Treatment of Foreign Pensions When It Comes to US Taxation

Understanding foreign pensions can be difficult, especially when you already have to navigate the often-complicated US taxation process while living abroad! Whether you’re planning to retire overseas or move back to the US eventually, you should be aware of some things regarding your foreign pension. In fact, Jacqueline Bugnion, former director of American Citizens Abroad, Inc., along with legal counsel Paula Singer, highlighted the consequences of foreign pensions and offered recommendations as to how they believe foreign pensions should be taxed.

Foreign Pensions and US Taxation: The Basics

With nine million Americans living abroad as expats, being taxed on their worldwide income by the US and likely also taxed in the country in which they reside, the tax implications of foreign pensions is an important topic. In general, foreign pensions are not considered qualified pension plans like those in the US, so the manner in which they are handled is different.

Currently, the following tax treatment applies to foreign pension plans:

  • Contributions – Since foreign pensions aren’t qualified plans, employee contributions do not reduce the employee’s taxable US income, and employer contributions to a foreign pension fund increase the employee’s taxable income.
  • US Taxation – With US qualified pensions, income accrues tax-free; however, foreign pensions are treated as income of the participant subject to taxes annually. In some cases, this is punitive if the foreign plan fund invests in foreign mutual funds or exchange-traded funds (classified by the IRS as passive foreign investment companies, or PFICs).
  • Double Taxation – Foreign pension fund distributions are taxed by the US and the country you reside in, which in many cases, you can avoid by claiming a Foreign Tax Credit. However, under US law, you’ll end up paying taxes twice on foreign pension accounts – when they accrue and when they are paid out. Note that tax treaties exist between some countries, which makes it easier for Americans to participate in foreign pension plans without incurring double taxation.

Reporting Requirements

The reporting requirements for foreign pensions are often complex, as additional requirements may exist on top of reporting employer contributions to foreign pensions and income earned from the pensions on your US tax return. You may also need to utilize the following forms, depending on your specific situation:

  • Form 3520 – required if you have any transactions with a foreign trust
  • Form 3520-A – required for trustees, and includes information the grantor needs to file Form 3520
  • Form 8621 – required if PFIC rules apply
  • Form 8938 – required for reporting on all foreign financial assets, including foreign pensions, if you meet the filing threshold
  • FinCEN Form 114 (aka FBAR) – fulfills the reporting requirement of foreign bank and financial accounts if you meet the filing threshold

Understanding which forms apply to your specific situation is not always straightforward, so consulting with an expat tax professional to determine US taxation requirements is a good idea.

Recommendations for Improving Treatment of Foreign Pensions

According to Bugnion and Singer, Congress must implement changes to amend how US taxation laws treat foreign pensions. They believe the changes should apply to all Americans abroad, not just those in foreign countries with a US tax treaty in place. These recommendations would mean foreign pension funds generally correspond to pension funds established in the US, and those that are considered comparable to US pension plans would be exempt from FATCA reporting and taxed like US pensions. The goal here would be to establish a more fair process for foreign pension treatment, in order to provide the same type of advantages US pensions receive when it comes to saving for retirement.

Need More Info About Foreign Pension Plans and US Taxation?

Our team of dedicated CPAs and IRS Enrolled Agents can help! Contact us today for the expat tax advice you’re looking for, so you can get back to what you do best – enjoying your adventure abroad.

Originally published in 2016; updated May 9, 2018.

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