Retirement Compensation Arrangement: Cross-Border Tax

A retirement compensation arrangement (RCA) is a plan where a Canadian employer pays money to a custodian to fund an employee’s benefits on retirement, loss of a job, or a substantial change in duties. The employer deducts the contributions, half of every contribution and of the trust’s income goes to the CRA as a refundable tax, and the employee is taxed only on payouts. Crossing the border adds Part XIII withholding on payouts, and for a US citizen, questions the IRS hasn’t settled. It’s one of the plans covered in cross-border retirement planning.

What is a retirement compensation arrangement?

It’s a plan under which an employer, a former employer, or someone not dealing at arm’s length with the employer makes contributions to a custodian in connection with benefits on, after, or in contemplation of an employee’s retirement, loss of office or employment, or a substantial change in services. That’s the definition in ITA 248(1). The custodian usually holds the money in a trust, called an RCA trust.

The definition then excludes a long list of plans that have their own rules: registered pension plans, pooled registered pension plans, deferred profit sharing plans, RRSPs, employee trusts, salary deferral arrangements, insurance policies, and others. One exclusion matters for cross-border files. Paragraph (l) excludes a plan “maintained primarily for the benefit of non-residents in respect of services rendered outside Canada”, and a separate rule pulls part of such a plan back in for Canadian residents, covered below.

The CRA’s RCA guide (T4041) also treats a pension plan the CRA refuses to register as an RCA for contributions made before the refusal.

How is an RCA taxed in Canada?

On three tracks. The employer deducts its contributions under ITA 20(1)(r). Half of each contribution, and half of the trust’s net income and capital gains, is a refundable tax under Part XI.3, refunded at half of every distribution. The employee pays nothing until money comes out, and then includes the full payout in income under ITA 56(1)(x).

The refundable tax is defined in ITA 207.5(1) as 50% of contributions, plus 50% of the trust’s income and gains net of losses, minus 50% of distributions. The custodian files a T3-RCA return and pays any increase within 90 days after the trust’s year-end under ITA 207.7, and the CRA refunds the tax as it falls. The CRA guide puts it plainly: “All distributions from an RCA trust are taxable.”

The paperwork the T4041 lists: the employer files Form T733 for account numbers, withholds the 50% and remits it by the 15th of the next month, and reports contributions on T737-RCA slips by the last day of February. The custodian files the T3-RCA every year, “even if there has been no activity”, and issues T4A-RCA slips for payouts. One recent change: since March 28, 2023, an “excluded contribution” is left out of the 50% base. That’s an amount paid under a specified arrangement, one whose main purpose is periodic supplementary pension payments, to obtain or renew a letter of credit or surety bond securing those payments.

	RCA	RRSP	Individual pension plan (IPP)
What it is	Employer-funded plan for benefits on retirement, job loss or a change in services (248(1))	The individual’s registered savings plan (s.146)	A registered pension plan with a defined benefit provision and fewer than four members, at least one related to a participating employer (Reg. 8300(1))
Going in	Employer deducts contributions, 20(1)(r); 50% refundable tax withheld	Deduction up to the limit in 146(5)	Employer deducts contributions that meet 147.2(1)
Growth inside	50% refundable tax on income and gains, 207.5(1)	No tax on the trust, 146(4)	No tax on a trust governed by a registered pension plan, 149(1)(o)
Coming out	Fully taxed when received, 56(1)(x)	Taxed when received, 146(8)	Taxed as a pension benefit, 56(1)(a)(i)
Paid to a non-resident	25% under 212(1)(j)	25% under 212(1)(l)	25% under 212(1)(h)
On leaving Canada	Not deemed sold, not on the T1161, 128.1(10)	Same	Same

The table shows why an RCA is a different tool. The RRSP and IPP grow untaxed inside a registered limit. An RCA has no registered limit, but half of everything inside sits with the CRA until it’s paid out. Statutory rates are shown before any treaty reduction.

What happens to my RCA when I move to the US?

Nothing on the way out, and withholding on every payout after. An interest in an RCA is an “excluded right or interest”, so Canada’s departure tax doesn’t deem it sold and it isn’t on the T1161 list. Once you’re a non-resident, each distribution falls under ITA 212(1)(j), which charges 25%, and the CRA says the treaty may reduce that rate where payments qualify as periodic pension payments.

“The income tax is 25% of the amount you paid … to the non-resident. However, if the payments qualify as “periodic pension payments” the income tax convention or agreement between Canada and the other country may reduce the rate of Part XIII tax.” (CRA, T4041)

The treaty piece is Article XVIII. Paragraph 3(a) defines “pensions” to include “any payment under a superannuation, pension or other retirement arrangement”, and paragraph 2(a) caps Canada’s tax on a periodic pension payment to a US resident at 15% of the gross. A lump sum doesn’t get that cap. For an RCA, section 5 of the Income Tax Conventions Interpretation Act generally counts a payment as a periodic pension payment only if it’s one of a series of annual or more frequent payments over your lifetime or at least 10 years, and the year’s payments don’t more than double from one year to the next. Settle the payment schedule with the custodian before the first payout. Part XIII withholding after you leave Canada covers the mechanics.

There’s a second option. ITA 217 lets a non-resident elect to file a Canadian return on “Canadian benefits”, which expressly include amounts taxed under 212(1)(j). That can help in a year with a large payout and little other Canadian income. The section 217 election walks through when it pays.

On the US side, Article XVIII(1) lets the country you live in tax pensions arising in the other one. How the US taxes your RCA payouts, and how a foreign tax credit applies to the Canadian tax, depends on your US return and is its own analysis. Receiving a Canadian employer pension in the US is the closest companion read.

Is a US citizen in a Canadian RCA hit by Section 409A?

It can be, and that’s the exposure to take seriously. IRC 409A defines a nonqualified deferred compensation plan as any plan that provides for the deferral of compensation, other than a qualified employer plan or certain leave and death benefit plans, and its list of qualified employer plans doesn’t include Canadian plans. If a plan fails 409A’s timing rules, deferred amounts become income with a 20% additional tax plus interest.

The regulations carve some foreign plans out. Treas. Reg. 1.409A-1(a)(3) excludes amounts a treaty makes excludable, and for US citizens and green card holders it excludes a “broad-based foreign retirement plan”, but only for nonelective deferrals within the section 415 limits. A broad-based plan must cover a wide range of employees, including rank and file, on nondiscriminatory terms. Our read: an RCA set up for one or two executives rarely meets that test.

A related rule, IRC 457A, taxes deferred pay from a “nonqualified entity” once it vests. For a foreign corporation, that term excludes one whose income is substantially all subject to a foreign income tax the statute accepts, which includes the tax of a treaty country when the corporation is eligible for treaty benefits. A Canadian operating company paying Canadian corporate tax will generally fall outside 457A, though it’s a facts question.

A funded RCA trust also raises a US timing rule outside 409A. IRC 402(b)(1) includes employer contributions to an employees’ trust that isn’t exempt under section 501(a) in the employee’s gross income under section 83, which looks to when the interest vests, not when it’s paid out. What isn’t settled: whether the Article XVIII(7) deferral election reaches an RCA trust, given that it covers plans “generally exempt from income taxation”, and an RCA trust is exempt from Part I tax under ITA 149(1)(q.1) but pays the Part XI.3 refundable tax; and how 409A’s timing rules map onto an RCA’s terms. We haven’t found IRS guidance that addresses Canadian RCAs by name. A US person should get the plan reviewed against 409A before deferrals start, because the fix after the fact is limited. Deferred compensation across the border covers 409A in more depth.

Does a US person report an RCA as a foreign trust?

Possibly, and it isn’t a clean answer. Revenue Procedure 2020-17 exempts eligible individuals from Form 3520 and 3520-A reporting for a “tax-favored foreign retirement trust”, but the trust has to meet every condition, including contribution limits (a percentage of earned income, $50,000 a year, or $1,000,000 lifetime) and, for an employer plan, nondiscriminatory coverage of a wide range of employees including rank and file.

“In the case of an employer-maintained trust, (i) the trust is nondiscriminatory insofar as a wide range of employees, including rank and file employees, must be eligible to make or receive contributions or accrue benefits under the terms of the trust” (Rev. Proc. 2020-17, section 5.03(6))

Our read: an executive-only RCA with no contribution cap will often fall outside that relief. Falling outside doesn’t by itself mean a 3520 is due. That turns on how the RCA trust is classified for US purposes and what the US person receives or is treated as owning, and the published guidance doesn’t resolve it for RCAs. Treat it as a question to answer before the first US return that includes the plan.

Can a US retirement plan become an RCA in Canada?

Yes, and it catches Americans who move north. The CRA says in its Roth IRA folio that US plans like a 401(k) that receive employer contributions are characterized as an employee benefit plan or an RCA under Canadian rules. Separately, ITA 207.6(5) deems the part of a foreign plan funded for Canadian-resident employees to be a separate RCA, with the 50% refundable tax on those contributions.

“it is the CRA’s understanding that employers typically make contributions to such arrangements, in which case the arrangement will be characterized either as an employee benefit plan (EBP) or a retirement compensation arrangement (RCA), as those terms are defined in subsection 248(1).” (CRA folio S5-F3-C1, ¶1.26)

The residents’ arrangement rule has a carve-out. Under 207.6(5.1), contributions for someone who joined the plan before becoming resident, or by the end of the month after, aren’t caught until the person has been resident for at least 60 of the 72 preceding calendar months. The T4041 describes the same carve-out. So a US employer that keeps funding a plan for an employee who has lived in Canada for years is the case to watch. What happens to a 401(k) when you move to Canada covers the plan you bring with you.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.