Foreign Pensions and US Taxes: A Complete Guide 

Foreign Pensions and US Taxes: A Complete Guide 

Understanding foreign pensions can be difficult, especially when you already have to navigate the 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 these facts regarding your foreign pension.  

In this guide, we’re going to answer a very important question: are foreign pensions taxable in the US? Let’s take a look. 

Key Takeaways

  • Foreign pensions are generally subject to US taxation. 
  • Taxpayers may have to report their foreign pensions on additional tax forms, such as a FATCA report or the FBAR. 
  • Expats who want to move their foreign pension to the US will face complications but do have options. 

Is a Pension from a Foreign Country Taxable in the US? 

Yes. Most foreign pension plans are subject to US taxation. To understand the differences between US pensions and their overseas counterparts, let’s take a look at the tax treatment applied to foreign pension plans.  

1. Taxation of Foreign Pension Contributions 

Since foreign pensions aren’t qualified plans, employee contributions do not reduce the employee’s taxable US income. Similarly, employer contributions to a foreign pension fund increase the employee’s taxable income.  

2. US Taxation of Foreign Pension Income 

With certain US-qualified pensions, income accrues tax-free. However, foreign pensions are treated as the participant’s income which is subject to taxes annually. In some cases, this is punitive if the foreign plan fund invests in foreign mutual funds or exchange-traded funds. These are classified by the IRS as passive foreign investment companies or PFICs.  

3. Double Taxation on Overseas Pensions 

Foreign pensions leave expats vulnerable to two kinds of double taxation. The first is that under US law, your pension funds are taxed both when they accrue and when they are paid out.  

The second type of double taxation on foreign pension accounts is even more of a problem. This happens when foreign pension fund distributions are taxed by both the US and the country of residence.   

Fortunately, tax treaties make it easier for Americans to participate in foreign pension plans without incurring double taxation. A tax treaty will define which country has the right to tax a given pension, removing the risk of both countries taxing it at the same time. 

Pro Tip

If you live in a country with no US tax treaty, you will remain at risk of double taxation. Fortunately, you may still be able to avoid this by claiming the Foreign Tax Credit. The Foreign Tax Credit is dollar-for-dollar credit based on the taxes you pay or owe to a foreign government. You can use this credit to offset your US tax bill by the same amount.

How to Report Foreign Pension Income 

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 on how to report foreign pension income, 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 is always a good idea.  

Are Pensions Considered Earned Income? 

No. Pension income is considered unearned income, not earned. 

Every expat should know these 25 things about US expat taxes. Find out for yourself.
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Can I Offset My Pension Income with The Foreign Earned Income Exclusion? 

The Foreign Earned Income Exclusion is a popular tax benefit that qualifying expats can use to exclude foreign earned income from taxation. So—do pensions qualify for this exclusion? 

Unfortunately, no. As mentioned above, pensions are not considered earned income. As such, you cannot use the Foreign Earned Income Exclusion to exclude pension income from US taxation, even if it is a foreign pension.   

Pro Tip

As mentioned above, you may be able to use the Foreign Tax Credit to reduce your US tax bill.

Are Foreign Pensions Reported on the FBAR? 

Americans who have $10,000 deposited in one or more non-US financial accounts are required to file FinCEN Form 114, also known as a Foreign Bank Account Report (FBAR). The FBAR was designed to combat tax evasion by making it harder for US citizens to hide money in offshore accounts. 

So, do foreign pension plans have to be reported on the FBAR? 

To answer that, we have to talk discuss some factors first. Most employer foreign pension plans fall under one of two types: defined benefit plan or defined contribution plan. 

1. Defined Benefit Plan 

A defined benefit plan is generally an employer or government plan funded by the employer or government, which provides for a fixed benefit in case of retirement or death. In most cases, plan participants are not considered the legal owners, nor can they direct the investments or cause a disposition of funds. Moreover, you may not be able to ascertain the current value or balance of a defined benefit plan before retirement. 

Many financial experts take the position that these plans do not need to be reported on the FBAR. However, a conservative approach would be to report it on the FBAR using a reasonable estimate—if the plan provides for a residual cash benefit payable to the beneficiaries upon the plan participant’s death before retirement age, this amount may be used as the balance to be reported on the FBAR. If you are currently receiving benefits under such a plan, you can report the total annual payments as the FBAR balance. 

2. Defined Contribution Plan 

A defined contribution plan is funded by the employer and often the employee as well; the employee can often direct the investments within the plan. Additionally, defined contribution plans almost always have an easily defined value or balance. Thus, defined contribution plans should always be reported on your FBAR. 

Several countries—such as Switzerland—have a tiered retirement scheme with three pillars. The first pillar is often a social security-type program, a welfare program providing defined benefits for old age and disability. This type of plan is not FBAR-reportable. The second pillar is often an employer pension plan, funded by the employer and employee, which is FBAR-reportable. The third pillar is generally an individual or private retirement plan, which is also FBAR-reportable, along with bank and financial accounts. 

While a social security-style retirement plan provided by a foreign government does not need to be reported on the FBAR, some foreign retirement plans are a hybrid of social security and a foreign pension plan, along with bank and financial accounts. These are generally compulsory, government-managed funds with contributions from both the employer and employee. Some notable examples are the provident funds of India, Singapore, and Hong Kong. Despite the similarities with social security-type programs, these types of foreign pension plans are FBAR-reportable. 

FATCA and Foreign Pensions 

The Foreign Account Tax Compliance Act (FATCA) is a similar program to FBAR reporting. Under FATCA filing requirements, all US citizens are required to report certain foreign assets to the IRS if they exceed certain thresholds. To do this, you would complete and file Form 8938. 

So, do you have to report foreign pensions under FATCA? In most cases, yes. In fact, Form 8938 specifically requires the reporting of foreign pensions, as opposed to only some pensions being reportable on the FBAR. 

Of course, this is only required if your foreign pension and other reportable foreign accounts exceed the FATCA filing thresholds based on your filing status and country of residence. What are those thresholds? You must file FATCA if your foreign financial assets exceed the following values: 

  • Single taxpayers living abroad: $200,000 on the last day of the tax year or $300,000 at any point during the year. 
  • Married taxpayers living abroad: $400,000 on the last day of the tax year and $600,000 at any point during the year. 
  • Single taxpayers living in the US: $50,000 on the last day of the tax year or $75,000 at any point during the year. 
  • Married taxpayers living in the US: $100,000 on the last day of the tax year or $150,000 at any point during the year. 

Have a Foreign Pension and Returning to the US? 

Many US citizens who work abroad return to the USA to live, and they bring with them savings accumulated in a foreign pension plan or superannuation account. If this is your situation, you may be pondering that often-asked question: “What should I do with my foreign pension?” 

Your first idea might be to roll your pension or superannuation funds over into an IRA or other US-based retirement plan. That is not allowed, as under the US Internal Revenue Code, most foreign pensions are not considered a “qualified trust.” That makes them ineligible to be rolled over. 

So what should you do instead? 

The benefit of pension and retirement plans is the tax-deferral treatment they are allowed. Generally, earnings accumulate in these plans tax-free until you receive distributions from the plan, which is usually during your retirement years. Also, the contributions made to the plan may have a tax benefit because they are not included in your US income for tax purposes. That means these contributions have been US tax-free until they are distributed to you. 

It is presumed that this tax deferral gives you a tax benefit because you will be in a lower tax bracket during your retirement years than you are during your working years. Only time will tell if that will actually be true, but it is important for you to understand the thinking behind tax deferral. 

As you may already know, sometimes these tax deferral benefits do not apply to foreign pensions. This is often the case because of tax treaty rules or because the country you live in does not have a tax treaty with the US. You may have had to include earnings and/or contributions to your foreign pension or superannuation account in your gross US income each year because they are taxable as they are paid into the plan. If that is true for you, read closely! Some of your foreign pension or superannuation money may be available to be distributed to you tax-free. 

If you had pension contributions (made by you or your employer) and/or pension account earnings that you included in your US income each year, as these amounts are paid into the plan, you now have a “cost” or “investment in the contract.” You can “recover” this cost tax-free, but only under very specific rules. For more information, you can refer to IRS Publication 575: Pension and Annuity Income—or even better, consult with a member of our Greenback tax team. 

Now that you have accurately determined any cost in your pension or superannuation account that you can recover tax-free, you are ready to consider your foreign pension options. Other than the fact that you cannot roll over the foreign pension into an IRA or other retirement account, the remaining options are very similar to most US pensions. 

  • You can leave the money in the foreign pension until you retire. Upon retirement, you can receive periodic distributions and include the taxable part of the distribution in your US income as it is received. 
  • You can have the entire pension paid to you in one lump sum distribution or periodically before you retire. You would then be free to reinvest the proceeds into a different investment account or spend it as you see fit. You would include the taxable part of the distribution in your US income the year it is distributed to you. 
  • You can leave the money in the foreign pension and pass it on to your heirs. 
Pro Tip

When considering an expat pension transfer, you should always do your best to avoid the 10% early withdrawal penalty that can apply to foreign or US pension or retirement accounts. To avoid that, you can either:

  • Wait until you turn 59½ to receive any foreign pension distributions.
  • Work with the holder of the retirement plan and set up “substantially equal periodic payments (at least annually) for your life.” Be careful to make sure the payments are determined correctly, as explained in IRS Publication 575 and Revenue Ruling 2002.62. (A Greenback tax professional is available for consultation to guide you through this.)

Need More Info About Foreign Pension Plans and US Taxation? 

Are foreign pensions taxable in the US? Hopefully, this guide has helped you understand how your foreign pension plan will be taxed. If you still have questions, we can help. At Greenback Expat Tax Services, we help Americans around the world manage their US tax obligations. Just contact us, and we’ll be happy to answer any questions you have. 

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