Retirement and Estate Planning for US Expats living in the UK
Watercolour Illustration by our client Ella Jackson
Pensions are a popular way of supporting yourself financially within your retirement. Whether you opt for a Social Security pension, Employer Pension or a Private Pension plan, there are many things to consider when navigating potential US Tax Challenges if you are an American living in the UK.
Social Security Taxes
Working in the US automatically makes you eligible to Social Security taxes which are withheld by your employer and submitted to the Internal Revenue Service (IRS) regularly. Many workers in the US will come to rely on their Social Security benefits when they come to retirement age and collect their investment. Whether you wish to claim your benefits early (Age 62 in the US) or claim at full retirement age (roughly 66 as of 2018) your eligibility depends on how many "quarters of coverage" (QC) you have obtained during your lifetime. The minimum requirement to claim Social Security is 40 QCs, with the opportunity to earn up to 4 QCs per year. Determining how many QCs you have collected can be found either online or by requesting a mailed copy.
Totalisation Agreement
The US and UK have designed a totalisation agreement that allows US citizens living in the UK to receive credit for work carried out in the UK if they find they have not collected enough QC credits to-date. This ensures you never pay into two separate government retirement systems, or equally, end up paying into none. Luckily, determining whether you are eligible for the US benefit takes into consideration your UK work history if you have at least 6 but no more than 40 US QCs. Your UK contributions are solely used to determine whether you qualify for US benefit and does not mean your UK credits are transferred to your US account. Becoming a UK citizen doesn't mean your benefits have to terminate - you can continue to claim US Social Security!
Pension Scheme
Due to new legislation, companies in the UK have to enrol UK based employees into a pension scheme by October 2018, potentially causing tax issues for US individuals. The three types of schemes available are: Group Personal Pension Scheme (GPPS), an occupational company pension arrangement, or the Government’s NEST (National Employers Savings Trust) scheme. The most popular of these has proven to be GPPS which can cause huge implications for Americans working in the UK.
In such schemes, pension contributions tend to be invested in a default insurance company managed fund. Insurance companies usually consider their 'mutual funds' under the PFICs (Passive Foreign Investment Companies) umbrella, which has begun to catch US expats out when they come to file their US tax return. These investments differ from other GPPS schemes as the money is subject to taxing under a punitive tax structure rather than sales being subject to capital gain tax rates. Pension treaty claims can be made to navigate certain US income tax clauses, but it's important to note that PFIC transactions must also be tracked every year, which can come at a great expense to the individual. ISAs and foreign investment accounts are also defined under PFIC reporting so establishing which scheme will be most financially beneficial for yourself is crucial when discussing your pension options with your employer.
Auto-enrollment without exploring the small print of US taxing implications may create huge taxing liabilities and reporting obligations for the individual. Opting out of employer's GPPS may prove to be the best option but this can often result in losing benefits of employer's pension contributions. SIPPs and ISAs are emerging as the most profitable option for US expats, therefore discussing your options with an advisor is essential to ensure your investments manifest in a valuable way to facilitate your future retirement plan.
Estate Planning
Alongside pension planning, individuals must consider their estate and how to negotiate US tax implications. The federal estate tax is a tax on assets transferred from deceased persons to the inheritor. Wealthiest estates are most liable to the tax due to a specified exemption level — $5.49 million per person (effectively $10.98 million per married couple) in 2017. In general, an inheritance in and of itself is not considered income, so you won't have to report your inheritance on your state or federal income tax return.
While inheritance in itself is generally not considered income, there may be built-in income tax consequences that come with your property. An example of this is inheriting an IRA or 401(k). Any distributions you take out of the IRA or 401(k) will needed to be included in your federal income, as well as your state income. Any estates outside the IRA or 401(k) bracket will be subject to capital gains taxes depending on the difference between the inherited value of the property and the sales price you receive when parting with the property.
Estate Planning For Expats
American expats with personal property in a foreign country may find it useful to consult with a financial advisor to go through their financial plans. If there are significant assets a wealth management advisor can discuss the United States estate tax treaty and how situs assets are taxed under common law, taking into account the cross border and civil law implications.