Pension and annuity income often form the cornerstone of retirement planning. For individuals with financial ties to both Canada and the United States, such as dual citizens, expatriates, or cross border workers, the tax treatment of this income becomes more complex. Domestic tax rules in each country differ in their characterization and taxation of retirement income, and the Canada-US Tax Treaty, particularly Article XVIII, plays a central role in harmonizing these differences and mitigating double taxation.
This blog post summarizes the US and Canadian domestic tax treatment of pensions and annuities and explains how Article XVIII of the Canada-US Tax Treaty governs the cross border taxation of such income.
US Taxation of Pensions and Annuities
Under the Internal Revenue Code (IRC), US citizens and residents are taxed on their worldwide income, including amounts received from foreign and domestic pensions, annuities, and registered retirement accounts.
Taxation of US Pension and Annuity Income
Most US pension and annuity payments, including those from 401k plans, IRAs, and qualified defined benefit plans, are fully taxable when distributed, provided contributions were previously made on a pre-tax basis. The taxable portion of an annuity is generally computed using the exclusion ratio under IRC §72.
Taxation of Canadian Retirement Accounts
For US tax purposes:
- RRSPs (Registered Retirement Savings Plans) and RRIFs (Registered Retirement Income Funds) are not tax-deferred by default. However, US taxpayers may defer US tax on income accruing within these plans if they make a timely election under Article XVIII(7) of the Treaty (commonly via Form 8891, prior to its obsolescence, or via general Treaty-based disclosure on Form 8833)
- CPP (Canada Pension Plan), OAS (Old Age Security), and private Canadian pensions are typically taxed as ordinary income by the IRS up to a specific percentage based on income level
Unless relief is granted under the Treaty, Canadian annuity income may be subject to full US taxation in the year of receipt.
Canadian Taxation of Pensions and Annuities
Under the Income Tax Act, Canadian residents are taxed on their worldwide income, including US pension and annuity income.
Taxation of Canadian-Sourced Pensions
Income from RRIFs, RPPs (Registered Pension Plans), OAS, and CPP/QPP is fully included in taxable income, with some exceptions (e.g. pension income splitting between spouses for residents over 65).
Annuities are generally taxed based on either:
- Prescribed annuity treatment (where a portion of each payment is considered a return of capital), or
- Accrual basis for certain deferred annuities
Taxation of US Retirement Income
US-sourced pension income (e.g. Social Security, 401k, IRA distributions) is also fully included in income for Canadian tax purposes. However, Canadian tax law allows for:
- Foreign tax credits to reduce double taxation
- Special Treaty relief on US Social Security benefits, and
- Reporting deferrals for US plans where applicable (e.g. 401k growth pre-distribution)
Article XVIII of the Canada-US Tax Treaty: Pensions and Annuities
Article XVIII of the Treaty specifically allocates taxing rights between Canada and the US on pensions, annuities, and social security benefits. The goal is to determine which country gest the primary taxing right and how the non-source country should treat the income.
Paragraph 1 – Pensions and Annuities
Subject to other provisions, pensions and annuities are taxable only in the country of residence of the recipient. For example, a Canadian resident receiving a 401k distribution is taxed only in Canada, not in the US. Similarly, a US resident receiving a Canadian RRIF payment is taxed only in the US.
However, this rule applies only if the pension is not considered social security-type income, and provided it qualifies as a ‘pension’ or ‘annuity’ under Treaty definitions.
Paragraph 2 – Social Security Benefits
Payments under the social security legislation of one country (e.g. US Social Security or Canada’s CPP/OAS) are taxable only in the country of residence, with specific limits.
- US Social Security benefits received by a Canadian resident are only 85% taxable in Canada, mimicking the US domestic inclusion rate
- Canadian CPP/OAS received by a US resident is taxable only in the US, per Article XVIII(2)
Paragraph 3 – Lump Sum Pensions
Canada reserves the right to apply special rules to lump-sum payments from Canadian pension plans. These lump-sum payments may be taxed differently from periodic payments and are subject to Part XIII withholding tax, unless reduced by Treaty provisions.
Paragraph 5 – RRSPs and Similar Plans
This paragraph permits a US resident to defer tax on income accruing inside a Canadian RRSP, RRIF, or similar plan, provided they:
- Were a resident of Canada when the contributions were made;
- Elected to defer US taxation;
- Reported the plan under required disclosure provisions (e.g. Form 8938, FBAR)
Note that, as of 2014, Form 8891 is no longer required, but deferral is still allowed if the taxpayer complies with current disclosure requirements.
Foreign Tax Credits and Coordination
In both countries, foreign tax credits (FTCs) are essential tools for avoiding double taxation when income is taxed in both jurisdictions due to non-Treaty scenarios and hybrid tax treatments.
For example, a Canadian resident taxed on US IRA distributions may use US withholding tax to claim a foreign tax credit in Canada. A US resident taxed on Canadian RRIF income may use Canadian withholding tax to offset US federal tax due, provided the income is not exempt under the Treaty.
Practical Considerations
Withholding Tax Implications
While the Treaty may assign exclusive taxing rights, domestic withholding obligations still apply in practice unless reduced or exempted by Treaty claim filings (e.g. IRS Form W-8BEN for Canadians or NR301/NR302 in Canada).
Reporting Complexity
Cross border pension recipients must navigate complex reporting obligations:
- US citizens in Canada: Forms 8938, 114, 8833, and 1040
- Canadians in the US: Canadian T1 returns, Form T1135, and coordination of foreign tax credits
Pension Splitting and Estate Considerations
Canada allows limited pension income splitting between spouses aged 65 or older, potentially reducing tax liability. US tax law does not permit this. Moreover, differing estate taxation rules may impact the after-tax value of pension plans passed to heirs.
Conclusion: Align Retirement Income with Tax Residency and Treaty Protections
Pension and annuity income can create substantial complexity in a cross border context. While Article XVIII of the Canada-US Tax Treaty provides important safeguards against double taxation and unwarranted withholding, its benefits are only available when properly understood and claimed.
Taxpayers who split time between countries, hold retirement accounts abroad, or are receiving benefits from foreign sources should consult with a cross border financial planner to:
- Confirm the proper tax treatment under domestic and Treaty law
- File required elections and disclosures
- Coordinate the use of foreign tax credits and leverage excess foreign tax credits, and
- Maximize the efficiency of retirement income streams