Disenchanted

nun,

As I work for a "city" they have no 401k plan option, they have their own plan. No SS contributions as we are exempt, hence the max WEP hit I will enjoy because I have less than 30 years of contributions at retirement and my "City" pension. I suppose I could also contribute to a standard IRA or a Roth but there are set limits.

I could contribute to deferred comp, even play catch-up, and use the UK disbursement to make up the amount I put in the DC fund, or maybe put the payments in to a 925 as I have two kids in college.

I wonder if I could claim it as self employed income? SEP IRA's have much higher contribution limits.

nun

Look into all the ways you can reduce your taxable income to offset the extra UK pension income you'll be getting: so IRA (ROTH won't reduce your taxable income, but is worth doing in addition); if your city has a voluntary DC plan max that out; if you work for local government you might have access to a 457; and then as you say there's the 529 plan.

You are not self employed so you can't do a SEP. Just use the UK pension income as an opportunity to put an equivalent amount into US tax deferred investments.

expat124

i've just joined this site...have not read through all posts but this is my experience: i am us citizen; returned to us some years ago and had a uk company pension from employment there that i started to take in 2010. i took the lump sum + reduced monthly distribution option. the lump sum was distributed tax free to me in the us. my monthly payments are wired to my us bank tax free and i declare that amount on my us tax filing as they are taxable and i chose to be taxed here rather than have tax taken out at source (UK.)

i hope this helps. this tax status was verified by my accountant and the relevant UK and US tax depts.

p.s. the lump sum was tax free in both countries so not added to us income.

nun

Well you got away with something there. It is well known that UK pension lump sum payments are fully taxable by the IRS when paid to US citizens or residents. You accountant and "relevant UK and US tax departments" got it wrong. Did they explain their reasoning?

lansbury

He has got out of the IRS audit period yet.

expat124

it may be different for other plans...that was my (correct) experience. i had a choice to take a partial (tax free) lump sum. with reciprocal uk/us tax agreement, it was also tax free (and declared) in the us.

expat124

i did not 'get away with' anything.

nun

What type of plan did you have.....had you built up a US tax free basis?

UK plans are not-US qualified and any lump sum payment will be taxable under the treaty, when paid to a US citizen or resident, because of the saving clause. I would be interested to know the reasoning your accountant used. In areas like this mistakes are often made by professionals and the IRS. A tax return can be accepted and not audited even if it contains some errors, but your assertion that the UK tax free lump sum is also tax free in the US is (IMHO) incorrect an others should not proceed on that assumption.

lansbury

The only pension where that would apply is a government service pension.

You only pay US tax on any part of a UK government service pension if you are a US citizen living in the US. Otherwise it is only taxed in the UK and the lump sum is then tax free as per UK rules. I got my police pension that way.

dunroving

I don't think anyone is accusing you of anything, you clearly acted in good faith on the advice of an expert. However, it seems the expert advised you incorrectly ... did you check the Tax treaty notes Nun pasted in in Post #8?

Interesting article on the subject here, portion of the text pasted below (my bold added):

"UK/US treaty impact

The UK/US treaty that came into force in 2004 contains a number of helpful provi­sions in respect of pen­sions; the exact meaning of a number of which are still subject to some debate.

· The treaty provides that the growth in value of a UK plan is not US-taxed until ultimately distrib­uted from the plan.

· Individual contributions into a UK plan may be US tax-deductible, up to equivalent US plan limits.

· Employer contributions into a UK plan may be non-US taxable until dis­tribution, again within US plan limits.

Unfortunately the actual application of those points is not quite that simple. The most argued provision relates to the US taxation of the UK tax-free lump sum. A literal reading of the treaty seems to suggest the US cannot tax. That falls away as the treaty contains a ‘saving clause’ that allows the US to ignore relief on lump sums, but then another section appears to give some hope after all.

Treaties, of course, are not to be read entirely liter­ally, and recourse can be had to other materials and commentary written by the treaty teams at the time of negotiation. The net result is that there must be some doubt that the US will in fact exempt the UK tax-free lump sum.

The taxpayer may choose not to claim the treaty benefits of course. So they may not try to exempt company contribu­tions, rather they may be able to cover any potential US tax liability with their excess foreign tax credits. They may even be able to do the same with the growth in value of the plan and many individuals will have actively planned their treatment, balancing their foreign tax position from one year to the next."

nun

There is always room for interpretation, but the saving clause seems pretty clear to me, as does the general consensus. Because Article 17.2 (which covers lump sum payments) is not exempted form the saving clause, that payment is taxable by the US. You might argue that the UK lump-sum payment is not really a lump-sum payment as it is not a distribution of the entire pension amount, but then it would still be income and taxable in the US.

If the treaty was not invoked over many years and FTCs were used to build up a US tax free basis then a portion of the UK tax free lump sum would also be tax free in the US.

I think this situation points out that tax advantages in one country do not automatically transfer to a tax return in another. Unless they are explicitly given in the treaty then local law will apply and unfortunately things like UK pension lump sums and ISA interest and gains are fully taxable in the US. One area where tax free status does transfer is for ROTH income.

dunroving

I hope it stays that way, as I plan to do a rollover of my TIAA-CREF 403(b) to a Roth IRA as has been suggested before.

Call me paranoid but tax laws and pension laws seem to be changing so rapidly (just look at the LTA and annual allowance for UK pensions over just a few years) that I don't trust the US or UK government to keep things the way they are.

One you didn't mention was endowment maturity lump sums - I had two mature after I returned to the UK and as far as my limited understanding is concerned, I'd have had to pay tax on these if I had stayed in the US. We're not talking huge amounts (and they both had a shortfall of about 30%) but it's the principle of the thing that grates.

durham_lad

+1 on the ROTH rules in the treaty continuing as is. I'm aggressively doing conversions in the 25% bracket before moving to the UK in a couple of years as I'll be in be the 40% bracket after that, including when RMDs kick in at 70.5.

theOAP

When I first read the original post, my immediate thought was someone overlooked the 'saving clause' (the OP is paying tax on the distributions, so pre-retirement, pre-paying all tax efficient planning wasn't involved).

We always know that each situation can be different, and the 'and declared' may be the clue.

We also don't know the time line on this situation. It is possible to have a 'tax free lump sum' in the UK, declare the lump sum on a US return where it is taxed, but still end up with no tax due. This can be accomplished if the person was a USC whilst employed in the UK (the OP says they 'returned' to the US?), have a sufficient salary AND sufficient additional savings earning interest (taxed at 40%), have used 1116 passive in past years, and offset the 'tax free lump sum' with carryover FTC credits (passive) from prior years (provided they are within the 10 year period). Excess passive credits build up rapidly when the interest from all savings are being taxed at 40%.

The tax free lump sum is declared and taxed, but there is no US tax due in the end. It's also possible the interpretation of the preparer was the pension income was general limitation (there is long standing disagreement on whether pension income is general or passive), and used excess general FTC credits of which there are usually quite a few given a higher salary. Barring that, the question must be was a treaty exemption (8833) filed? If so, then we know the saving clause was overlooked.

nun

I agree. I see two ways there would be no tax on the lump sum; either a tax free basis was built up over the years; or there were substantial FTCs available to offset US tax. Neither of these would require application of the treaty. As you say if the US tax free nature of the lump sum is being asserted entirely because of the treaty without the use of FTCs then the accountant in this case has got it wrong.

We need to be careful of wording in this situation. UK tax free lump sums are taxable in the US, but no tax might be due because of FTCs.