Contributions to UK Pension (similar to 401k) – tax free in the US?

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Topic Author
ThisTooShallPass123
Posts: 6
Joined: Sun May 16, 2021 3:01 pm

Contributions to UK Pension (similar to 401k) – tax free in the US?

Post by ThisTooShallPass123 »

I have read through the US UK Income Tax Treaty and the Technical Explanation to the best of my ability. My question is how contributions to a UK pension should be classified in the following scenario(s). Note, this only relates to filing US taxes, not UK taxes. Also, I’m using the word “pension”, but this is a plan where a percentage of salary is contributed, and then the employer also kicks in an amount – very similar to a US 401(k).

Details:
  • EU Citizen working and living in UK (pre-Brexit), and started contributing to a UK pension plan (having contributed to this before moving to the US is important as it relates to the treaty).
  • Moved to US under a UK contract and kept contributing to the UK pension via paycheck deductions. For US tax filing purposes, reduced US income by the amount contributed to the UK pension by having a negative entry for “Other Income” on Form 1040.
  • Obtained green card, continued contributions to the UK pension and offsetting end of year taxes by a negative entry for “Other Income” on Form 1040.
  • Became a US citizen, contributions continued, offsetting income when filing taxes continued as in prior years.
When I read through the US/UK treaty, it seems fairly straightforward:
contributions paid by or on behalf of that individual to the pension scheme during the period that he exercises an employment or self-employment in the other State shall be deductible (or excludable) in computing his taxable income in that other State [Article 18, Paragraph 2a]
The Technical Explanation adds:
It is irrelevant for purposes of paragraph 2 whether the participant establishes residence in the State where the individual renders services (the “host State”). The benefits provided in paragraph 2 are similar to the benefits the U.S. Model provides with respect to contributions.
Other relevant points:
• Amount contributed has always been around $5,000 to $7,000 USD (under US/UK limits)
• The US W-2 does not appear to deduct the pension contributions from Box 1 (Wages).

The specific questions are:
  • Is the approach of simply reducing income as a qualified UK pension contribution on the Other Income section of the 1040 appropriate?
  • Does residential status (resident, permanent resident (green card), citizen) matter in any of this?
The main reason I started questioning this approach is other articles, such as this: https://www.hrblock.com/expat-tax-prepa ... on-schemes
Thanks to the U.S./U.K. tax treaty, U.S. citizens with U.K. pensions can deduct contributions from income to their U.K. pension just like they could for an American 401(k) or similar retirement vehicles. However, you must reside within the U.K. to get this preferential treatment—the minute you move back to the U.S. you’re taxed on your U.K. pension contributions just like you would be for any other nonqualified plan.
In my specific scenario, it was a move from the UK to the US, and then later obtaining US citizenship. But maybe the important aspect is this the plan originated in the UK and the contributions just continued?

Any further info or guidance is much appreciated.
TedSwippet
Posts: 3772
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Contributions to UK Pension (similar to 401k) – tax free in the US?

Post by TedSwippet »

Welcome.
ThisTooShallPass123 wrote: Sun May 16, 2021 7:38 pm My question is how contributions to a UK pension should be classified in the following scenario(s). ...
... Became a US citizen, contributions continued, offsetting income when filing taxes continued as in prior years.
So, you are currently: a US citizen; a US resident; and, holding and making contributions to a UK pension plan. That gives you some treaty coverage, but the open question is, to what degree?
ThisTooShallPass123 wrote: Sun May 16, 2021 7:38 pm When I read through the US/UK treaty, it seems fairly straightforward:
contributions paid by or on behalf of that individual to the pension scheme during the period that he exercises an employment or self-employment in the other State shall be deductible (or excludable) in computing his taxable income in that other State [Article 18, Paragraph 2a]
The part that I think you have missed in the treaty is Article 1 paragraph 4, the so-called 'saving clause', and Article 1 paragraph 5(b). Emphasis below is mine:
4. Notwithstanding any provision of this Convention except paragraph 5 of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if this Convention had not come into effect.

5. The provisions of paragraph 4 of this Article shall not affect:
...
b) the benefits conferred by a Contracting State under paragraph 2 of Article 18 (Pension Schemes) and Articles 19 (Government Service), 20 (Students), and 28 (Diplomatic Agents and Consular Officers) of this Convention, upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State.
So, Article 1 paragraph 4 disallows the entire treaty for US residents and US citizens, and Article 1 paragraph 5 then re-allows a small handful of articles. Article 1 paragraph 5(b) says that Article 18 paragraph 2 is an exception to Article 1 paragraph 4, but only if you are not a US citizen or green card holder. You are a US citizen (and formerly a green card holder), so Article 1 paragraph 4 applies, and this overrides (negates) the Article 18 paragraph 2 that you are relying on to make your UK pension contributions US tax-relieved.

The Technical Explanation has a bit more to say on this. Again, the emphasis is mine here:
Article 18
...
Relation to other articles
... Paragraph 2 is not subject to the saving clause by reason of subparagraph 5(b) of Article 1. Accordingly, the benefits of paragraph 2 will be available to residents of the United States who are not citizens of the United States nor admitted for permanent resident ("green card" holders) in the United States.
So, you were fine up to the date on which you became a green card holder. At that point, it appears that you lost treaty coverage for contributions to your UK pension, so that they became part of your annual US taxable income.

Excruciating, isn't it?
Topic Author
ThisTooShallPass123
Posts: 6
Joined: Sun May 16, 2021 3:01 pm

Re: Contributions to UK Pension (similar to 401k) – tax free in the US?

Post by ThisTooShallPass123 »

So, you were fine up to the date on which you became a green card holder. At that point, it appears that you lost treaty coverage for contributions to your UK pension, so that they became part of your annual US taxable income.

Excruciating, isn't it?
Thank you for the explanation. I have tried to find flaws in your logic, haha...unfortunately I have not found any.

Does this imply some sort of accounting, similar to a Form 8606, where I should keep track of money already taxed? I would hate to put in $5,000 one year, pay tax on it, take out $6,000 down the road (assuming $1k in gains), and get taxed on $6,000. That would essentially double tax the contribution.

Thanks again for the additional info on the treaty; much appreciated.
TedSwippet
Posts: 3772
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Contributions to UK Pension (similar to 401k) – tax free in the US?

Post by TedSwippet »

ThisTooShallPass123 wrote: Mon May 17, 2021 9:32 am Does this imply some sort of accounting, similar to a Form 8606, where I should keep track of money already taxed? I would hate to put in $5,000 one year, pay tax on it, take out $6,000 down the road (assuming $1k in gains), and get taxed on $6,000. That would essentially double tax the contribution.
I imagine that there could be some way in the US tax code to account for what might be a mix of post-tax and pre-tax contributions to a non-US pension plan covered by treaty. But since I am not a US citizen, or green card holder, or resident, and so not under the jackboot of the IRS (hooray!), I'm afraid that I don't know what that would be, if indeed it exists at all. Sorry.

A cursory check of the US/UK tax treaty didn't show up much of anything useful, at least as far as I could see, though I might have missed some detail. Article 24, 'Relief from Double Taxation', talks only about crediting US tax against UK tax, and vice versa, to avoid both countries taxing a single piece of income. The treaty perhaps won't concern itself with the ways in which the US might contrive to itself tax a single piece of income twice.

One thing to realise is that due to timing issues, some element of cross-border double-tax can be quite common, both in ordinary accounts and in pensions, and even where there is a treaty. For example, some US states do not recognise non-US pensions for treaty purposes (for example, California famously does not allow Canadians living there to defer tax on gains inside their RRSP accounts, even though these are treated as US pensions for federal tax purposes; could be the same for SIPPs and other UK pensions too). Or, you open and hold a non-US and non-treaty pension, move to the US, pay US tax annually on gains inside the pension as if a grantor trust, leave the US, and then pay tax again on the pension withdrawals because your non-US country will not credit US taxes paid years or decades earlier on those gains. A treaty is less about avoiding double tax for individuals than it is about dividing up the spoils for the countries involved.

For you, the thing to do for now is to stop making UK pension contributions, and use IRAs or 401ks instead. That should at least lessen issues going forwards. I don't know what you do to clean up any past contributions to UK pensions that you have already made and which you may have now incorrectly (perhaps invalidly, under the treaty) claimed as US tax deferred.
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