You work hard and, being the financially savvy person that you are, you put a portion of your earnings into the best retirement vehicle available where you’re working. Now you find yourself in the United States as a new resident, citizen, or green card holder. If you’re like many newly-arrived or returning US taxpayers, you’re just letting your retirement savings grow tax-free in your former home. But are those earnings really tax-free? Unfortunately, the reality is that your foreign retirement fund may be about to pull you into one of the most complex and confusing corners of US international tax law.
The Internal Revenue Code is full of retirement vehicles that enjoy great US tax benefits: individual retirement accounts (IRAs) and 401(k) plans, for example. The problem is that the tax law requires that these retirement accounts be established in the US in order to qualify for favorable treatment. So if your retirement fund was established abroad, such as an Australian superannuation fund or a Chilean pension account, it won’t be treated as a qualified retirement plan in the US.
Having a foreign retirement account while you’re a US tax resident can have a number of negative impacts. If you continue to make contributions to the account, they may not be deductible from your taxable income. Furthermore, earnings that grow free of foreign tax may very well be taxable income in the US. If your foreign retirement account holds mutual funds, those will likely be treated as Passive Foreign Investment Companies (PFICs), which will mean that if you receive a distribution or sell shares at a gain, even within your retirement account, you could suffer current taxation at a punitive rate.
And then there is the reporting. Not only is there required reporting for US taxpayers with foreign financial accounts, the US tax code typically sees foreign individual retirement plans as “foreign trusts” because they are held and managed by an independent custodian. If you are treated as the US owner of a foreign trust you also need to submit Form 3520 and Form 3520-A every year or face a minimum $10,000 penalty for each form.
Tax treaties may affect the treatment of foreign retirement accounts. A few countries, including Canada and the United Kingdom, have treaties with the US that deal with retirement plan issues specifically and therefore plans from those countries may avoid some of the worst of these rules. It is always important to check if tax treaty relief is applicable to your situation. Reporting is usually still required even when a tax treaty can reduce the tax cost.
If you’re a US taxpayer with a foreign retirement account, talk to your tax and financial advisers to see if you are subject to disadvantageous tax treatment and discuss with them the best way to remedy the situation. Saville’s Global Tax and Advisory Group also stands ready to help you with your international tax questions and can work with your financial advisers in the US and abroad to help protect your retirement savings from needless penalties.
Written By: Robert Smith, Tax Senior, CPA