US citizens who live in the UK should be aware of the tax implications that come with receiving pensions and Social Security benefits from the US. We aim to explain how income is taxed under the UK-US Double Taxation Convention in a clear and simple way. This will cover remittance basis, lump-sum payments, and the treaty’s saving clause. We hope that this information provides helpful guidance on the topic. Please keep in mind that this is a general overview. If you have any questions about your specific situation, please give us a call to discuss.
As a dual UK-US citizen living and residing in the UK, you may be receiving US Social Security benefits. According to the UK-US Double Taxation Treaty, only the UK has the authority to tax these payments. You must declare these benefits on the foreign pages of your UK Self-Assessment tax return, as stated in Article 17(3) of the treaty. Keep in mind that since no US tax is deducted from these benefits, you cannot claim Foreign Tax Credit Relief.
US Pensions
The taxation of US pensions such as 401(k) plans, IRAs, Roth IRAs, SEP IRAs, and KEOGH plans varies based on your residency status and the type of pension:
Taxation in the US: Generally, these pensions are exempt from US tax if they are liable for UK tax. If US tax has been withheld, you should file a US tax return to seek a refund, as the UK does not offer a tax credit for this. If the pension is not subject to UK tax (e.g., under the remittance basis without remittance to the UK), it may be taxed in the US.
Taxation in the UK:Pensions are typically taxable in the UK unless you use the remittance basis. Notably, parts of the pension not liable to US tax (e.g., Roth IRA distributions or “after-tax” contributions) are also not taxed in the UK. Certain lump-sum withdrawals from non-UK pension schemes may be tax-exempt under specific circ*mstances.
Roth and Traditional IRAs
Roth IRAs:Distributions to UK resident that are not taxable in the US remain untaxed in the UK.
Traditional IRAs:These are taxed in the UK as foreign interest, and the gross interest should be reported on the Self Assessment Tax Return using the supplementary page SA106.
Lump-Sum Withdrawals
Withdrawing your entire 401(k) as a lump sum while residing in the UK involves complexities. In the US, such a withdrawal incurs income tax and possibly an early withdrawal penalty. According to Article 17, Paragraph 2 of the UK-US Tax Treaty, this lump sum should not be subject to UK tax. Nevertheless, you must still report this income on your UK tax return.
The Saving Clause
The tax treaty includes a “saving clause” allowing the taxation of citizens by their own country as if no treaty existed. This could mean that HMRC might tax the lump-sum withdrawal from a 401(k) plan despite the treaty. However, HMRC typically adheres to the treaty, making the application of the saving clause to this scenario unlikely. On the contrary, HMRC will disallow any tax deducted on monthly payments of US pensions by the IRS.
UK State Pension and US Social Security
If you have worked in both the UK and the US, you may be entitled to receive a UK State Pension and US Social Security benefits. The UK State Pension is based on your UK National Insurance contributions, while your US Social Security contributions determine US Social Security.
Under the UK-US Social Security Agreement, you can combine your periods of contribution in both countries to meet the minimum eligibility requirements for benefits. This means that if you have not contributed enough in one country to qualify for benefits, your contributions from the other country can be taken into account.
However, it is important to note that each country will calculate your benefit based on your contributions to their respective systems. You will receive separate payments from each country, and the amount you receive from each will depend on your contribution history in that country.
Windfall Elimination Provision (WEP)
If you are entitled to both a UK State Pension and US Social Security benefits, you should be aware of the Windfall Elimination Provision (WEP). The WEP is a US rule that may reduce your US Social Security benefit if you also receive a pension from a job where you did not pay US Social Security taxes, such as a UK State Pension.
The WEP reduction is based on a complex formula that takes into account your years of substantial earnings in the US and the amount of your non-covered pension. The maximum reduction under WEP is limited to 50% of your non-covered pension amount.
If you expect to receive both a UK state pension and US Social Security benefits, it is crucial to factor in the potential impact of the WEP when planning your retirement income.
Living in the UK as an American can make taxes complicated. It’s wise to seek tax advice from one of our tax professionals who understand both US and UK taxes. Remember to consider how your UK State Pension and US Social Security benefits work together. Our tax advisors can help you navigate the rules, benefits, and exemptions to ensure a secure retirement.
