As a US citizen or green card holder living and working in the UK, you may participate in a UK employer pension scheme to save for retirement. While these pension plans offer valuable benefits for your future, understanding how they are taxed by the US government is essential to avoid surprises during tax season.
Types of UK Employer Pension Schemes
The UK has a variety of pension schemes designed to help employees save for retirement. As a US expat, it’s important to recognize how these pensions work and how they are treated for US tax purposes.
Some common UK employer pension schemes include:
- NEST (National Employment Savings Trust): NEST is a government-backed pension scheme in the UK, designed for employees of small to medium-sized employers who do not have access to a traditional pension plan. Contributions are made automatically through payroll deductions, and the pension grows tax-free in the UK.
- AVIVA: AVIVA is one of the UK’s largest insurance and pension providers, offering workplace pensions for employees, including defined contribution schemes. Contributions are typically made by both the employer and employee, and the pension grows tax-free in the UK.
- Standard Life, Scottish Widows, and Legal & General: These companies also offer defined contribution pension schemes, where both the employer and employee contribute to the plan, and the pension grows without being taxed in the UK.
How the US Treats UK Employer Pension Schemes
For US tax purposes, pensions held abroad are subject to a different set of rules compared to US retirement accounts like 401(k)s or IRAs. The key question for US expats with UK employer pensions is how these schemes are treated under US tax law, which can be quite complex.
Tax Deferral in the UK vs. Taxation in the US
In the UK, contributions to pensions such as NEST and AVIVA are tax-deferred, meaning that you don’t pay taxes on your contributions or the investment gains until you withdraw the funds in retirement. However, the U.S. tax treatment of these pensions can differ. The IRS does not automatically grant tax-deferred status to foreign pension plans. This means that while your pension may grow tax-free in the UK, the U.S. taxes it as if it were a foreign trust or non-qualified plan.
The IRS requires US citizens to report their foreign pension accounts on Form 8938 (Statement of Specified Foreign Financial Assets) if the total value of their foreign assets exceeds certain thresholds. You may also be required to file Form 3520/3520-A if you have a foreign pension that is classified as a trust under US tax law.
Employer Contributions and Taxation
In the UK, employer contributions to pension plans like NEST, AVIVA, or Standard Life are generally not considered taxable income for employees at the time of contribution. These contributions are exempt from income tax in the UK, and they are typically made directly into your pension fund.
However, the US may view these employer contributions differently. The IRS may require you to report employer contributions as income on your US tax return, depending on the structure of the pension. The contributions may also be subject to US taxation, and any gains within the pension fund may be taxed when withdrawn, even if they are tax-deferred in the UK.
Taxation Upon Distribution
When you begin withdrawing funds from your UK pension in retirement, the US will tax the distributions. Even though the UK allows you to withdraw pension funds tax-free up to a certain limit or at lower tax rates, the US taxes foreign pension distributions as ordinary income. The tax rate applied will depend on your total income in the year of withdrawal.
Additionally, there may be a 10% early withdrawal penalty if you take funds out before reaching the age of 59½, unless you qualify for an exception under US tax law.
US-UK Tax Treaty: Avoiding Double Taxation
Fortunately, the US and the UK have a tax treaty that helps prevent double taxation on pensions and retirement income. Under this treaty, you may be able to claim a credit or exclusion for taxes paid to the UK on pension income. However, the IRS still requires you to report the income and may tax it at the standard US rates, even if you qualify for treaty benefits.
You can typically use the Foreign Tax Credit (FTC) to offset any taxes paid to the UK, reducing your US tax liability. This is especially useful if you are paying taxes in the UK on your pension distributions. However, the IRS requires you to provide proof of foreign tax payments, so keeping detailed records of pension contributions and taxes paid is crucial.
Reporting Foreign Pensions
US expats are required to report their foreign pensions on certain forms when filing their US taxes. These forms help the IRS track foreign income and ensure proper tax treatment.
- Form 8938: If the value of your foreign pension and other foreign financial assets exceeds certain thresholds, you must file Form 8938 to report these assets.
- Form 3520/3520-A: If your foreign pension is classified as a trust, you may also need to file Form 3520/3520-A to report any transactions or distributions from the pension.
Failing to report foreign pensions or failing to comply with the IRS reporting requirements can result in substantial penalties, so it’s essential to ensure that you are fully compliant.
Planning for Retirement as a US Expat
As a US expat working in the UK, planning for retirement involves understanding how your UK pension will be taxed by the US. It’s crucial to consider the tax implications of both your contributions and withdrawals, as well as the potential for double taxation.
Consulting with a tax professional who specializes in expat taxation is highly recommended to ensure that you are taking advantage of all available tax benefits, such as the Foreign Tax Credit and the US-UK tax treaty. Additionally, understanding how to structure your pension withdrawals can help you avoid unnecessary penalties and minimize your overall tax liability.
