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A mixed blessing
UK pensions don’t qualify as retirement plans under US domestic legislation because they are not established in the USA. Despite this, in theory, the current US/UK income tax treaty allows US citizens and residents to claim relief in three ways:
- On certain contributions to plans
- On income and gains within the plan before there is a distribution or benefit
- On amounts drawn from the plan that are UK tax-free
In practice, however, a lack of clarity in the relevant provisions makes applying the treaty relief complicated and subject to interpretation. With SIPPs, for example, while the treaty can protect an individual from US taxation on income and gains in a pension plan, additional reporting obligations for non-US trusts may arise.
In fact, the treaty won’t always benefit US taxpayers. In some cases, it makes sense to waive treaty benefits and include income and gains from a pension scheme, particularly with an employer plan. This can happen when the contributions or the full vested accrued benefit can be added to US taxable income with little or no increase in the resulting tax, for example. Doing so allows the basis to build up in the plan for US tax purposes and the individual to use UK tax credits to offset the increased income. If a taxpayer is transferring funds to a SIPP, they may also choose to forgo the treaty and treat the transfer as taxable in the US (but relieved by foreign tax credits).
In such cases, the amounts in question are taxable only once in the US. They should be tracked to ensure that pension payments at retirement take account of previously taxed income for US purposes.