For most of us, having spent years wrestling with the convoluted and overly complex UK pension landscape, moving to America presents us with a new convoluted and complex system to learn. Only this time there is the added complicator that your non-US past could add extra spice.
This is not an exhaustive list. For concision, we have cherry-picked the most relevant plans/aspects for our clients and thus who we expect to be the majority readership of this blog (British expats, senior managers of multi-nationals, net worth $2-10m).
Please note that all contribution limits and income limits discussed in this blog are for the tax year 2023. Contribution and income limits change over time and may be different in future years.
Workplace Retirement Accounts: 401(k) and 403(b)
Your main workplace retirement account is likely a 401(k) if you work for a private employer, 403(b) if you work for a non-profit or an educational institution, or a 457(b) if you work for a state or local government. Beyond that distinction, they are largely similar.
401(k) plans are the most common type of US retirement account that we encounter. An expat comes over to the US, usually transferred by their employer, and as soon as they are on a local contract (which could be immediate), are offered the opportunity to particulate in the 401(k) in much the same way there were participating in their company pension scheme in the UK. And they usually should, because it’s good for their retirement and frequently provides “free money” in the form of their employer’s contribution.
In 2023, here are some details about 401(k) / 403(b) plans:
- Participants can contribute $22,500 personally if under the age of 50
- An additional $7,500 personal contribution can be made if over the age of 50, known as catch-up contributions (for a personal total of $30,000)
- Personal contributions, known as salary deferrals, are deducted from salary before tax. (If Roth contributions are available and elected, these contributions are deducted after-tax.)
- Usually, but not always, the sponsoring employer will also make contributions.
- These contributions may be standalone and/or a salary match (e.g. they will match 4% of your salary as long as you are also contributing 4%). They can also include discretionary profit sharing.
- The total annual maximum limit that can be contributed (sum of employee + employer contributions) to a 401(k) / 403(b) is $66,000 (or $73,500 if over 50 y/o).
- Plan assets grow and earn interest & dividends tax-deferred, but all traditional withdrawals are taxable as income. (Roth contributions, if available, and earnings are generally not taxed upon withdrawal.)
- Early access, if available – differentiating these from UK pensions – but access pre-59.5 y/o usually suffers a 10% penalty in addition to income tax. Some plans allow for penalty-free distributions as early as 55. UK pensions are accessible from age 55, but are essentially completely inaccessibly pre-55.
Personal Retirement Accounts: Rollover IRA, Traditional IRA, Roth IRA
There are others –Simple IRA & SEP IRA, but these are much less common amongst our clients and readers.
Rollover Individual Retirement Accounts (IRAs)
Most frequently come about when someone leaves their employer (moves company or retires), but sometimes an in-service rollover may be available (see blog). A participant has more freedom and control over an IRA than they do a 401(k). It is also used as a consolidation vehicle to merge several 401(k)s and/or IRAs into a single retirement account.
- Grows and earns interest & dividends tax deferred, but all withdrawals are taxable as income.
- Early access if available – differentiating these from UK pensions – but access pre-59.5 y/o usually suffers a 10% penalty in addition to income tax (UK pensions are accessible from age 55, but are essentially completely inaccessibly pre-55).
These are retirement accounts mostly for people who do not have access to a workplace retirement account (i.e. 401(k) etc). Contribution limits are much lower – $6,500 if below 50 y/o with a further $1,000 allowable if above 50 y/o – and there is obviously no employer contribution.
Like a 401(k) you may receive a tax deduction for the money you contribute to a Traditional IRA, which will grow tax deferred but is then taxable upon withdrawal (subject to same 59.5 age restriction with 10% penalty for earlier access).
There are a couple of things to be mindful of. You need earned income to get the deduction. If you are contributing to an IRA, it is likely because you do not have access to a workplace retirement account. This may mean you have no income. You cannot make an IRA contribution without earned income, except in the case of a spousal IRA (where you can contribute if your spouse has sufficient income).
Furthermore, if you participate in a retirement plan at work, such as a 401(k), your IRA deduction may be limited or disallowed based on your income. Although you can contribute $6,500 (or $7,500 if you’re 50 or older) to a traditional IRA as long as you have sufficient income, you may not be able to deduct your contribution on your taxes if your income exceeds IRA thresholds. Most of our clients exceed these thresholds (e.g. $136,000 modified adjusted gross income for Married, filing jointly).
Like an IRA, you need earned income to be eligible to contribute to a Roth IRA, and the amount contributed cannot be more than the amount you earn. The same contribution limits apply – $6,500 in 2023, or $7,500 if you are age 50 or older. Unlike an IRA, you’ll pay taxes on the amount you contribute to a Roth IRA. However, the money grows tax-free in the account, and no income tax will be due on Roth IRA withdrawals in retirement if certain stipulations are met. A Roth IRA does not require that you take distributions in retirement.
While you can’t take a tax deduction on a Roth IRA because contributions are made after-tax, Roth IRAs have income limits as well. They indicate how much you can contribute to a Roth, if at all, and they apply whether or not you participate in a 401(k). Income limits, which are based on modified adjusted gross income, essentially rule this out for many people (e.g. $228,000 for Married filing jointly).
Some 401k plans have the option for Roth contributions. Another way for higher earners to participate in a Roth is via a conversion from a traditional (i.e. non-Roth) IRA. A Roth conversion is especially attractive if you expect your future tax rate to be higher than your current rate because you don’t pay tax on withdrawals from Roth IRAs. As a high-earner, you can also get around Roth IRA income limits by making a contribution to a Traditional IRA and then converting it to a Roth , a process commonly referred to as a backdoor Roth IRA. You may owe federal income tax on any amount you convert and it could be substantial – this is what generally stops people converting, especially while working and earning and thus in a higher tax bracket already.
Required Minimum Distributions (RMDs)
- Another key differentiator with UK pensions is the concept of “Required Minimum Distributions” (or RMDs). From age 73 (or 72 if you turned 72 in 2022 or earlier), participants are forced to make an annual withdrawal of taxable funds based on life expectancy tables (the portion of your account you’re required to withdraw increases with age) and thus allows the IRS to start recuperating some of the tax it allowed you to defer.
- The RMD rules apply to employer sponsored retirement plans (401(k), Roth 401(k)s, 403(b) plans, 457(b), etc.) as well as traditional IRAs and IRA-based plans such as SEPs, and SIMPLE IRAs.
- The IRS penalty for not taking an RMD, or for taking less than the required amount, is steep: 25% of the amount not taken on time. This is somewhat similar to the UK’s regime of an automatic “Benefit Crystallization Event” (BCE) at age 75, to force some people to withdraw taxable fund before age 75 (or potentially suffer punitive tax on the forced BCE)
- RMDs do not apply to Roth IRAs
- Inherited IRAs have a very different RMD schedule, and you may be forced to start withdrawals much sooner.
Further British Expat Considerations
If like most, but not all, British expatriates living in America you plan on remaining and retiring in America then there really aren’t that may complications and/or considerations beyond wrapping your head around another retirement saving and planning system.
However, if you expect to leave the USA, here are some things to consider:
- US retirement accounts remain in the USA until withdrawn. We are not aware of any facility to transfer / rollover a US retirement account into any non-US retirement account (i.e. an IRA cannot be rolled into a UK SIPP).
- If leaving the USA as a US citizen then you are subject to US taxes and required to file US tax returns annually, wherever you live. Tax treaties may exist to defray some (but not all) of this taxation, but not always.
- If leaving and giving up permanent residence (i.e. Green Card) or US citizenship, you may be considered a “Covered Expatriate” and subject to the Exit Tax (topic for another blog).
- If you are a Covered Expat, an IRA may be caught up in this and become fully taxable upon exit. Furthermore, this is a “phantom tax” and the IRA could later be subject to tax in your future country of residence without any relief. It is imperative if you are leaving the US as a Covered Expat that you take tax advice to manage this process.
- 401(k)s may be excluded from the Exit Tax calculation, but any future withdrawals suffer mandatory 30% withholding in the US. Your future country of residence is likely to tax this money as well, which may create administration hassles for you.
- US citizens living outside the US and withdrawing funds from their IRAs are likely to be liable for local tax first, but your IRA custodian may enforce a minimum level of withholding, again potentially creating administration issues for you if you need to claim it back from the IRS.
We cannot stress this enough – expatriates need quality cross-border tax advice specific to the non-US country. For example, British expatriates and/or those who have returned (or plan on returning) to the UK should seek advice from experienced cross-border professionals with specific UK expertise. This is a minefield and qualified advice could save you an enormous amount of financial and emotional stress.
Followers of this blog and our podcast are going to get bored of hearing us repeat this, but we will continue to do so because we consider it so fundamentally important.
Plan First Wealth LLC is a Registered Investment Adviser. The 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.