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Foreign pension plan considerations for U.S. taxpayers.

Foreign pension plan participation is an issue for U.S. citizen employees who reside abroad and foreign nationals temporarily residing in the U.S.

However, U.S. citizens and permanent residents ("green-card" and statutory resident, non-immigrant visa holders) may benefit by contributing to a foreign pension plan in a jurisdiction with favorable provisions and an Income Tax Treaty with the U.S.

Tax advisors, financial planners, and wealth managers should consider taking advantage of opportunities for tax deferred savings and other benefits for their High Net Worth clients, by contributing to a foreign pension plan alongside other wealth preservation strategies such as private placement life insurance and foreign or domestic trusts.

A foreign pension plan may have higher contribution limits than those available under U.S. qualified plans, and certain pensions allow the in-specie contribution of shares and partnership interests. Contributions to a foreign pension plan could be made in addition to annual contributions to a U.S. qualified plan, and in some jurisdictions, are unlimited.

The benefit of higher contribution and tax deferral would most likely outweigh the loss of the annual tax deduction that may have already been met due to U.S. pension participation. Alternatively, the deduction would have been insignificant at higher levels of income or due to lower effective U.S. tax rates, because of the ability to claim U.S. tax benefits such as the foreign earned income, housing exclusions, and foreign tax credits.

Annual earnings in a foreign pension plan may be tax exempt for U.S. tax purposes under an income tax treaty, thereby providing equivalent treatment to a U.S. qualified pension plan.

Distributions may be restricted to a specified age, for example 50. However, distributions may be taken without any early (pre 591 ") distribution penalties that are imposed under U.S. tax rules. Distributions may be afforded preferential treatment through a tax exemption for a percentage of the plan balance. Under an Income Tax Treaty, this benefit is preserved for U.S. citizen and resident taxpayers. For example, under U.K. and Malta income tax rules, a single 25% or 30% tax exemption (respectively) is permitted. This tax exemption is provided under U.K. and Malta Income Tax Treaties. Likewise, a U.S. Roth IRA distribution, which is entirely tax exempt under U.S. tax rules, is also treated as tax exempt under U.K./ Malta tax rules for a recipient who is resident in those countries.

Malta appears to be a favorable jurisdiction where U.S. citizens, permanent residents, and statutory residents can establish a pension plan to supplement their current retirement savings, or establish a personal pension plan if local pension offerings are non-existent / are subject to U.S. income tax. This is generally the case for U.S. citizens and green-card holders who reside in countries that do not have a tax treaty with the U.S. (e.g. Hong Kong, Brazil, Singapore) or where the treaty does not provide tax deferred treatment of annual earnings for a contributory plan (e.g. Ireland, Italy, Switzerland).

For example, a U.S. citizen residing in Hong Kong and employed by a Hong Kong (or other) foreign employer can establish a personal pension plan in Malta. Contributions to a Malta-based pension plan are unlimited and are not deductible from a U.S. tax perspective, however the contributions can grow tax-deferred until retirement. This is attractive compared to the US contribution limit of $5,500 (for an IRA).

Application of Treaty

Under most tax treaties, only residents of the U.S. may claim treaty benefits. The definition of tax residence for treaty purposes is usually defined as a person who, under the laws of a Contracting State, is subject to tax because of his domicile, residence, or citizenship. However certain treaties contain an exception to this general rule and require that a U.S. citizen or permanent resident reside in the U.S.

For example under the U.S.-Malta Income Tax treaty, the definition of tax residence is a person who is subject to U.S. tax because of domicile, residence, or citizenship, with no additional requirement that a U.S. citizen or permanent resident must reside in the U.S. Therefore U.S. citizens and residents who are living abroad can apply the benefits of the Malta treaty.

Tax Deferred Earnings

An Income Tax Treaty must provide for an exemption from tax for earnings in a pension plan. For example, under Article 18.1 of the U.S.-U.K. Income Tax Treaty, income earned by the pension fund may be taxed as income only when actually distributed to the individual.

Generally, U.S. Income Tax Treaties contain a "savings clause" which provides that the U.S. can tax U.S. citizens and residents as if the treaty had not come into effect. However, under Article 1.5(a) of the U.S.-U.K. Income Tax Treaty, the savings clause does not apply to Article 18.1

Taxation of Distributions

Under Article 17.1(a) of the U.S.-Malta Income Tax Treaty, a distribution from a Maltese pension plan which is owned by a U.S. resident, shall only be taxable in the U.S.

Article 17.1(b) provides that the amount of a pension distribution that would have been exempt from tax in Malta if the beneficial owner were a resident of Malta, will be exempt from income tax in the state where the recipient resides (the U.S.).

Under Article 1.5(a) of the U.S.-Malta Income Tax Treaty, the savings clause does not apply to distributions from a pension plan (subparagraph (b) of Article 17.1). Because Article 17.1(b) is the provision that preserves the tax exemption benefit under Malta tax rules, and because the savings clause does not apply, the literal terms of Article 17.1(b) are applicable and mandate that the tax-free benefit applicable to a distribution from a pension plan established in Malta is recognized under U.S. tax rules.

Private foreign pension plans are classified as follows and must be reported accordingly;

* Taxable foreign grantor trust (Form 3520, FBAR required)

* Exempt foreign pension plan under an Income Tax Treaty (Form 3520 & Form 8833, FBAR required)


If contributions are permitted under the laws of the country where the foreign pension is established, and earnings in the plan are tax deferred under a tax treaty, practitioners should consider the following issues and strategies to minimize U.S. tax, as well as increase retirement savings:

* Foreign nationals who are planning to relocate to the U.S. may consider contributing cash or in-specie investments to a foreign pension plan before establishing U.S. residency.

* If U.S. citizen or green-card holder is employed by a foreign employer, consider contributing to a foreign pension plan as an alternative, or in addition to, life insurance/annuities.

* Consider if a U.S. resident can increase retirement savings by making voluntary contributions to a foreign (home country) pension plan.

* As a complimentary structure to Gift Charitable Trust planning for pre-tax, non-qualified deferred income, consider after tax contribution to a foreign pension plan and reinvesting on a tax deferred basis before December 31, 2017.

* Should the carried interest rules change, contribution of post-tax earnings to a foreign pension can achieve renewed tax deferred investing, investment diversification, and reinvestment in foreign funds (PFICs).

* A foreign pension plan is not considered U.S. property for foreign nationals residing in the U.S, and is not subject to U.S. estate tax.

* Also consider taking a taxable distribution from a foreign pension plan if the distribution is only taxable in the U.S. to claim the benefit of excess foreign tax credit carryovers (before expiration). This could achieve a U.S. tax exemption as well.

Dominion, established in 2001, has grown to become one of the leading providers of innovative and compliant solutions in Private Wealth, Pensions, Trust & Corporate services from within Europe, the United States of America, and the United Kingdom.

Dominion Fiduciary Services Limited and its affiliates do not give tax, investment or financial advice. We work exclusively with professional intermediaries. Specialist advice should always be sought when entering into a transaction.

James Cassidy, CPA

Dominion New York
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Title Annotation:Sponsored Content: DOMINION
Author:Cassidy, James
Publication:The CPA Journal
Geographic Code:4EXML
Date:Dec 1, 2016
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