US citizens residing in the UK with American retirement accounts face unique tax considerations when taking distributions. The type of distribution, whether regular (periodic) or lump sum, can significantly affect how it is taxed in both the US and the UK. Understanding these differences is crucial for optimising tax efficiency and ensuring compliance in both jurisdictions.
US Tax Treatment
For US citizens, the US taxes worldwide income regardless of where they live. Pension distributions, whether from a 401(k), traditional IRA or Roth IRA, are no exception.
401(k) and Traditional IRA
Regular distributions: Taxable as ordinary income in the US. Lump sum distributions: Also taxable as ordinary income. However, if taken before age 59½, a 10% early distribution penalty may apply unless an exception is met.
Roth IRA
Qualified distributions (account held for at least 5 years and recipient over age 59½): Tax-free. Non-qualified distributions: Earnings portion is taxable, and may be subject to the 10% early distribution penalty.
UK Tax Treatment
As a UK tax resident, the UK also reserves the right to tax worldwide income. However, the US-UK income tax treaty provides relief that helps prevent double taxation.
Article 17 (Pensions and Annuities)
Regular (periodic) pension payments: Taxable only in the country of residence (UK), unless the payments would have been exempt in the source country (US). For example, if a Roth IRA distribution would be exempt from tax in the US, the UK must also exempt it.
Article 17(2) (Lump Sum Payments)
Lump sum distributions: Taxable only in the country where the pension is established (US). This means the UK should not tax lump sum withdrawals from US pensions.
Summary Table
401(k)/Traditional IRA Regular Distributions:
Taxed in both countries. Relief available through the foreign tax credit.
401(k)/Traditional IRA Lump Sum Distributions:
Taxed in the US only, under Article 17(2).
Roth IRA Qualified Distributions: Tax-free in both the US and UK, under Article 17(1).
Roth IRA Non-qualified Distributions: Taxable earnings portion and penalties in the US, also taxable in the UK. Foreign tax credit may apply.
Example
Jane is a dual US-UK citizen living in London. At age 60, she withdraws $30,000 from her traditional IRA over a period of 12 months.
US: The entire $30,000 is taxable as ordinary income.
UK: The UK also taxes the income as a regular pension under Article 17(1). Jane can claim a foreign tax credit.
Now suppose Jane instead takes a $30,000 lump sum distribution from her 401(k):
US: The distribution is taxable as ordinary income.
UK: The distribution should be exempt from UK taxation under Article 17(2).
Final Thoughts
The tax treatment of US pension distributions for UK residents depends not only on the account type, but also on whether the distribution is regular or lump sum. Misunderstanding these differences can lead to unexpected tax bills or missed opportunities for relief.
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.
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