Table of contents:
Q: Is my pension taxable? SIPP, ISA, GPP - can they be deferred?
A: In general, pension distributions are taxable for U.S. citizens in the U.S. and the UK.
Employer pension - income deferral. Individual plans - not eligible.
Employer retirement plans and individual pension plans (SIPP, GPP) qualify for income deferral.
Non-pension investment products with income deferral allowed in the U.K. (ISA) are not eligible for income deferral in the U.S.
Deferral of the incU.S is a privilege - not many countries offer this.
Most countries do not have the privilege of income deferral for any pension plans. Only a few countries and the U.K. is one of them, U.K.e this privilege, but it only applies to employer pensions, not individual retirement plans.
So what does this mean for my tax return?
Of these plans, only growth in the ISA is included in your annual income. When you receive it, it will be excluded from the taxable portion of pension distributions.
Q: I am a covered expatriate. How will my pension be taxed after expatriation?
A: U.S. pensions are eligible for deferred compensation. They are not subject to taxes under the deemed sale rules.
For eligible deferred compensation items, the plan administrator or trustee must withhold U.S. tax at 30% on the taxable portion of a distribution. This practice of withholding tax at the time of issuance is done instead of the application of deemed sale rules on the day before the date of expatriation.
Ineligible deferred compensation items (non-U.S. tax-deferred accounts) will be treated as being distributed on the day before the date of expatriation. The deemed distribution will be subject to income tax at ordinary income tax rates. Still, the penalties that generally apply to early withdrawals from such accounts will not apply to a deemed distribution under the expatriation rules. A basic adjustment will reflect the taxes incurred due to the deemed distribution under the expatriation rules.
Q: How do I report my pension if its value is not calculated until retirement?
A: Some practitioners take the position that a defined benefit plan does not need to be reported on FBAR because plan participant does not have an account in their name with control or signatory authority.
However, this advice contradicts the Basic Questions and Answers on Form 8938, suggesting a "reasonable estimate" of the value of the defined benefit plan. A defined benefit plan usually has a residual cash value payable to the beneficiaries if the plan participant dies before retirement age. This is the value of a defined benefit plan (the UK or another country) reportable on FBAR:
If you can reasonably estimate the value of the pension, enter the estimate as the maximum value.
If you cannot estimate reasonably, enter the sum of distributions during the year as the maximum value.
Note: the account does not need to be reported if you cannot estimate and there were no distributions.
Q: Is it possible to roll over a pension fund or superannuation benefits into a U.S.-based account without owing taxes?
A: If a U.S. citizen who worked in Australia wanted to transfer his superannuation pension to the U.S., it would be impossible to roll those funds over into a U.S.-based retirement account without paying taxes.
Superannuation is considered a foreign non-IRS qualified retirement plan, and any transfer of these funds is a taxable event.
Q: I will roll over the 401(k) plan to my IRA. How will TFX report it, as income or a withdrawal?
A: When someone rolls over their employer-sponsored retirement saving plans, such as a 401(k), 403(b), or 457 into an Individual Retirement Account (IRA), the tax treatment depends on the type of rollover. There are two main types: direct rollover and indirect rollover.
Direct Rollover: If the individual chooses a direct rollover, the funds from the 401(k) plan are transferred directly to the IRA without the individual ever taking possession of the money. This type of rollover is not subject to immediate taxation. The funds will continue to grow tax-deferred within the IRA until distributions are taken in the future.
Indirect Rollover: In an indirect rollover, the funds are distributed to the individual, and they have 60 days to deposit the money into an IRA. However, there are important tax implications to consider with an indirect rollover. By default, the plan administrator is required to withhold 20% of the distribution for federal income taxes. If the individual fails to deposit the full amount (including the withheld amount) into an IRA within 60 days, the amount not rolled over will be treated as a taxable distribution. Additionally, if the individual is under 59½ years old, they may be subject to a 10% early withdrawal penalty on the taxable portion of the distribution.
Example: Jordan, age 42, received a $10,000 eligible rollover distribution from her 401(k) plan. Her employer withheld $2,000 from her distribution.
If Jordan later decides to roll over the $8,000, but not the $2,000 withheld, she will report $2,000 as taxable income, $8,000 as a nontaxable rollover, and $2,000 as taxes paid. Jordan must also pay the 10% additional tax on early distributions on the $2,000 unless she qualifies for an exception.
If Jordan decides to roll over the full $10,000, she must contribute $2,000 from other sources. Jordan will report $10,000 as a nontaxable rollover and $2,000 as taxes paid.
If you roll over the full amount of any eligible rollover distribution you receive (the actual amount received plus the 20% that was withheld - $10,000 in the example above):
Your entire distribution would be tax-free, and
You would avoid the 10% additional tax on early distributions.
Refer to the IRS website for more detailed information and resources on rollovers.
Q: Is that true that expats cannot contribute to ROTH IRAs?
A: No, this is not true.
To qualify for a ROTH IRA, a taxpayer must have earned income. Because of this rule, if all of your income is excluded through the Foreign Earned Income Exclusion, you cannot make contributions to a ROTH IRA. You may not choose to exclude only part of your foreign-earned income to contribute to a ROTH IRA. The rule is - to exclude it all or nothing.
However, you may claim the shorter 12-month period abroad, which will naturally reduce the amount of the exclusion, thus leaving a part of your earned income qualifying for ROTH.
Having a part of your income exempt from the exclusion would remain below the tax threshold (bearing in mind the personal exemption and standard deduction). You would also be eligible to contribute to a ROTH IRA if the amount contributed does not exceed the reported income ($5,500). You can have your cake and eat it too.
You may also participate in an employer-sponsored 401-K plan. The Foreign Earned Income Exclusion applied to your wages will be reduced to the number of contributions made to the plan.
Q: How much can I contribute to my IRA for this calendar year? Do I need to make my contributions before the year-end?
A: Contributions to Traditional or ROTH IRAs can be created until April 15, 2023 (for the 2022 tax year).
We recommend that you file your tax return early next year so that we can calculate how much you can put toward your IRA when we're preparing your return. That way, you can be sure you won't ever need to amend your return.
Q: This year I paid the penalty for excess ROTH contributions. What can I do now to prevent paying the penalty next year? Will I be able to contribute to my ROTH IRA again?
A: We applied a 6% penalty for excess ROTH contributions because we excluded your foreign-earned income. The income tax rate on the non-excluded earnings would be much higher (15% to 28%, depending on your gross income).
To avoid paying the penalty next year, you will need to do two things:
You will need to withdraw your excess contributions by the end of the year. If your excess contributions were made for 2022, you must withdraw them before the due date of your federal tax return for 2022, including extensions (October 15, 2023, if an extension was filed). You must withdraw the entire amount of excess contributions and any accumulated earnings from that amount. If you don't do so, you will continue to pay the penalty on your excess contributions every year, and the option to withdraw your extra contributions will no longer be available.
Don't hesitate to get in touch with us early next year. We will prepare a draft of your tax return and tell you the number of contributions you are allowed to make over the rest of the year. Do not make any contributions now. You have until April 15 of next year to make contributions for this year.