US Tax of Foreign Pension Plans: 402(b) Income Tax Rules

Foreign Pension Plans 402(b) & U.S. Tax

Foreign Pension Plans 402(b) & U.S. Tax: When U.S. Persons have worked in a foreign country and/or for a foreign employer, they may have a foreign pension plan. Even if the foreign country treats the pension in the same way that the U.S treats a similar U.S. pension (such as a 401K), the IRS requirements for reporting and tax of the foreign pension under IRC 401, 402, and 401 will (usually) differ.

In general, a foreign pension is taxed in the country of residence (treaty or non-treaty rules)

Therefore, if the U.S. person has a foreign pension, but resides in the U.S., the United States will have the opportunity to tax the income.

Let’s review the basics of US Tax of Foreign Pension Plans.

Worldwide Income & Foreign Pensions

The United States follows a worldwide income tax model.

That means that the U.S. taxes US Persons on their worldwide income.

US Person means more than just U.S. citizens, it includes:

In addition, worldwide income includes income sourced in both the United States and abroad.  For example, even if a U.S. citizen resides in Singapore and earns all of her income from consulting work in the UK and Australia – the U.S. can still tax all of the income.

*Foreign Earned Income Exclusion and Foreign Tax Credits may reduce net effective tax liability.

Pension Contributions vs. Growth vs. Distributions

When it comes to Foreign Pensions, there are three (3) main aspects to the taxability of the pension:

  • Contributions
  • Growth
  • Distributions

Foreign Pension Contributions

Typically, contributions to a foreign pension are taxable.

Even if it operates like a 401K, it will still be taxable in the U.S.m unless it meets either of the following:

  • Qualified and Exempt under IRC 401/402(a) and 501; and/or
  • Excluded by Tax Treaty.

The former is difficult, because most foreign pensions are not qualified and exempt under the Internal Revenue Code. Even if it is, there are other issues to consider, including the HCE (Highly Compensated Employee) rules.

The latter is more common (but still not very common).

For example, in the U.K./U.S. Tax treaty, it provides that if a U.S. person works for a U.K. employer who contributes to a UK pension plan (borne from employment), then the contributions are deductible on a US tax return up to the amount permitted for the U.S. equivalent. (vice versa for a UK person working for a US employer)

Foreign Pension Growth (Accrued)

The growth within the foreign pensions are generally taxable.

For example, in the case of Singapore and the CPF, the U.S. has issued memoranda detailing the taxability of both the contributions and growth.

If the Foreign Pension Plan is qualified, then the growth is not taxable.

If the Foreign Pension plan is not qualified, the growth is taxable when it is available (available used as a “legal term of art.”)

The tax treaties may change the taxability, and most treaties limit taxation to distributions and by the country of residence of the taxpayer (not the source).

Foreign Pension Distribution Income

Distributions for foreign pension is generally taxable by the country of residence of the beneficiary (employee/former employee). This is the general rule whether or not there is a tax treaty in place.

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