Retirement Programs in Canada and the UK have some serious US tax consequences

Overview

We work with plenty of clients in both the UK and Canada.  Most of them are aware that they must report foreign accounts on form 8938 and/or the FBAR form 114, but few of them know the implications of these filings. 

In this post we’ll highlight some of the basic concepts while trying to steer clear of tax jargon (as much as possible!). As always, make sure you consult with a tax expert about the nature and intricacies of your specific accounts when filing your return. 

Who does this impact?

Let's start by defining who these issues relate to. If you are considered a US resident for tax purposes by the substantial presence test (SPT), a green card holder, or a natural citizen living in the UK or Canada, this may be relevant for you.

Canadian Retirement Programs - RRSP

Let's start with the Canadian registered retirement savings plan (RRSP).  This is a retirement vehicle much like a US IRA account where pre-tax dollars grow tax free in Canada until distributed.

While the growth is tax free in Canada, if you do not make the appropriate election the growth of that account will be taxable on your US tax return.  Fortunately, you can use form 8891 to elect to treat the RRSP like a registered account in the US and skip paying tax on the growth in the account. Phew!

Distributions remain taxable to US and Canadian tax filers, but there are many tax strategies to avoid double taxation including tax treaties and foreign tax credit.

Canadian Retirement Programs - TFSA

Another beautifully designed savings vehicle is the Canadian Tax Free Savings Account (TFSA).  In basic terms this is a savings account that grows tax free (similar to a Roth 401k). 

In Canada you can withdraw from the account anytime and the earnings are tax free.  The downside is that there are no tax strategies to avoid paying tax in the US on the growth.

UK Retirement Programs - ISA 

Let us shift to the UK Individual Savings Account (ISA). There are a variety of ISA types - cash, stocks and shares, innovative finance, and Lifetime. They allow interest on cash and income/capital gains from investments be tax free in the UK.

However, this tax free income does not translate to the US. To further complicate matters you need to determine if it is a foreign grantor trust or not according to IRS codes (see section 671-679). On your US return you will need to show income on schedule B or D if it is an individual account and not held in a foreign trust. 

If the account turns out to be a foreign trust account, you may have additional requirements to file form 3520 and 3520-A.  Further, if it is held in a trust you may have to report Passive Foreign Income Company (PFIC) income on form 8621 and you’ll have an unfavorable tax rate on the investment.  The subject of trust or non-trust is controversial.  It can be a gray murky area but it boils down to: is the ISA manager considered a fiduciary?  By most UK definitions that answer is no, so chances are your ISA creates income for you but not requirements to file forms 3520 or 8621.  However, we’ll help you navigate these classifications.

UK Retirement Programs - SIPP 

The last type of account to review is the self-invested personal pension (SIPP). This is a self-guided retirement plan, allowing you to put money into a list of approved investments.  It is comparable to any traditional IRA in the US with the difference being that you do not claim it pre-tax, but rather take a credit for the contribution on the UK tax return and that credit gets deposited directly into the account itself. 

Growth is tax free in the UK. Typically, the funds can be withdrawn tax free (up to 25% of total in the account per year) starting at age 55.  The great news on these accounts for US taxes: there is a tax treaty to have it treated like a US account to avoid taxes on the growth.  Distributions can also be offset with either a tax treaty or foreign taxes paid.

This post only covers the most widely used accounts in the UK and Canada but there are others. Always seek the advice and guidance of a tax professional if you have international accounts to avoid serious consequences.