Some US citizens working abroad end up moving back to the US to live later on, and bring along foreign income they accumulated in a foreign pension or superannuation account. After handling complex expat taxes while living abroad, moving back to the States might cause a sigh of relief when it comes to taxation – but there are certain things you should plan for when it comes to your foreign pension!
Let’s Break It Down
So, you may be thinking of rolling your pension or superannuation dollars over into an IRA or another type of US retirement plan. However, that is not allowed since the US Internal Revenue Code states that most foreign pensions are not considered a “qualified trust.”
As you’re probably aware, the benefit of pensions and retirement plans is the tax-deferral treatment they offer. Most often, your earnings will accumulate in these plans tax-free until you receive distributions from the plan – usually during your retirement. Contributions made to the plan are a tax benefit, since they are not included in your US income for tax purposes.
It’s assumed that this tax deferral gives you a tax benefit, since you’ll likely be in a lower tax bracket during your retirement years than in your working years. This may or may not be the actual outcome, depending on your specific situation – but that is the thinking behind the tax deferral.
In some cases, tax deferral benefits don’t apply to foreign pensions because of tax treaty rules or because your host country doesn’t have a tax treaty with the US. In these cases, you might have to include your foreign income or contributions to your foreign pension or superannuation account within your gross US income, since they would be taxable as they are paid into the plan. There are a few details you should be aware of in this case, since this money may be available for tax-free distribution.
If you had pension contributions (by you or your employer) or account earnings that you included in your US income each year since these amounts are paid into the plan, you have what is now a “cost” or “investment in the contract.” You have the ability to recover this cost tax-free, but there are specific rules you must follow. It’s a good idea to consult with a tax professional, or refer to IRS Publication 575 “Pension and Annuity Income.”
Once you’ve determined if there is any cost in your pension or superannuation that you can recover tax-free, you can consider your foreign pension options. While you can’t roll it over into an IRA or other retirement account, your other options are similar to most US pensions. These include:
- Leaving the foreign income earnings in the foreign pension until you retire. When you retire, you can receive periodic distributions and include the taxable part in your US income as it is received.
- Having the entire pension paid to you in one lump sum distribution or periodically until retirement. You’d then be able to reinvest the proceeds into a different investment account or spend it how you wish. You would include the taxable part of the distribution in your US income the year it’s distributed to you.
- Leaving the money in the foreign pension and pass it along to your heirs.
What to Know About the Early Distribution Penalty
There is typically a 10% early distribution penalty that applies to foreign or US pension or retirement accounts. While this doesn’t apply to any cost or nontaxable portion of your foreign pension distribution, it can apply to the taxable part of your “early” distributions.
There are a few ways you can avoid this penalty, such as:
- Waiting until the year you turn 59.5 or later to receive any foreign pension distributions.
- Working with the retirement plan holder to set up “substantially equal periodic payments, at least annually, for your life.” The payments must be determined in accordance with the allowable methods, which you can find in IRS Publication 575 and Revenue Ruling 2002.62.
Because of the complicated nature of foreign pensions, it is always recommended to consult with a tax professional to be sure you’re fully aware of how to handle these when moving back to the US!
Have More Questions About Foreign Income Earned from Your Pension?
Greenback can help! Our team of expat-expert CPAs and IRS Enrolled Agents is here to help you navigate the complex nature of expat taxation – get in touch with us today!