US Treatment of UK Pension Funds

The Foreign Account Tax Compliance Act (FATCA) requires that US tax residents, citizens and permanent residents (green card holders) provide details of their foreign assets, subject to some minimum values, and indicate where the income appears in their US tax return. By its very nature, there will be many occasions where both FATCA and FBAR reporting requirements will apply to British expats in the US.

One common misconception is that foreign pension funds held by expatriates in the US are tax-exempt and lie outside the scope of US taxation as a result of the Double Tax Treaty between the US and UK. Unfortunately, that is not the situation, and expats in the US should seek tax advice about including any pensions within US tax returns and before making any withdrawals.

The news isn't all bad; for example, it may be possible to rely on Treaty provisions to exclude the 25% UK pension lump sum which is not taxable in the UK from taxation in the US. Depending on your precise circumstances the savings in this situation can be very significant, but specialist US tax advice is absolutely required.

Note that almost no foreign pension plans will be qualifying pension plans for US tax purposes, as the legislation requires that the fund or plan needs to have been created or organized in the United States. The US tax treatment of foreign funds is highly complex and may be dependent on the type of pension fund involved - whether it is, for example; 1) an employer sponsored and funded defined contribution plans 2) a defined benefit plan funded by employer contributions 3) a personal pension plans, funded by the individual; or 4) an unfunded plan maintained by an employer.

The tax treatment and reporting requirements may also depend on whether the pension/superannuation scheme is considered a trust, the type of trust, and whether the individual is a "highly compensated employee" for US purposes ($130,000 p.a. in 2021). There is also the clear potential in a number of situations for the individual to be taxed in the US on the annual earnings accruing within their pension scheme and often US tax advisors will simply indicate that foreign pension funds should be taxed as "foreign grantor trusts" - with pension fund earnings, even if not accessible, included in US taxable income.

This is a complex area which could have significant financial implications for British and other expatriates working in the US. Expats with international employers should seek clarification on their position, if it hasn't already been provided, and other expats should seek specific professional advice. The same applies in relation to British expats who have returned to the UK and have US pension funds - advice should be sought prior to any withdrawal.