Is a Foreign Pension Taxable in the US?
As a US expat working overseas, you will need to understand how foreign pensions are taxed. Are foreign pensions taxable in the US? Can you move a foreign pension to another country?
Navigating the tax rules for foreign pensions can be tricky, but that’s where Greenback Expat Tax Services comes in. With over a decade of experience helping Americans abroad, our team of friendly and knowledgeable tax professionals are experts in expat tax matters. We understand the ins and outs of international tax laws, especially when it comes to the complexities of foreign pensions. Greenback makes it easy to get clear, personalized advice, so you know exactly where you stand.
In this guide, we will answer all your pension tax questions—and more. Here’s what you need to know about foreign pensions and US tax laws.
Key Takeaways
- Foreign pensions are generally subject to income tax in the US by the IRS.
- The rules for taxing a foreign pension will vary depending on several factors, including income tax treaties.
- It is impossible to “roll” a foreign pension into a US-based retirement savings account.
Foreign Pensions Are Taxable in the US
Most foreign pension plans are subject to US taxation. In fact, many of the tax rules for foreign pensions are the same as those for US-based pensions. However, there are some notable differences.
To understand the differences between US pensions and their overseas counterparts, let’s look at how your foreign pension may be taxed in the US.
1. Taxed now? Later? Now and later?
A foreign pension has three separate parts for US tax purposes:
- Your contributions
- Your foreign employer’s contribution
- Any investment income the pension accrues
Each of these three parts may be taxed now or later depending on various factors, such as the terms and conditions of the pension itself—and if there are any tax treaty benefits you can claim. One part of your pension may be taxed when received, while others may not.
Rest assured: all three parts of your pension will be taxed eventually. It’s just a question of when.
2. Taxation of Foreign Pension Contributions
Since foreign pensions aren’t qualified plans under the strict rules of Internal Revenue Code (IRC) section 401, employee contributions do not reduce the employee’s taxable US income. Employer contributions to a foreign pension fund will increase the employee’s taxable income.
3. Taxation of Annual Foreign Pension Investment Income not Withdrawn
With certain US-qualified pensions, income accrues tax-free. However, foreign pensions are treated as the participant’s income, subject to annual taxes—even if you don’t withdraw the money. This could result in a higher tax liability.
If the foreign pension fund invests in foreign mutual funds or exchange-traded funds, the IRS could classify these as passive foreign investment companies (PFICs). PFICs are subject to special—and often punitive—tax rules, possibly significantly complicating your taxes.
4. Taxation of Foreign Pension Withdrawals
Withdrawals from foreign pensions are not taxable if all the following are true:
- Your contributions were not deducted from your US tax returns
- Your employer’s contributions to your pension plan were included as taxable income on your US tax return
- All annual investment income was included as taxable income on your US tax returns
Because it might be years or even decades until you withdraw funds from a foreign pension, keeping detailed records regarding what was and was not included as taxable income on your tax returns is imperative. Without good records, the IRS could deem 100% of pension distributions taxable income.
The US may tax you on a foreign pension now, whereas a foreign country might not tax you until many years later. This could ultimately lead to double taxation. However, you might be able to claim a tax treaty benefit or the Foreign Tax Credit to reduce (or erase) your US tax bill.
How to Report Foreign Pension Income
The reporting requirements for foreign pensions are often complex. You may have to file multiple forms to report the details of your foreign pension, such as:
- Form 3520: Required if you have any transactions with a foreign trust. (Pensions and retirement plans are often considered trusts.)
- Form 3520-A: Required to be filed by the company that manages your foreign pension. If the company managing your foreign pension does not file a form 3520-A, you will have to file it yourself.
- Form 8621: Required if PFIC rules apply.
- Form 8938 (FATCA): Required for reporting on all foreign financial assets, including foreign pensions, if you meet the filing threshold.
- FinCEN Form 114 (FBAR): Required for reporting foreign bank and financial accounts that meet the filing threshold.
Understanding which forms apply to your specific situation is not always straightforward. To learn more, consult with an international tax professional.
Are Pensions Considered Earned Income?
No. Pension income is unearned income, not earned. What’s the difference?
- Earned income is money you receive in exchange for work or services you perform—like wages, salaries, tips, and commissions.
- Unearned income includes interest on savings accounts and investments, dividends from stocks or mutual funds, alimony payments, Social Security benefits, pensions, and veteran’s benefits.
Because pensions are considered unearned income, you cannot use the Foreign Earned Income Exclusion to exclude a foreign pension from US taxation.
Foreign Pensions and FBAR
Americans who have $10,000 deposited in one or more non-US financial accounts are required to file 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? Generally, yes. The FBAR instructions require you to report all financial accounts; in most cases, foreign pensions are considered financial accounts.
However, to better answer that question, let’s examine a few types of employer-sponsored foreign pension plans.
1. Defined Benefit Plan
A defined benefit plan is a retirement plan funded by an employer or government that provides a fixed benefit upon retirement or death. In these plans, participants are not considered legal owners and cannot control investments or withdraw funds. The current value or balance of these plans may be difficult to determine before retirement.
While many financial experts believe defined benefit plans do not require FBAR reporting, it may be advisable to report them for transparency. If you choose to report, there are two main scenarios to consider:
- Before retirement. If the plan offers a death benefit (a cash amount payable to beneficiaries if you die before retiring), you can use this amount as the FBAR balance.
After retirement. For those already receiving payments in retirement, the total annual payments can be reported as the FBAR balance.
2. Defined Contribution Plan
A defined contribution plan is funded by both the employer and the employee. The employee can direct the investments within the plan. Defined contribution plans almost always have an easily defined value or balance.
3. Tiered Retirement Scheme
Several countries—such as Switzerland—have a tiered retirement scheme with three pillars:
- First. 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.
- Second. Both the employer and employee fund this employer pension plan that is FBAR-reportable.
- Third. This is an individual or private retirement plan that is FBAR-reportable.
Please note that 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 compulsory, government-managed funds with employer and employee contributions.
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. 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.)
Have a Foreign Pension and Returning to the US?
Many US citizens who work abroad return to the US eventually. If you’re planning to come home someday, you may be hoping to bring your foreign pension with you.
Your first idea might be to roll your pension or superannuation funds into an IRA or other US-based retirement plan. Unfortunately, this is not allowed since most foreign pensions are not considered qualified trusts, making them ineligible to be rolled over. So, what should you do instead?
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. Simply 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.
Depending on your tax situation, you may be able to maximize your savings through tax deferral treatment.
What Is Tax Deferral Treatment?
Tax-deferral treatment allows earnings to accumulate in pension and retirement plans tax-free until you receive distributions after retirement. Contributions made to such plans may also have a tax benefit because they are not included in your US income for tax purposes.
That means these contributions will be tax-free in the US until they are distributed to you. This may give you a tax benefit because you will probably be in a lower tax bracket when you retire than you were during your working years.
However, these tax deferral benefits do not always apply to foreign pensions. You may have to include earnings and/or contributions to your foreign pension or superannuation account in your US gross 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. (Or better yet, consult with a member of our Greenback tax team!)
When considering a US-based pension/retirement transfer, you should always do your best to avoid the 10% early withdrawal penalty. To avoid that, you can either:
- Wait until you turn 59½ to receive any foreign pension distributions.
- Work with the retirement plan holder and set up substantially equal periodic payments (at least annually) for your life. Make sure the payments are correctly determined, as IRS Publication 575 and Revenue Ruling 2002.62 explains. (A Greenback tax professional is available for a consultation to guide you through this.)
Foreign pension plans may also have early withdrawal and other similar penalties, so you should look into this well before making any withdrawals.
Learn More About Foreign Pension Plans and US Taxation
We hope this guide has helped you understand how your foreign pension plan may be taxed. If you still have questions, we can help! As a taxpayer dealing with foreign pensions, you may have unique concerns.
Contact us, and one of our customer champions will gladly assist you. For specific advice on your tax situation, click below to get a consultation with one of our expat tax experts.
