BASIS a tax blog by Steve Kobes

Your Mega Backdoor smells like a Canadian Contri­bution

Aug 24, 2026

Since sharing my Roth 401(k) Odyssey, multiple readers have asked me privately about the tax consequences of doing a “mega backdoor” in-plan Roth conversion after becoming a resident of Canada. For the time being, I do not recommend doing this. However, proposed legislation may bring us better outcomes for in-plan conversions.

A Roth 401(k) needs the treaty today

All Roth accounts — whether Roth IRA or Roth 401(k)[1] — need the protection of Article XVIII paragraph 1 of the US-Canada tax treaty[2] in order to work well in Canada. This provision grants reciprocal treatment of cross-border pension payments: a resident of Canada can receive a US pension, and the portion which would be tax-free in the US is also tax-free to Canada.

Without the treaty, a Roth 401(k) is double-taxed in a common scenario. Your contributions were made from after-tax dollars while you were living in the US, and your withdrawal after moving to Canada is fully taxable as a “superannuation or pension benefit” under s. 56(1)(a) of the Income Tax Act.[3] There is no exclusion in Canada for the return of non-resident contributions that were already taxed elsewhere.[4]

This could change in the near future with Bill C-31,[5] as discussed below.

A Canadian Contribution probably taints the Roth 401(k)

Article XVIII arguably denies treaty benefits for Canada-resident contributions to all Roth accounts. Paragraph 1 applies to “pensions”, which according to paragraph 3(a) includes “any payment under a superannuation, pension or other retirement arrangement”. But paragraph 3(b) restricts this by stating that for purposes of Article XVIII,

“the term ‘pensions’… includes a Roth IRA… or a plan or arrangement created pursuant to legislation enacted by a Contracting State after September 21, 2007 that the competent authorities have agreed is similar thereto”

except that

“from such time that contributions have been made to the Roth IRA or similar plan or arrangement, by... a [Canadian] resident..., to the extent of accretions from such time, such Roth IRA or similar plan or arrangement shall cease to be considered a pension” (emphasis added).

This is the treaty’s expression of the rule that Roth accounts can be “tainted” by what the CRA refers to as a “Canadian Contribution”.[6] The first Canadian Contribution bifurcates the account into two parts:

It is not entirely clear if the treaty’s references to a “similar plan or arrangement” should be understood to include a Roth 401(k). This wording was added in 2007 with the treaty’s Fifth Protocol in contemplation of future laws. A strict reading suggests that it does not apply to an arrangement whose enabling legislation was already in existence on September 21, 2007, no matter how “similar” it is to a Roth IRA. And such is the case for designated Roth accounts in 401(k) and 403(b) plans, which come from the Economic Growth and Tax Relief Reconciliation Act of 2001.[7]

So on the one hand, a technical argument could be made that the Roth 401(k) is not created pursuant to post-2007 legislation, and therefore paragraph 3(b) restricts Canadian Contributions only for a Roth IRA and not a Roth 401(k). Under this theory, regardless of any contributions made while resident in Canada, the Roth 401(k) continues to be a pension under the general rule of paragraph 3(a).[8]

On the other hand, a Roth 401(k) is clearly similar to a Roth IRA, and paragraph 3(b) may be said to evince an intention to paint all Roth-like arrangements with the same brush. One of the principles of treaty interpretation according to the Supreme Court of Canada is that “unlike statutes, treaties must be interpreted with a view to implementing the true intentions of the parties”.[9]

Allowing resident contributions to a Roth 401(k) would also open a massive loophole in conjunction with the documented understanding that “following a rollover contribution from a Roth 401(k) arrangement to a Roth IRA, the Roth IRA will continue to be treated as a pension”.[10] The treaty negotiators surely did not intend that the restriction on Canadian Contributions to a Roth IRA could be trivially circumvented by re-routing the contribution through a Roth 401(k).

Therefore, I think the best reading of the treaty — certainly the reading that errs on the side of caution — is that any Roth-like arrangement is tainted by a Canadian Contribution.

A mega backdoor looks like a Canadian Contribution

Does a “mega backdoor” transaction[11] constitute a Canadian Contribution if you are a tax resident of Canada at the time you perform it?

A typical mega backdoor takes money that came in as an after-tax employee contribution to a non-Roth account within the 401(k), and transfers it to the plan’s designated Roth account.[12] US tax law treats this as a rollover contribution to the Roth 401(k),[13] effectively doing an end-run around the elective deferral limit.[14]

It’s hard to deny that the in-plan conversion is, at least in substance, a “contribution” to a “plan or arrangement” that is “similar” to a Roth IRA. The conversion is not a contribution to the overall 401(k) plan, but it obviously moves money into the Roth portion of the plan, which is the intended target of the carveout in Article XVIII(3)(b).

This conclusion is, I think, entirely consistent with the CRA’s view that a designated Roth account is “simply a feature of a 401(k) plan”.[15] That comment refers to the treatment of the plan under the Income Tax Act, which generally regards the overall plan as an “employee benefit plan” (EBP).[16] It does not imply that the Roth feature is somehow irrelevant to the application of the treaty.

Consequences of tainting a Roth 401(k)

If a designated Roth account in a 401(k) plan has been “tainted” by an in-plan conversion, the Canadian tax treatment must be determined according to the characterization of the 401(k) plan under the Income Tax Act.[17] The CRA generally considers a 401(k) plan to be an “employee benefit plan” (EBP), except to the extent that special rules for a “retirement compensation arrangement” (RCA) are engaged.[18] The RCA rules are discussed further below; let’s assume for now that the entire plan is an EBP.

Investment income still deferred

An employee benefit plan has some tax deferral built-in: the income from investments inside the plan is not taxable to the employee until money is paid out of the plan.[19] Therefore, the undistributed income in a Roth 401(k) is tax-deferred in Canada even after the account has been tainted by a Canadian Contribution. We don’t need any treaty rules for that!

This is the point on which a Roth 401(k) most obviously diverges from a Roth IRA in Canadian law. A Roth IRA requires a treaty election to defer Canadian tax on earnings,[20] without which they are taxed as if the owner held the investments directly. That election is essentially superfluous for a Roth 401(k).[21]

Similarly, under current law there is no immediate income inclusion for Canadian tax purposes resulting from an in-plan Roth conversion. After all, the designated Roth account is “simply a feature” of the overall plan,[22] and the overall plan is a tax-deferred EBP. However, this is likely to change with the passage of Bill C-31 (discussed below).

Distributions subject to Canadian tax

Distributions from the plan are where we see the most obvious impact of tainting a Roth 401(k) with a Canadian Contribution. As previously discussed, the treaty exempts US-qualified pension payments from Canadian tax. But a treaty-ineligible EBP distribution is included in income under one of two provisions:

The CRA has suggested that the allocation between resident and non-resident services may be done on an apportionment basis,[24] and that the return-of-contributions element may be determined in a manner consistent with US rules,[25] which allocate pro rata between contributions and earnings.[26]

It should also be noted that where a 401(k) contribution occurs in respect of resident services, there are special adjustments which reduce the employee’s RRSP contribution room.[27] A full discussion of these adjustments is beyond the scope of this post.

Treaty bifurcation ordering

It is unclear what ordering applies to the determination of how much of a Roth 401(k) distribution can be attributed to the treaty “pension” balance, which enjoys reciprocal treatment, and how much is coming from the tainted portion of the account.

It’s notable, though, that a Canadian Contribution does not result in a proportional allocation of subsequent earnings between the two “buckets” arising from the bifurcation. Instead, the treaty locks in the pre-existing balance as an upper-bound quantum eligible for protection.[28] All future income, including earnings on the treaty-protected capital, lands in the tainted bucket!

In light of this asymmetry, it may be defensible to regard distributions as draining the treaty-protected balance “first”. A CRA interpretation on this point would be welcome.

Example

Let’s suppose you participate in a 401(k) plan that is maintained primarily for US employees, and while living in the US you contribute $40,000 to a designated Roth account in the plan. Investment gains have brought its balance to $50,000 by the time you move to Canada, and you then contribute another $10,000 out of wages earned after becoming resident. The new balance of $60,000 eventually doubles to $120,000 at which time you take a $90,000 lump-sum US-qualified withdrawal. What income does this produce in Canada?

An interesting subtlety illustrated by this example is that when the account is bifurcated by a Canadian Contribution, the treaty-protected balance is not coterminous with the portion allocable to non-resident services for s. 56(1)(a)! The later-accruing investment gains on non-resident contributions are outside of the treaty’s protection.

Avoiding RCA status

Special rules for a “retirement compensation arrangement” were enacted in 1986 to disincentivize the use of non-registered pension plans in Canada.[29] Where the RCA rules apply, they supersede the EBP rules.[30] RCA treatment is quite punitive because all contributions and earnings are subject to a 50% tax under Part XI.3 of the Income Tax Act.[31] The tax is recoverable upon distribution from the arrangement,[32] but the forgone income is not, so this amounts to a 50% haircut on total investment return.

Fortunately, a 401(k) plan normally escapes RCA classification by virtue of the exception for a plan that is “maintained primarily for the benefit of non-residents in respect of services rendered outside Canada”.[33] However, if new contributions are made by or for a Canada-resident employee, they should watch out for the “resident’s arrangement” rules, which turn a portion of the plan into a deemed RCA.[34]

In two common cases, it remains possible for a resident of Canada to contribute to a 401(k) plan without creating a resident’s arrangement:

The latter basically gives newcomers to Canada a 5-year “safe harbor” period during which they may continue contributing to a foreign plan without triggering RCA rules.

Two changes in Bill C-31

Some of this analysis could change if and when Bill C-31 receives Royal Assent. This bill expands the definition of a “foreign retirement arrangement” (FRA) to include a 401(k) plan.[37]

The main purpose of the change is apparently to eliminate the possibility of a tax-free withdrawal using the reasoning of Jacques v. The Queen,[38] where the Tax Court of Canada found that the appellant’s 401(k) was not a pension plan. The CRA’s longstanding position has been that a 401(k) generally is a pension plan,[39] so under that view Bill C-31 is not a radical departure.

There are, however, some side effects of a 401(k) being classified as an FRA which have not received much attention yet. Things may change as the dust settles, but based on the current draft I see good news and bad news.

In-plan conversions will become taxable events?

The bad news is that an in-plan Roth conversion will now be caught by s. 56(12) of the Income Tax Act. This provision is engaged when

“an amount in respect of a [FRA] is, as a result of a transaction, an event or a circumstance, considered to be distributed to an individual under the income tax laws of the country in which the arrangement is established”

with the result that the amount is “deemed to be received by the individual as a payment out of the arrangement” for the purpose of s. 56(1)(a). So it would no longer be the case that the conversion itself is not a taxable event in Canada.

The original purpose of s. 56(12) was basically to tax Roth conversions from traditional IRAs,[40] so it is very likely that the CRA will interpret it as also applying to Roth 401(k) conversions[41] once the expanded definition of an FRA becomes law.

Greater reciprocity?

Another interesting side effect of being an FRA is that payments relating to non-resident services will be taxed under ITA s. 56(1)(a)(i)(C.1), which embeds reciprocity by excluding such a payment

“to the extent that the amount would not, if the taxpayer were resident in the [foreign] country, be subject to income taxation in the country”.

This reads similarly to the treaty’s reciprocity rule in Article XVIII(1). But in the case of a Roth 401(k), it is potentially more generous than the treaty, because it is not limited by a balance cap after a resident contribution!

To be sure, we must still divide the payment between the jurisdictions of 56(1)(a) and 6(1)(g). But assuming this division permits a pro rata allocation of earnings, the amount exempted by FRA reciprocity may be substantially larger than what treaty reciprocity would have allowed ($72,000 versus $50,000 in the example above).

If this interpretation is correct, it seems that Bill C-31 may enable Canadian residents to execute Roth “conversion ladder” strategies in 401(k) plans, which are problematic today because of the treaty’s Canadian Contribution rules.

Conclusion

Today, a Canadian Contribution to a Roth 401(k) is nearly always a mistake, and unfortunately it is one that cannot really be fixed afterwards.[42] Employees planning a move from the US to Canada should be cautioned that it can easily happen inadvertently, especially when the 401(k) plan custodian allows in-plan conversions to be set to occur automatically.

Bill C-31 may unlock some new planning opportunities for Roth conversions. However, it raises questions about exactly how the FRA rules will apply to 401(k) plans, which may take time to fully settle. The CRA also has not provided enough guidance about how to compute the income inclusion from a tainted Roth 401(k) distribution under the current treaty rules.

  1. Consistent with common parlance, I will use the term “Roth 401(k)” as a shorthand for a “designated Roth account” in a US 401(k) plan as contemplated by section 402A of the Internal Revenue Code of 1986, as amended (herein referred to as “IRC”). You should keep in mind, however, that the designated Roth account is not a separate plan, but rather a special account within a 401(k) plan. The plan may include both Roth and non-Roth accounts. ↩︎

  2. Convention Between the United States of America and Canada with Respect to Taxes on Income and on Capital, signed at Washington, DC on September 26, 1980, as amended by the Protocols signed on June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997, and September 21, 2007 (herein referred to as “the US-Canada treaty”). ↩︎

  3. RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as “ITA”). ↩︎

  4. Rasmussen v. The Queen, 2019 TCC 124 (CanLII). ↩︎

  5. Bill C-31, Budget 2025 Implementation Act, No. 2 (first reading May 6, 2026). ↩︎

  6. Folio S5-F3-C1, Taxation of a Roth IRA, para. 1.12–1.14. ↩︎

  7. EGTRRA § 617(a), 115 Stat. at 103, adding section 402A to the IRC. ↩︎

  8. The Treasury Department’s Technical Explanation of the 2007 Protocol states that “the term “pensions” includes pensions paid by private employers (including pre-tax and Roth 401(k) arrangements).” Notably this clarification appears in the context of 3(a), not 3(b). ↩︎

  9. Canada v. Alta Energy Luxembourg S.A.R.L., 2021 SCC 49 (CanLII), para. 37. ↩︎

  10. Technical Explanation of the 2007 Protocol, p. 30. This understanding is repeated in Folio S5-F3-C1 para. 1.14. ↩︎

  11. For an introduction, see [Schwab] What Is a Mega Backdoor Roth Strategy?. For IRS technical guidance on in-plan conversions, see Notice 2010-84 as modified by Notice 2013-74. ↩︎

  12. Another variation on the mega backdoor is to withdraw the after-tax 401(k) contribution and roll it over to a Roth IRA. But in this post I will focus on the Roth 401(k). ↩︎

  13. IRC § 402A(c)(4)(E). ↩︎

  14. Direct (non-rollover) contributions to the designated Roth account are currently allowed up to $24,500 under IRC § 402(g), whereas the mega backdoor can use contributions beyond that, subject to the § 415(c) overall limit of $72,000. Notice 2025-67 provides these 2026 figures, which are adjusted annually. ↩︎

  15. CRA Document 2020-0846401E5. ↩︎

  16. My previous post, A Roth 401(k) Odyssey, elaborates on this point. ↩︎

  17. The Canadian tax treatment of a foreign plan such as a 401(k) is explored in depth by Jennifer S. Horner, “Canadian Taxation and Cross-Border Pensions” (2009) 57:4 Canadian Tax Journal 905–930. See also D. Bruce Ball and Brenda R. Dietrich, “Canadian Taxation of Foreign Pensions” (2000) 48:6 Canadian Tax Journal 1908–1932. ↩︎

  18. CRA Document 9428135. ↩︎

  19. Interpretation Bulletin IT-502, “Employee Benefit Plans and Employee Trusts” (Mar 28, 1985), para. 6. For a deep dive on Canadian EBP rules, see John M. Solursh and Jeff Sommers, “Employee Benefit Plans”, in 1997 Deferred Income Arrangements Con­fer­ence (Toronto: Canadian Tax Foundation, 1997) 6:1-39. ↩︎

  20. Article XVIII paragraph 7. See Folio S5-F3-C1 para. 1.9. ↩︎

  21. Folio S5-F3-C1 para. 1.26: “Because an individual who holds an interest in an EBP or RCA is not subject to current taxation under the Act on the income accrued in the arrangement, there is no benefit in filing the Election.” See further discussion in A Roth 401(k) Odyssey. ↩︎

  22. CRA Document 2020-0846401E5. ↩︎

  23. ITA s. 6(1)(g)(ii). ↩︎

  24. Folio S2-F1-C3, Pension Benefits, para. 3.35. See also Horner at 926 (Example 3). ↩︎

  25. CRA Document 9906645. ↩︎

  26. IRC § 72(e)(8)(B); see also Reg. § 1.402A-1(c) Q-3. ↩︎

  27. Income Tax Regulations ss. 8308.1 and 8308.2; see also CRA Document 2010-0388731E5 and Horner at 916–918 (pension adjustment for expatriates) and 919–920 (pension adjustment for commuters). ↩︎

  28. Article XVIII paragraph 3(b) denies pension status “to the extent of accretions from such time” as a Canadian Contribution has occurred. See also Folio S5-F3-C1 para. 1.13. ↩︎

  29. See generally Jim Kahane, Uros Karadzic, and Simon Létourneau-Laroche, “A Fresh Look at Retirement Compensation Arrangements: A Flexible Vehicle for Retirement Planning” (2013) 61:2 Canadian Tax Journal 479–502. ↩︎

  30. Clause (c.2) of the ITA s. 248(1) definition “employee benefit plan” excludes any portion of the arrangement that is an RCA. ↩︎

  31. ITA s. 207.7(1); “refundable tax” is defined in s. 207.5(1). ↩︎

  32. ITA s. 207.7(2). ↩︎

  33. ITA s. 248(1) definition “retirement compensation arrangement”, clause (l). ↩︎

  34. ITA s. 207.6(5) and (5.1). ↩︎

  35. ITA s. 207.6(5.1)(b)(i). This exception would apply to cross-border commuters or others who work in the US but have remained tax residents of Canada. ↩︎

  36. ITA s. 207.6(5.1)(b)(ii). ↩︎

  37. Bill C-31, clause 129, replacing Income Tax Regulations s. 6803, prescribing things which constitute an FRA. Currently, only a traditional IRA is prescribed to be an FRA. ↩︎

  38. 2016 TCC 245 (CanLII). See Kevyn Nightingale and Katherine Fayolle, “Finance Changes Taxation of US 401(k) Plans”, Wolters Kluwer Tax Topics No. 2740 (Sep. 23, 2025). ↩︎

  39. See e.g. CRA Document 9428135. Thus the contrary holding in Jacques is an anomaly, and the plan in that case had some unusual features which contributed to the result. For example, it “did not provide for the payment of anything that could be described as a fixed or determinable allowance or a regular post-retirement income” (para. 21). ↩︎

  40. Department of Finance, Explanatory Notes Relating to the Income Tax Act, the Excise Tax Act and Related Legislation (Oct 24, 2012), clause 194: “For example, if an individual converts an IRA into a Roth IRA… simply by amending the plan terms, section 408A(d)(3)(C) of the Code treats the converted amount as a distribution… For Canadian tax purposes, however, the converted amount might not be considered to have been received by the individual and, thus, could escape taxation in Canada… New subsection 56(12) clarifies that such ‘deemed’ distributions under the Code are to be treated as distributions for Canadian income tax purposes.” ↩︎

  41. The deemed-distribution provision for a Roth 401(k) conversion in IRC § 402A(c)(4)(E)(ii) is very similar to the one for a Roth IRA conversion in § 408A(d)(3)(C) which the Finance technical note expressly referred to. ↩︎

  42. CRA Document 2020-0846401E5: “Neither the Act nor the Treaty provides any mechanism by which a Canadian Contribution, or the negative tax ramifications of a Canadian Contri­bution, can be reversed or rectified.” ↩︎