Moving to Canada and unsure about your 529 plan? Our expert blog offers valuable guidance for your transition. For U.S. tax purposes, the earnings accumulate tax-free within the 529 plan and distributions are excluded from income as long as the proceeds are used to pay for qualified higher education and thanks to the Tax Cuts & Jobs Act (TCJA) of 2017, private school for grades K-12 now also qualify.
Unfortunately, Canada Revenue Agency (CRA) does not grant the same tax-favored status to the 529 plan. For Canadian tax purposes the income earned, such as interest, dividends and realized capital gains, in the 529 plan is taxed annually, whether or not the proceeds are used to pay for qualified expenses. Thus, the 529 plan loses its appeal for future Canadian residents.
What Are the Available Options?
The options with respect to the 529 plan include keeping the account with the existing custodian and declaring the investment income each year to CRA, transferring the account to a US family member who does not plan to move to Canada, liquidating the 529 plan and paying the applicable taxes and 10% penalty or thanks to the recent changes effective 2024, potentially transferring some of the funds to a Roth IRA.
Did You Know You Can Potentially Transfer Funds From the 529 Plan to a Roth IRA?
That’s right, you can transfer up to $35,000 per beneficiary from the 529 plan to a Roth IRA without income tax or the 10% penalty! This is a great opportunity for many clients, however certain conditions must be met. In order to qualify, the 529 plan must be at least 15 years old, and the transfer cannot exceed the amount contributed plus earnings more than five years before the transfer. As a result, new contributions to the 529 plan made within the previous five years are not eligible to be moved. In addition, the rollover is limited to the Roth IRA annual contribution limit, however the AGI limit is waived. If you do qualify, you will benefit from having a Roth IRA in Canada, as CRA will grant the same tax-free status to the Roth IRA provided you file an initial election with your Canadian tax return in the first year that you establish residency and avoid making subsequent contributions to the Roth IRA account.
Can I Withdraw Funds From the 529 Plan to Pay for Canadian Universities or K-12?
Many Canadian universities qualify as eligible institutions for U.S. tax purposes, allowing for tax-free and penalty-free withdrawals. As mentioned earlier, the tax free status does not apply to Canada, as for Canadian tax purposes the 529 plan is a regular brokerage account. However, the 529 plan receives a step-up in basis in Canada, equal to the account’s fair market value converted in Canadian currency on the date the account holder establishes residency in Canada. Therefore, while income is taxed in Canada, capital gains would differ because the cost basis varies between Canada and the U.S., generally being lower in Canada due to the step up in basis. There is a $10,000 limit per student for grades K-12. Whether Canadian private schools are considered qualified expenses remains uncertain. No specific guidance has been provided on this topic, and most 529 plan custodians are unable to address this question.Â
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