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Non-taxability of Partial Pension Withdraws

Non-taxability of Partial Pension Withdraws

Old Mar 27th 2015, 2:33 pm
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Default Non-taxability of Partial Pension Withdraws

Hi,

I was wondering if people have opinions on the following strategy I proposed I think might work:

TaxProTalk.com • View topic - Lump-sum Distribution of UK Pension

The basic idea is that lump-sum payments from UK pensions have a tax free element. Problem is the saving clause in the US/UK tax treaty treats lump sums distributions differently. Lump-sum isn't defined in the tax treaty so we go to local law. Lump sum is defined as all the pension in one year. The UK now allows multiple withdraws with a 25% free element so wouldn't be a lump sum according to the US.
So it could be taxed at no greater rate than it would be taxed by a resident in the UK.
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Old Mar 27th 2015, 6:31 pm
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by Neillc37
Hi,

I was wondering if people have opinions on the following strategy I proposed I think might work:

TaxProTalk.com • View topic - Lump-sum Distribution of UK Pension

The basic idea is that lump-sum payments from UK pensions have a tax free element. Problem is the saving clause in the US/UK tax treaty treats lump sums distributions differently. Lump-sum isn't defined in the tax treaty so we go to local law. Lump sum is defined as all the pension in one year. The UK now allows multiple withdraws with a 25% free element so wouldn't be a lump sum according to the US.
So it could be taxed at no greater rate than it would be taxed by a resident in the UK.
I'm not sure of your logic unless the tax treaty gives taxing rights of a pension to the UK and untaxable by the IRS when a resident of the US. If not, the income will have to be reported on your US tax return and is likely taxed at your highest marginal tax bracket (except after-tax contributions) since it is in addition to other income.

The IRS seldom allows income from another country not to be reportable. If it did, everyone would get slick tax accountants to get income from many different countries to avoid taxes and then tax rates would have to be increased to make up for the shortfall.

Last edited by Michael; Mar 27th 2015 at 6:38 pm.
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Old Mar 27th 2015, 7:40 pm
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by Michael
The IRS seldom allows income from another country not to be reportable. If it did, everyone would get slick tax accountants to get income from many different countries to avoid taxes and then tax rates would have to be increased to make up for the shortfall.
This is the same logic that allows a Roth IRA withdraw by a UK resident to be tax free. The UK can tax the withdraw but only at the rate it would be at if the person was a US resident (0%).
If I was a UK resident and took my pension out in two pieces in different years then 25% of the distribution would not be taxed. US law doesn't define this as a lump sum so the lump sum exemption in the tax treaty doesn't apply. If I withdrew the whole lot in one year different rules would apply.
My pensions are old so they may not have the new options allowed. I have 5 years till I can draw on them as well.
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Old Mar 27th 2015, 8:36 pm
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by Neillc37
Hi, I was wondering if people have opinions on the following strategy I proposed I think might work:

TaxProTalk.com • View topic - Lump-sum Distribution of UK Pension

The basic idea is that lump-sum payments from UK pensions have a tax free element. Problem is the saving clause in the US/UK tax treaty treats lump sums distributions differently. Lump-sum isn't defined in the tax treaty so we go to local law. Lump sum is defined as all the pension in one year. The UK now allows multiple withdraws with a 25% free element so wouldn't be a lump sum according to the US.
So it could be taxed at no greater rate than it would be taxed by a resident in the UK.
Unfortunately the Forum search function is down - if it weren't I'd point you toward a recent post by BE member, nun, which, I believe, proposed the same thing.

He may well see your post and comment further.....

ps I found the link referred to above (be sure to scroll down):
http://britishexpats.com/forum/usa-5...737360/page12/

Last edited by MMcD; Mar 27th 2015 at 8:51 pm.
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Old Mar 28th 2015, 2:54 pm
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by Neillc37
.........The basic idea is that lump-sum payments from UK pensions have a tax free element........ The UK now allows multiple withdraws with a 25% free element so wouldn't be a lump sum according to the US.
So it could be taxed at no greater rate than it would be taxed by a resident in the UK.
The method of taxation under the new pension rules is not entirely clear at this time, and may vary according to the amounts withdrawn and when they are withdrawn.

This weeks Money Box (BBC Radio 4) was devoted to the new pension rules. Taxation is discussed at 06:40.

BBC Radio 4 - Money Box, Pension Freedom Special
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Old Mar 28th 2015, 4:11 pm
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Default Re: Non-taxability of Partial Pension Withdraws

The mismatch in the use of "lump-sum" between HMRC and the IRS and the lack of it's definition in the DTA is frustrating and confusing.

The usual IRS usage is the distribution of a accounts compete value.....for the UK "tax free lump sum" its a 25% one time payment. Up to now people seem to have concentrated on the "one time" nature of the payment as defining it as a lump sum and applied the "lump-sum" DTA Article. This is frustrating because distributions from ROTHs are treated as income and so are tax free in the US and the UK.

So I would now argue that if you take the UK 25% tax free amount as a series of payments it is definitely not a lump sum.....its a series of periodic payments....it's tax free income and taxed as such. So by the DTA it will be tax free in both the UK and the US because Article 17.1.b is exempt form the Saving Clause. The next question is how many years do you need to spread the payment out over?

Last edited by nun; Mar 28th 2015 at 4:19 pm.
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Old Mar 28th 2015, 4:52 pm
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by nun
The next question is how many years do you need to spread the payment out over?
I'm going to stretch the depth of your records for this one, because I've lost the reference over time (and hard drives!).

Back when there was the UK site for professionals (forget the name), LIZZIT answered a question relating to (some type of) pension withdrawals and the time between partial withdrawals to be non-taxable. She mentioned the need for a 12 month period minimum between withdrawals, or possibly 1 tax year (I can't remember which).

We both used it as a reference at the time. Any chance you still have it?

On a separate topic, in the Money Box programme, there was mention of a scenario (which could vary with providers) where a number of partial withdrawals are made, and if a "lump sum 25%" has not been taken originally, then a 25% portion of each separate withdrawal is deducted for the tax free amount.
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Old Mar 28th 2015, 5:06 pm
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by theOAP
I'm going to stretch the depth of your records for this one, because I've lost the reference over time (and hard drives!).

Back when there was the UK site for professionals (forget the name), LIZZIT answered a question relating to (some type of) pension withdrawals and the time between partial withdrawals to be non-taxable. She mentioned the need for a 12 month period minimum between withdrawals, or possibly 1 tax year (I can't remember which).

We both used it as a reference at the time. Any chance you still have it?

On a separate topic, in the Money Box programme, there was mention of a scenario (which could vary with providers) where a number of partial withdrawals are made, and if a "lump sum 25%" has not been taken originally, then a 25% portion of each separate withdrawal is deducted for the tax free amount.
Yes I remember the LIZZIT/GUYA discussion, but it seems to have disappeared from the web. The UK pension reforms give you a lot of flexibility as to how you take the 25% tax free part of a pension pot. Stretch it out over a number of years and payments and I don't see how it could be seen as a lump sum.

Last edited by nun; Mar 28th 2015 at 5:11 pm.
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Old Mar 28th 2015, 5:32 pm
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by theOAP
She mentioned the need for a 12 month period minimum between withdrawals, or possibly 1 tax year (I can't remember which).
If you read my detailed analysis in the link you will see that a lump sum is defined as a total distribution within one year. I quote the tax code on this.
So you have to take out in at least two pieces in two separate years to get the 25% tax free element.
I believe this is a new situation created by the new pension rules.
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Old Mar 28th 2015, 10:22 pm
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Default Re: Non-taxability of Partial Pension Withdraws

Since the uk specifically calls these lump sum withdrawals I think we'll all have a hard time getting the IRS to let them be tax free under the treaty if they decide to challenge it. Not that I agree with the IRS but unfortunately they don't speak the same English in the US!

EDIT Interestingly I see from the original post the rule for undefined terms. Since this is US taxation we are talking about generally the US definition would be used. No doubt though they would seek to use one of the get out phrases: " unless the context otherwise requires " or if "the Competent authorities agree on a meaning"
I think the IRS could have a case to say the context requires it to be a lump sum since the Uk calls it so.

Last edited by jb82; Mar 28th 2015 at 11:07 pm.
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Old Mar 29th 2015, 12:44 am
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by jb82
EDIT Interestingly I see from the original post the rule for undefined terms. Since this is US taxation we are talking about generally the US definition would be used. No doubt though they would seek to use one of the get out phrases: " unless the context otherwise requires " or if "the Competent authorities agree on a meaning"
I think the IRS could have a case to say the context requires it to be a lump sum since the Uk calls it so.
Note that the technical explanation has this to say:
Paragraph 2 is intended to deal with a particular type of double non-taxation that arose
under the prior Convention because the United Kingdom does not tax lump-sum distributions
from pension funds. Under the prior Convention, a lump-sum payment was treated in the same
way as any other pension, and was taxable only in the country of residence of the beneficial
owner. Accordingly, a person who anticipated receiving a lump-sum distribution from a U.S.
pension scheme with respect to employment in the United States could avoid U.S. withholding
tax on the distribution by establishing residence in the United Kingdom for the year in which he
received the distribution. The person would not be subject to tax in either the United States or
the United Kingdom with respect to the lump-sum distribution, resulting in a significant
windfall.
So this was put together to stop US persons avoiding tax on US pensions. I want to get the benefit of the 25% tax free element that's part of the bargain for having a UK pension. Just like a Roth distribution is tax free in it's entirety despite portions of it being untaxed. That's part of the Roth bargain.
I posit that if my strategy is unsound then the Roth will become taxed.
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Old Mar 29th 2015, 2:16 am
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by Neillc37
So this was put together to stop US persons avoiding tax on US pensions. I want to get the benefit of the 25% tax free element that's part of the bargain for having a UK pension. Just like a Roth distribution is tax free in it's entirety despite portions of it being untaxed. That's part of the Roth bargain.
I posit that if my strategy is unsound then the Roth will become taxed.
There is no question about the tax free nature of ROTH distributions in the US and the UK....that's well known and documented by HMRC, and obvious wrt the IRS. It's the one time nature of a payment that drops it into the lump-sum category rather than being periodic...if you can make the payment periodic you can apply Article 17.1.b and maintain the tax free nature.
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Old Mar 29th 2015, 2:41 am
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by nun
There is no question about the tax free nature of ROTH distributions in the US and the UK....that's well known and documented by HMRC, and obvious wrt the IRS. It's the one time nature of a payment that drops it into the lump-sum category rather than being periodic...if you can make the payment periodic you can apply Article 17.1.b and maintain the tax free nature.
The Roth gains it's protection from the same articles in the tax treaty that I propose to use for the pension. I don't need to draw out my Roth with periodic payments to have protection. They could tax Roth though if I drew the money out in one go being a UK citizen if I was resident in the UK. They just chose not to.
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Old Mar 29th 2015, 2:53 am
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by Neillc37
The Roth gains it's protection from the same articles in the tax treaty that I propose to use for the pension. I don't need to draw out my Roth with periodic payments to have protection. They could tax Roth though if I drew the money out in one go being a UK citizen if I was resident in the UK. They just chose not to.
Usa taxes on citizenship rather than residency so put in the saving clause to cover that. So the roth is not being subjected to a US saving clause like a uk lump sum. Really they were being generous allowing some elements to escape the saving clause. The roth being a us vehicle means the treatment is straightforward as the UK taxes on residency. also The uk has a similar product in the Isa so probably does not mind that roths are tax free in the uk since they are similar to ISAs.

The usa even ignores the tax wrapper of the Uk's ISA.

I think it is important for the usa to block the tax free lump sum from pension schemes when the usa equivalents (say a 401k) do not allow that.

Last edited by jb82; Mar 29th 2015 at 3:05 am.
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Old Mar 29th 2015, 3:34 am
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Default Re: Non-taxability of Partial Pension Withdraws

Originally Posted by jb82
The usa even ignores the tax wrapper of the Uk's ISA.
The ISA is taxable in the US because it is not 'primarily used for retirement' and hence is not a pension as far as the tax treaty is concerned. Otherwise it would be protected and withdraws would be tax free.

Originally Posted by jb82
I think it is important for the usa to block the tax free lump sum from pension schemes when the usa equivalents (say a 401k) do not allow that.
You need to use statements in law and the tax treaty to say why it's taxable (the 25%). Clearly the US wants to tax everything it can in the most complex ways it can come up with. It had to give up some rights to have it's citizens work in the UK. I have 5 years left to go. I am hoping there has been more analysis by then. If it's not clearly understood its worth me getting professional analysis to see if I can do this. This assumes I can't bleed all this money out at close to 0% tax anyway in retirement since I plan to spend decades doing it.
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