Is Foreign Retirement Income Taxable in the US?

The United States tax system applies to the worldwide income of its citizens and residents, a principle that extends to foreign retirement plans. For U.S. persons, which includes citizens, green card holders, and individuals meeting the substantial presence test, the taxability of these plans depends on a set of default U.S. tax rules. These rules govern how contributions, growth, and distributions are treated.

These rules form the baseline for taxation but can be modified by international tax treaties. The specifics of a person’s tax situation can change based on their country of residence and the location of the retirement plan. Understanding the foundational U.S. tax principles is the first step in determining the tax obligations associated with a foreign retirement plan.

US Taxation of Foreign Retirement Plans

Without a tax treaty, the U.S. tax code applies default rules to foreign retirement plans. These rules differ from the tax-favored status granted to domestic plans like 401(k)s. The U.S. does not recognize the special tax status a foreign country may provide to its retirement plans, which can lead to immediate tax consequences for U.S. persons.

Tax treatment covers contributions, growth, and distributions. Employee contributions to a foreign pension are made with after-tax dollars and are not deductible on a U.S. tax return. Any contributions made by an employer are considered taxable compensation to the employee in the year they are made and must be included in gross income.

Growth within the plan, such as interest, dividends, and capital gains, is also subject to U.S. taxation. These earnings are taxable to the U.S. person in the year they are earned, not when they are distributed. Even if the funds remain in the plan, the investment growth must be reported annually on a U.S. tax return.

When distributions are taken, the tax treatment depends on what has already been taxed by the U.S. The portion of the distribution representing a return of previously taxed amounts, such as contributions and growth, is received tax-free as a “return of basis.” Any amount received above this basis is taxable income. Keeping records of all previously taxed amounts is necessary to avoid double taxation.

The Role of Bilateral Tax Treaties

Bilateral income tax treaties between the United States and other countries can alter the default tax rules for foreign retirement plans. These agreements aim to prevent double taxation and provide a framework for which country has the right to tax certain income. The U.S. maintains tax treaties with approximately 60 countries, and a person can find a list of current agreements on the IRS website.

A benefit provided by many tax treaties is tax deferral. Under a treaty, the U.S. may agree to recognize the tax-deferred status of a foreign retirement plan, meaning annual growth is not subject to U.S. tax as it accrues. Instead, the income is taxed only when it is distributed, similar to a traditional U.S. retirement account.

Treaties also establish “sourcing rules” that determine which country has the primary right to tax pension distributions. Most treaties grant the country of residence the right to tax pension and annuity payments. For example, if a U.S. resident receives a pension from a private employer in a treaty country, that income would be taxable only in the United States. Rules for government pensions are often different, with the paying country retaining the primary right to tax the income.

A feature of U.S. tax treaties is the “saving clause,” which allows the U.S. to tax its citizens and residents as if the treaty did not exist. This clause preserves the U.S. right to tax based on citizenship. However, the articles related to pensions are often specific exceptions to the saving clause, which allows U.S. persons to benefit from the treaty’s provisions. To claim treaty benefits, a taxpayer may need to file Form 8833, Treaty-Based Return Position Disclosure.

Information and Forms for Reporting

To properly report foreign retirement income and accounts, a taxpayer must collect key details about their plan, including:

• The name and address of the financial institution holding the account
• The account number
• The gross amount of any distributions received during the year
• The amount of any foreign taxes paid on that income
• The maximum value of the account during the year

Reporting the Account

The Report of Foreign Bank and Financial Accounts (FBAR), or FinCEN Form 114, must be filed if the aggregate value of all foreign financial accounts exceeds $10,000 at any point during the calendar year. This filing requirement includes retirement and pension accounts.

Form 8938, Statement of Specified Foreign Financial Assets, is filed with a taxpayer’s annual income tax return. This form is required if the total value of specified foreign financial assets exceeds certain thresholds, which are higher for taxpayers living abroad. For a single individual living in the U.S., the threshold is met if assets are worth more than $50,000 on the last day of the year or more than $75,000 at any time during the year.

Reporting the Income

The taxable portion of any distribution from a foreign retirement plan is reported on Form 1040, U.S. Individual Income Tax Return. The income is entered on the line for pensions and annuities. All foreign currency amounts must be converted into U.S. dollars using a consistent and reasonable exchange rate.

To avoid double taxation, a taxpayer can claim a credit for foreign income taxes paid on the retirement distributions using Form 1116, Foreign Tax Credit. To complete this form, the taxpayer will need to provide the amount of foreign-source income and the foreign taxes paid. Claiming this credit can reduce the U.S. tax liability on the foreign pension income.

How to File Your Tax and Information Returns

The FBAR (FinCEN Form 114) is not filed with your tax return but must be submitted electronically through the Financial Crimes Enforcement Network’s BSA E-Filing System. The deadline for filing the FBAR is April 15 of the year following the calendar year being reported, with an automatic extension to October 15 available.

Your income tax return, Form 1040, and any associated forms like Form 8938 and Form 1116, are filed together with the IRS. This can be done by mailing paper forms or by filing electronically using tax preparation software or through a tax professional.