For UK citizens who have moved to the United States and become US tax residents, understanding the tax treatment of UK workplace pensions is an essential part of international tax planning. UK work pensions, including defined benefit (DB) and defined contribution (DC) schemes, present several complex considerations under US tax law and the provisions of the US-UK Income Tax Treaty.
Overview: Tax Residency and Global Taxation
The US taxes its residents (citizens and green card holders included) on their worldwide income. This means if you are a UK citizen living in the US and receiving or accruing a UK work pension, it is potentially subject to US taxation, even if it is not yet being distributed.
Fortunately, the US-UK Income Tax Treaty provides relief that may reduce or defer US tax exposure depending on the specifics of the pension scheme and when benefits are accessed.
Key Considerations for UK Work Pensions in the US
1. Types of UK Work Pensions
UK workplace pensions come in two broad categories:
Defined Benefit (DB) Schemes: Provide a guaranteed income based on salary and years of service. Defined Contribution (DC) Schemes: Accumulate value based on contributions and investment performance.
Both types are treated as foreign pension plans for US tax purposes and are not recognised as “qualified plans” under US tax law.
2. Tax Treatment During Accumulation
Without treaty protection, the US might attempt to tax:
Employer contributions as current income Investment growth annually, even if not withdrawn
However, Article 18(1) of the US-UK Income Tax Treaty provides that the US should not tax the income of a UK pension scheme until a distribution is made, provided the individual was a UK resident when the contributions were made and the pension scheme is recognised for UK tax purposes.
This defers US taxation until withdrawal, mirroring the treatment under UK rules.
3. Tax Treatment on Distribution
Under Article 17(1)(b) of the Treaty, distributions from UK pensions to US residents are generally taxable only in the United States.
The UK does not withhold tax on pension distributions if you are no longer tax resident there. The US taxes these distributions as ordinary income.
This means that when you start receiving your UK pension in retirement, the amounts will be included in your US tax return and taxed according to your marginal rate.
4. Lump Sum Payments
If you take a tax-free lump sum from your UK pension (commonly 25% of the total fund), the UK will not tax it. However, the US may treat the full lump sum as taxable income, unless a valid interpretation of the Treaty is applied.
There is ongoing debate about whether the Treaty permits the same tax-free treatment in the US. It is important to work with a professional to assess your specific facts.
5. Foreign Tax Credit or Exclusion
Because UK pension distributions to US residents are typically only taxed in the US (per the Treaty), the Foreign Tax Credit does not generally apply. But if any UK tax has been paid, the credit may offset the US liability.
Planning Tips and Common Pitfalls
Report Foreign Accounts: If your UK pension is held in an account with a reportable balance, it may need to be disclosed on FBAR (FinCEN 114) and Form 8938. Avoid Early Withdrawals: Taking distributions before age 59½ could trigger early withdrawal penalties under US rules. Coordinate With a Specialist: The interplay between US domestic law and the US-UK treaty requires nuanced analysis.
Final Thoughts
Navigating the tax treatment of a UK work pension while living in the US involves understanding both domestic tax rules and treaty provisions. While the US-UK Income Tax Treaty can help defer or reduce US taxation, compliance requirements remain significant.
The information in this blog post is for general informational purposes only and does not constitute professional tax advice. We strongly recommend consulting a qualified tax professional before making any decisions. US Expat Tax Advisor is not liable for any actions taken based on this content.
If you would like more information or want to schedule a one-on-one consultancy call, please get in touch using our contact form.
