc.), we construct integrated cross-border portfolios customized to each investor’s personal risk tolerance, needs, and goals. Please contact Cardinal Point to discuss your cross-border investment management, tax, retirement, and other financial planning needs. For more information, please visit www.cardinalpointwealth.com.
John McCord, CFP®, CIM®, CRPC®, TEP, Vice President, Portfolio Manager, Partner, Cardinal Point Wealth Management, Orange County, California.