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Investing in Individual Retirement Plans Abroad – What to Watch Out For
Mohitindervir Sandhu of H&R Block looks at Foreign Trusts
No retirement portfolio is complete without a private retirement plan. However, as a US taxpayer, choosing one based outside the US can result in unwittingly creating a situation where your portfolio, as well as your distributions, could be heavily taxed, thus defeating its purpose.
When we think about trusts, it’s easy to believe that they’re just complex vehicles for legally sheltering income. However, regardless of a trust’s purpose, it is simply an arrangement where one party (a trustee) manages assets on behalf of another party (a beneficiary). Trusts can be used in all kinds of situations, and are not just an instrument for high income taxpayers. For example, if you have a retirement account, such as a 401(k), then you technically have an interest in a trust as a beneficiary.
Individual retirement accounts (as opposed to those provided by an employer) based outside the US are no exception – they are usually also considered trusts. However, in the eyes of the IRS, such trusts must be reported separately from your 1040. A US taxpayer who has a foreign employer plan typically does not have to worry about filing foreign trust forms. This is because while the foreign employer plans are technically trusts, they are exempt from having to be reported on any additional trust tax forms.
For example, a taxpayer who has a QROP in the U.K. or Pillar 3 plan in Switzerland may be required to file all the following forms:
• Schedule B Part III
• Form 3520
• Form 3520-A
• Form 8833
• FBAR, and
• Form 8938 because they have an interest in a specified foreign financial asset.
There can be steep penalties for the non-filing of each of these forms, so it is important to understand each form’s requirements.
In addition to being treated as a foreign trust, the underlying assets of the trust/retirement account can also require filing other forms. Specifically, if the account has non-US based mutual funds, the taxpayer may also have to file a Form 8621. Owning a PFIC (Passive Foreign Investment Corporation) requires tedious tracking of each transaction. Unlike investing in a US fund where a sale is subject to the capital gains rate, all income from a PFIC including dividends (both realized or reinvested) are taxed at punitive rates. In fact, portions of the dividend or gains you realize can be taxed at the highest individual tax rate (37% for 2018) rather than receiving preferential capital gain tax rates.
One of the most attractive features of many private retirement accounts is preferential tax treatment, either in the form of a lower rate or a tax-free lump sum distribution of a portion of the pension pot (which is common among UK pensions). However, unless there are specific provisions within the income tax treaty between the pension country and the US, those distributions will also be taxable for US purposes.
The only way to extricate yourself from these obligations is to either renounce your US citizenship or formally relinquish your green card. Keep in mind that not only would you have to expatriate for immigration purposes, you must also expatriate for tax purposes by filing a final year return with Form 8854.
Thus, the lesson here is exercising caution and consulting a Tax Advisor before contributing to a non-US retirement or investment account. It’s important to have a Tax Advisor help you sort through the distinctions and devise a strategy to minimize your tax burden as you build a solid foundation for your retirement.
H&R Block Expat Tax Services is a specialized team of tax attorneys, CPAs and enrolled agents whose singular focus is preparing taxes for Americans living abroad. Remember that US tax reporting for expats is complex and specific to each person’s situation