Is UK Pension Plan Income Taxable in the US?
In short, yes. Irrelevant of how the UK views these personal pension payments, the IRS will be collecting tax on any amount withdrawn from your pension plan.
There are currently around 700,000 British nationals living in the US, as well as 166,000 US nationals living in the UK. The likelihood is that some or most of these individuals have built up UK pension benefits.
Is the income taxable in the UK?
Luckily, due to the double taxation agreement in place between the UK and the USA, the income is only taxable in your country of residence but only if certain steps are taken.
If you apply for your NT code, you can have the income paid out gross of UK taxation. You then declare the pension income on your US tax return and pay the relevant tax.
Having the NT code in place, avoids the UK HMRC taxing the payments at source. You can read our blog here on how to apply for your code.
What about the 25% Pension Commencement Lump Sum (PCLS)?
In the UK, HMRC generously allows you to take 25% of your pension value tax-free (capped at the LTA limit).
Unfortunately, this benefit does not apply in the US and the full amount will be taxable at your marginal rate. If you have taken a large lump sum, it could push you into the higher rate bands and subsequently a large US tax bill.
It’s therefore important to take caution when drawing down income from your UK pensions, as benefits that apply in the UK may not apply in the US.
When can I access it?
You can access your UK pension from the age of 55. This is thanks to the ‘Pension Freedoms Act 2015’ which gave people greater freedoms over how they and when they drawdown their pensions.
This is compared to the US, where you have to be 59 ½ to access a IRA/401K without penalties. If you withdraw from your plan prior to 59 ½, the US Government charges a 10% penalty on the fund value.
The UK pension can be quite useful therefore, as people tend to draw down their UK pension income to bridge the gap between 55 and when they can access their US penalty tax free. The withdrawals can be phased to ensure they are taken tax efficiently, making use of the relevant tax bands.
The importance of getting advice
It’s always useful to take some advice before making a decision regarding your pension and retirement plan. This can be assessing your options in terms of transferring to a solution that provides flexible access, or when and how much to draw down to ensure you don’t receive an unpleasant surprise from the IRS.
If you are a US resident with a UK pension, please feel free to get in touch for a free, no-obligation consultation.