If you’re a US expat living abroad and wondering whether to save for retirement in a local or US pension, or if you have acquired a foreign pension plan during your time living and working abroad, there are several important factors to bear in mind.
As an American living abroad, you’re still subject to US tax laws due to America’s Citizenship Based Taxation system. While foreign pension plans typically enjoy favorable tax treatment in their own countries, they may not receive similar treatment under US tax rules, meaning that you may have to report your foreign pension as part of your annual US tax return, and there may be potential tax liabilities.
In this article, we provide an overview of foreign pension plans and some of the main considerations associated with them.
Foreign pension plans and US taxation
Some foreign pension plans function similarly to retirement accounts in the US, allowing you to either contribute pre-tax income and defer paying any tax until you make withdrawals, or to contribute post-tax income and make tax-free withdrawals in retirement.
Many Americans with foreign pensions mistakenly believe that foreign pension plans receive the same US tax benefits as US pensions and retirement accounts. However, in terms of US taxes, foreign pension plans generally do not qualify for the same tax perks as US accounts. In the absence of a tax treaty, contributions to foreign pension plans are usually not tax deductible or tax-deferred for US income tax purposes, and in some cases, you may be taxed on the annual growth in the plan, even if it’s not distributed to you. Similarly, neither are withdrawals from foreign pensions automatically US tax-free.
Here are some foreign pension plans frequently encountered by Americans living abroad:
- U.K. workplace pensions and self-invested personal pensions (SIPPs)
- French Plan d’épargne retraite (PER)
- Australian superannuation system
- Canadian registered retirement savings plans (RRSPs)
- Swiss three-pillar pension system
However, there is some good news. The US has income tax treaties with certain countries, including Canada, the UK, Germany, Belgium, and the Netherlands, which include provisions on pensions. If your pension is from one of these countries, you may receive favorable treatment under these treaties. Since a key element of income tax treaties is to avoid double taxation of income, treaties will in many cases provide for similar treatment of pension benefits in the country of residence as in the treaty country.
It’s important to stay compliant with US tax laws regarding foreign pensions to avoid potentially penalties. Reporting foreign pensions on your US tax return can be complex and time-consuming though. There is also uncertainty regarding the application of US tax laws to some types non-US pension plans. In general, while some pension funds may be exempt, proactive reporting is advisable to avoid penalties and fines.
There are several ways in which you may have to report foreign pension plans in the US:
Form 1040 – Typically, employer and employee contributions must be reported as part of your gross income, as well as distributions from foreign pension plans.
FinCEN 114 (FBAR) if the total value of the balances of all your foreign financial accounts, including your pension plan, exceeds $10,000 at any time during the year.
FATCA Form 8938 if the combined value of your foreign accounts and assets exceeds a $200,000 at the end of the year or $300,000 at any time in the year.
Form 8621 if your foreign pension account is not recognized as a pension under the tax treaty, then the assets within may be Passive Foreign Investment Companies (PFIC). This refers to pooled foreign investments such as mutual funds and some pension plans, and these types of investments are also taxable in the US.
Form 3520 if your foreign pension is held in a trust-like structure. Additionally, if your pension assets in trust are treated as if they’re owned directly by you, you may need to file Form 3520-A in addition to Form 3520.
Ensuring proper reporting of your foreign pension income is essential to remain compliant with US tax laws.
Should you save for retirement in the US or abroad?
It’s always sensible to seek advice from an expat specialist financial advisor when retirement planning as an expat. It’s still possible to contribute to US IRA plans as an expat, although if you claim the Foreign Earned Income Exclusion when you file your US taxes, you may be limited. Some of the main considerations are whether you plan to retire in the US or abroad, where you are receiving your income from which you want to make contributions, and the relative strengths of the two currencies.
Incorporating your foreign pension into your retirement plan
It can still make sense to contribute to a foreign pension plan even without treaty protection or US tax-qualified status as part of your retirement strategy. For example, if you employed abroad and your employer contributes to a foreign pension plan on your behalf, the benefits could outweigh the tax liability. It can also be beneficial to have both US and foreign pension plans to diversify the currencies in which you’ll receive income in retirement.
With good advice and careful planning, your foreign pension can be a valuable part in your retirement portfolio.
Withdrawing from Pensions
Another important financial planning aspect for people who have pensions in multiple countries is, when the time comes, which pensions to tap, and when to do so. Countries have different rules as to when a pension-owner can begin distributions from pensions. In some cases, tapping a pension early can lead to penalties, or perhaps there is an age at which mandatory withdrawals are necessary, or it may be a possibility to convert one type of pension account to another with different benefits.
In conclusion
As an American expat, it’s important to understand the relevant tax laws and reporting requirements to sidestep potential liabilities and penalties. In some cases, focusing on US-based investments may offer you the most effective path to future financial security. Given the complexity of foreign pension rules, it’s advisable to seek the advice of an expat financial advisor before starting to contribute or filing your US tax return.
If you have any questions about financial planning as an American living abroad, get in touch.
This article is for informational purposes only; it is not intended to offer advice or guidance on legal, tax, or investment matters. Such advice can be given only with full understanding of a person’s specific situation.