Our clients – and presumably readers of this blog – are internationally mobile people. Many have lived and worked in other countries before arriving in America and, as a result, have pensions (and sometimes other assets) in countries other than the US or the UK (DTAs).
As with UK pensions as a US resident and/or citizen, because there are no ready answers and many complications, these can be neglected and forgotten about until they need to be addressed (usually at or near retirement). Sometimes this can have negative consequences. We are not experts in non-US or non-UK pensions, but having come up against this several times, we can share some of our experience.
The topic of this blog is Tax Treaties (also known as Double Taxation Agreements “DTA”s) because that is what is likely to be most relevant when it comes to non-US pensions.
What are DTAs?
A tax treaty is a bilateral (two-party) agreement made between two countries to resolve issues involving double taxation of passive and active income of each of their respective residents and citizens. Income tax treaties generally determine the amount of tax that a country can apply to a taxpayer’s income, capital, estate, or wealth.
Both countries may enter into a tax treaty to agree on which country should tax income to prevent the same income from getting taxed twice.
It is important to stress that while DTAs may offer relief from double taxation, and in some cases may eliminate it altogether, the existence of a DTA relevant to your situation does not guarantee the eradication of double tax. Even if covered, a DTA could mitigate double tax, but you may still suffer some double tax.
For a list of all the countries with which the US has a tax treaty, please see here.
DTAs and Pensions
DTAs are important when it comes to foreign pensions. Without a tax treaty in place that defines what qualifies as a pension, the US will not recognise an asset as a pension for tax purposes.
For example, if a pension vehicle is recognized as a qualified foreign pension under the tax treaty, as a UK SIPP does according to numerous cross-border tax advisers, it can usually be treated as follows:
Investments may grow, can be traded (gain realized), earn coupons and dividends tax-free.
Distributions (i.e. withdrawals)
These are subject to income tax payable in country of residence (i.e. US)
Non-US investment funds (i.e. passive forward investment companies or PFICs)
These may be acceptable investment vehicles, which is especially helpful if the foreign pension is in a currency other than dollars.
It is important to note that “treaty relief” may need to be actively claimed. That is to say, it may not be enough to simply rely on the existence of the treaty and the common knowledge that a pension qualifies for the treatment confirmed by the treaty. It may need to be actively claimed via reporting on certain forms to the IRS (such as 8833).
As we always say, every expat should consult with a cross-border tax adviser with specific UK:US experience and expertise.
Pensions without DTAs
What if you worked and built-up pension assets in a country with whom the US does not have a DTA? Well – and this can be super confusing – you may have a pension that is considered a pension in the country where it is based, may even be literally called a pension, but the US does not consider it a pension and there is no treaty available to claim such basis on your US tax return.
Potentially this means you will not benefit from gross rollup, and you could be penalized for the investments within the plan if they are considered PFICs. And/or there may be other complications depending on how the US views the “pension” wrapper. For example, if the US considers it insurance, it will be reportable and taxed a different way to if it considers it a Foreign Grantor Trust.
Frequently, we encounter expats who have been happily treating their foreign pension as a pension on their US tax return to later discover no treaty exists and they have been inadvertently reporting and taxing it incorrectly. This then usually needs to be resolved, and it can be both financially and emotionally costly. A good cross-border tax adviser will help you avoid and manage these issues.
DTAs address much more than pensions, but that has been our topic here. If your pension is in a country that has a tax treaty with the US, it is likely (although not definite) that it will be covered and can be treated as a pension in the US. However, it may be necessary to actively claim such treatment, and working with a cross-border tax adviser is advisable.
If your pension is in a country without a treaty with the US, it is unlikely to be treated as a pension, and this might come as a shock. Especially if you have been treating it and reporting it as a pension and have therefore been reporting it and taxing it incorrectly. Working with a cross-border tax adviser to avoid and manage these potential issues is advisable.
Plan First Wealth LLC is a Registered Investment Adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Plan First Wealth does not provide any tax and/or legal advice and strongly recommends that Clients seek their own advice in these areas.