UK AND US PENSIONS FOR US TAXPAYERS

by Paul Devonshire, in ,

Updated to reflect HMRC’s revised guidance on pension lump sums (March 2025). 

This is a complicated area but it does provide scope for some effective planning using foreign tax credits and the UK/US Double Taxation Agreement. It is also an area where the ground has shifted recently: in March 2025 HMRC published updated guidance which reverses the long-standing understanding of how lump sums from US pension plans are taxed in the UK. This is a brief summary — you should seek professional advice before acting on any of these issues.

General points

Both the UK and the US provide tax incentives for retirement saving through pension schemes. Contributions made to a pension receive tax relief (up to certain limits) and growth within the plan is not currently taxed. Tax generally arises only when monies are distributed from the plan.

The UK and US have entered into a Double Taxation Agreement (the “Treaty”) that deals specifically with pension schemes and pension income. Some significant points arising from the Treaty are as follows:

  • Contributions (employee and employer) into a UK pension can obtain tax relief in the US.
  • Growth in the value of a UK pension can be claimed as tax free in the US until distribution.
  • Periodic pension payments are generally taxed in the State where you are resident, not the State from which the pension is paid.
  • Amounts that would be tax free if paid to a resident of the State in which the pension is established (for example, the tax-free element of a Roth IRA) are also tax free in the other State.
  • Lump sums are, on the face of the Treaty, taxable only in the State in which the pension scheme is established — but see the important section below on HMRC’s revised position.

These are very general points. US citizens should always consider the “saving clause” (Article 1(4) of the Treaty) when considering what US tax relief is available. The saving clause essentially allows the US to disregard most parts of the Treaty for its citizens. As explained below, HMRC has now confirmed that it is prepared to invoke the same clause in the other direction for UK residents.

HMRC’s updated guidance on lump sums (March 2025)

On 12 March 2025, HMRC published updated guidance in its International Manual (INTM163160 and related pages) dealing with lump sums paid from pension schemes under Double Taxation Agreements. This is the first time HMRC has published guidance on the point, and it contains two significant developments.

1. What counts as a “lump sum”?

“Lump sum” is not defined in UK tax legislation or in the Treaty itself. HMRC’s guidance now sets out the factors it will consider, principally the frequency of payments and the proportion of the fund withdrawn on each occasion:

  • A one-off, standalone payment of all or a significant portion of the fund is likely to be a lump sum.
  • Payments made with regularity — including, in our view, Required Minimum Distributions taken annually — are likely to be treated as periodic pension payments, taxable in the country of residence under Article 17(1) in the normal way.
  • Irregular, ad hoc withdrawals are likely to be treated as lump sums, although HMRC will look at the pattern over a longer period. HMRC’s own example: where roughly £20,000 is drawn each year, the payments are periodic; if £50,000 is drawn in one year, the excess £30,000 over the established pattern may be treated as a lump sum.

The characterisation matters because the Treaty treats periodic pensions and lump sums entirely differently, and because the UK tax outcome now differs sharply between the two.

2. US pension lump sums paid to UK residents — a reversal of prevailing practice

Article 17(2) of the Treaty provides that a lump sum derived from a pension scheme established in one State and beneficially owned by a resident of the other State is taxable only in the State in which the scheme is established. Since the Treaty came into force in 2003, the prevailing practice has been for UK residents to treat lump sum distributions from US plans (401(k)s, IRAs) as exempt from UK tax on this basis, with only US tax applying.

HMRC’s updated guidance rejects that reading. HMRC’s position is that Article 1(4) — the saving clause — permits each State to tax its own residents as if the Treaty did not exist, except for provisions specifically preserved in Article 1(5). Article 17(2) is not one of the preserved provisions. The result, on HMRC’s analysis:

  • A lump sum paid from a US pension plan to a UK resident is subject to UK income tax, notwithstanding Article 17(2).
  • A foreign tax credit is available in the UK for US tax paid on the same distribution, so relief from double taxation is preserved — but the individual will end up paying tax at the higher of the two effective rates, which for most UK residents means topping up to UK rates.
  • HMRC has confirmed it will not apply the citizenship limb of the saving clause to UK citizens who are not UK resident — the change is directed at UK residents.

It is worth noting that the US has always regarded Article 17(2) as an anti-avoidance measure and has taken a mirror-image approach to its own citizens, so US citizens resident in the UK were already taxable in the US on lump sums. What has changed is the UK side of the equation: the days of extracting a US pension as a lump sum free of UK tax while resident here are, on HMRC’s current stated position, over.

UK pensions

There are several types of UK pension: employer final salary (defined benefit) plans, employer defined contribution plans and personal pensions (SIPPs).

UK taxation

Tax relief is provided on contributions in one of two ways. Either the personal contribution reduces taxable income, providing full relief, or relief is given at source at the basic rate (20%) with higher and additional rate relief claimed through the Tax Return. Employer contributions are not subject to UK tax.

A non-working spouse may make gross annual contributions to a UK pension of £3,600 and receive 20% tax relief.

Contributions may be made by non-UK residents (limited to the amount of their UK earnings in the tax year). Therefore, if you receive deferred UK earnings after you leave the UK it may be possible to make pension contributions and claim UK tax relief.

The annual allowance for qualifying pension contributions is £60,000. Contributions are also limited to your earnings in the tax year (or £3,600 if higher relief-eligible earnings are not available). The £60,000 allowance is tapered by £1 for every £2 that your adjusted income (broadly, income plus employer pension contributions) exceeds £260,000, down to a minimum of £10,000. More detail here.

If you do not use your full annual allowance in a year, unused allowance can in some circumstances be carried forward for up to three years.

The UK taxation of payments from a UK pension depends crucially on where you are resident when you receive the payment. If you are resident in a country with an appropriate Double Taxation Agreement, periodic pension payments will generally be exempt from UK tax and taxable in your country of residence.

US taxation of UK pensions

UK pensions are not US-qualified plans, but the Treaty generally provides a choice:

  1. Do not claim Treaty relief. Claim no US tax relief on your pension contributions and include employer contributions as current income. If your earnings are fully subject to UK tax, foreign tax credits will more than likely cover any additional US tax on the contributions. Amounts that have already been taxed in the US build up basis and can subsequently be distributed free of US tax.
  2. Claim Treaty relief. The US provides tax relief on personal contributions and employer contributions are not taxable currently. US tax will arise on eventual distributions, but this may be sheltered by unused foreign tax credits available at that time.

You therefore have some discretion over how UK pension contributions are treated now and over the final tax treatment of distributions. Treaty positions should be disclosed on Form 8833 where required.

Planning points

UK tax rates are generally higher than US rates and you will typically pay more UK tax than you can use on your US Return. Excess credits can be carried back one year and forward for up to ten years before expiring. Pensions allow you to manage both your UK tax and the stock of unused UK tax credits on your US return.

Where you have pension monies that have not obtained US tax relief, it may be possible to absorb old credits that are approaching expiry by moving UK pension monies between plans without claiming Treaty relief on the transfer.

Lump sum planning remains valuable — but following HMRC’s March 2025 guidance the analysis has changed materially, particularly for US plans, and each case should be reviewed against the new definition of a lump sum before any withdrawal is made.

US pensions

The most common US pensions for UK-based taxpayers are 401(k) plans (employer sponsored, funded by employee and employer contributions) and IRAs (Traditional and Roth) set up and funded by individuals. 401(k) monies can be rolled into an IRA tax free, and Traditional IRA/401(k) funds can be converted to a Roth IRA; the conversion is subject to US tax but carries no early withdrawal penalty.

Contributions to Traditional IRAs can qualify for US tax relief, whereas Roth IRA contributions receive no relief. However, qualifying distributions from a Roth IRA are tax free in both the US and — under the Treaty exemption for amounts that would be tax free in the scheme’s home State — the UK. Traditional IRA/401(k) distributions are at least partly, and often fully, taxable.

For UK residents, the UK treatment of Traditional IRA/401(k) withdrawals now depends heavily on the character of the payment:

  • Periodic distributions (including regular drawdown and RMDs) are taxable in the UK as pension income under Article 17(1), with the US allowing credit for UK tax for its citizens.
  • Lump sums are, per HMRC’s March 2025 guidance, taxable in the UK under the saving clause, with UK credit for US tax paid. This is the reverse of the credit ordering that applies to periodic payments and requires careful coordination of payment dates on both sides.

Distributions from IRA or 401(k) plans are also subject to US tax, but to the extent a part of the taxable distribution is non-US source — broadly, the part relating to contributions made while working or living outside the United States — the US tax on that part can be offset by available UK tax credits.

Tax planning

Monies held within a Roth IRA are tax free on distribution in both countries and it may be advisable to roll over from a 401(k)/IRA into a Roth IRA. Where the conversion occurs while you are UK resident, the effective US tax rate on the conversion may be reduced by foreign tax credits, and State taxation is avoided. This can hold even where the 401(k)/IRA monies are 100% US source. The UK treatment of a conversion should be confirmed in advance, particularly in light of HMRC’s revised approach to lump sums.

Where a large withdrawal is contemplated, consider whether a series of regular periodic payments achieves the objective at a lower combined rate than a single lump sum, given HMRC’s new characterisation rules.

Although IRAs (Traditional and Roth) are not qualifying UK pensions — you cannot claim UK tax relief on contributions — the UK will not tax income or gains arising on monies held within them. In this respect they are more effective than UK savings wrappers such as ISAs, which have no tax-free status in the US.

As stated above, this is a basic summary of the rules and opportunities that may be available. HMRC’s March 2025 guidance in particular has changed the landscape for anyone with US retirement plans who is, or is planning to become, UK resident, and existing drawdown strategies prepared under the old understanding should be revisited. These areas are complex and you should seek professional assistance if you wish to explore them in more detail. PJD Tax can assist if required.