Retirement can be an exciting moment in many people's lives. As a US person planning to retire in the UK, with a mixture of US and UK pensions, it's important for you to make a plan to prevent double taxation and minimise the US/UK tax burden as much as possible.
The case study below shows how one of our clients benefited from tax reliefs, distributions at lower tax rates, and avoiding double taxation when withdrawing from US and UK pensions.
Case study: Planning ahead for lower tax rates
Mrs Pounce is an American client of ours who had been living in the UK for ten years and was approaching retirement. She was looking to retire in the UK and required a review of her US and UK pensions, which had built up over her working life, to make a plan to withdraw from them in both a US and UK tax efficient way. Mrs Pounce took financial advice too, but this article focuses on the US/UK tax position.
Withdrawing pensions
For a dual US and UK taxpayer, the US-UK double taxation treaty can be used to prevent double taxation, but firstly we will want to review the domestic US and UK tax rules to make a tax-efficient plan.
There are a number of factors to take into account if you want to minimise the tax you have to pay upon withdrawing your pensions. The following table is a useful overview of how pension distributions are taxed for US citizens:
| Plan location | What received? | UK tax | US tax |
| UK | 25% lump sum | Nil | Nil |
| UK | Balance | Taxed if resident | Taxed but credit available |
| US | 100% of sum | Nil | Taxed |
| US | Partial distribution | Taxed if resident | Taxed but credit available |
To minimise your US/UK tax exposure, the order of the pension distributions should be reviewed at the same time as financial advice is taken. Advice should be sought to determine what qualifies as a lump sum.
UK pensions
Mrs Pounce had not realised that the 25% Post Commencement Lump Sum (PCLS) could be received tax free in both the UK and the US, provided the correct claim is made under the US/UK double taxation treaty. She is pleased to have access to this tax-free cash. Mrs Pounce is currently in the top rate of UK tax. She can take this payment ahead of retirement and have access to the money at 0% tax rather than the 45% she pays on her income currently. The funds from the 25% PCLS will help meet her spending needs in the short term.
After she retires Mrs Pounce will no longer be an additional rate taxpayer. Further to our planning she intends on withdrawing from her UK pensions, keeping her income within the basic rate UK tax, meaning they will be taxed at up to 20%. This is a 25% tax saving.
US pensions
Mrs Pounce has a couple of Individual Retirement Accounts (IRA) in the US. If the withdrawals qualify for lump sum treatment, the US will tax the distributions and not the UK. US tax rates are generally lower than in the UK – they are currently up to 37% rather then up to 45% in the UK. This gives Mrs Pounce access to more funds in her retirement, at a lower tax rate than what she is paying now. We will review this at the time of distribution to ensure that the lump sum distribution does not push her other income sources into a US tax rate that mean UK foreign tax credits are not adequate to cover the US tax due.
Mrs Pounce could take partial distributions from her US pensions. As her plan is to keep her tax rate in retirement to 20%, the total distributions from both her US and UK plans need to be reviewed to keep her in the basic tax rate band. She will need to consider the timing of UK tax payments to avoid double taxation. Generally, if UK tax is paid in the same calendar year that IRA distribution is generated, it can reduce the US tax due.
Moving back to the US
Mrs Pounce wants to retire in the UK. However, there is a small possibility that she may move back to the US. At this stage her tax obligations will switch to having a US focus, so we will review the pension distribution plan again before her move.
How we can help
Planning for retirement in an unfamiliar environment can be confusing. We're here to simplify the tax and take a risk-sensitive approach to financial planning, which puts you in control. With both US/UK tax and financial planning specialists under one roof, our experts can collaborate to advise on the best way to plan for the future, with an approach tailored to your unique circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.