Roth IRA – UK and US Tax Implications Depend on Domestic and Treaty Rules
Last Update: December 2021
American citizens moving to the UK often arrive with their U.S. retirement accounts intact. With the increased popularity of Roth IRAs, especially among millennials, it’s not uncommon for our UK clients to have questions about the cross-border tax implications of maintaining a Roth IRA while living in the UK.
In this blog, we address the tax implications of Roth IRA ownership for UK resident U.S. citizens, with particular emphasis on the applicable provisions of the US-UK income tax treaty.
The US-UK treaty has specific provisions that affect the treatment of Roth IRAs held by UK residents. In this regard, it’s important to recognize that there is no uniform U.S. tax treaty law – each treaty has its own particular nuances that must be mastered in order to fully realize its benefits.
US Taxation of the Roth IRA
In terms of U.S. taxation, the Roth IRA is perhaps best explained in contrast to the traditional IRA. The traditional IRA allows you to deduct contributions and defer tax on account earnings, but distributions are subject to taxation. In contrast, a Roth IRA holder is not allowed to deduct contributions, but can defer tax on account earnings, and distributions are not subject to taxation.
Participation in a Roth RIA has certain conditions, including income thresholds, which are modified each year. Participants are also limited in the amount that can be contributed each year.
Roth IRA income limits in 2020 are $139,000 of modified adjusted gross income (MAGI) for singles and $206,000 of MAGI for joint filers. The limits increase in 2021 to $140,000 for singles and $208,000 for joint filers.
Roth IRA contribution limits are $6,000 in 2020 ($1,000 can be added for people aged 50 and older). U.S. expats need to pay particular attention to the rule that you cannot contribute amounts that are excluded under the foreign earned income exclusion, a basic expat tax method used to prevent the double taxation of income.
UK Taxation of the Roth IRA as Modified by Treaty
When it comes to understanding the UK tax implications of Roth IRA participation, the US-UK income tax treaty is an important authoritative source, as it specifically covers cross-border pension situations.
Article 17 of the Treaty deals with pension distributions, while Article 18 deals with pension earnings.
Roth IRA – UK Taxation of Pension Earnings
Article 18 of the Treaty provides that if a resident of a Contracting State (in our case, the UK) participates in a pension scheme established in the other Contracting State (in our case, the U.S.), the State of residence (in our case, the U.K.) will not tax the income of the pension scheme with respect to that resident until a distribution is made from the pension scheme.
The U.S. Treasury Department’s Technical Explanation to the Treaty provides a helpful example: “Thus, for example, if a U.S. citizen contributes to a U.S. qualified plan while working in the United States and then establishes residence in the United Kingdom, paragraph 1 [of Article 18] prevents the United Kingdom from taxing currently the plan’s earnings and accretions with respect to that individual.”
Thus, under the Treaty, earnings in a U.S. pension should seemingly not be taxable in the hands of a UK resident as they are generated. The HMRC’s Double Taxation Relief Manual apparently confirms this interpretation of the Treaty.
Roth IRA – UK Taxation of Pension Distributions
Article 17 of the Treaty distinguishes between periodic and lump-sum payments. In the case of periodic payments, Article 17(1) states that the state of residence (in our case, the UK) has the exclusive right to tax pensions, but must exempt from tax any amount of such pensions that would be exempt from tax in the State in which the pension scheme is established if the recipient were a resident of that State (in our case, the U.S.).
Fortunately, the U.S. Treasury Department’s Technical Explanation to the Treaty explains Article 17(1) using the Roth IRA as an illustrative example. The Technical Explanation states, “Thus, for example, a distribution from a U.S. ‘Roth IRA’ to a UK resident would be exempt from tax in the United Kingdom to the same extent the distribution would be exempt from tax in the United States if it were distributed to a U.S. resident.”
Thus, since the U.S. exempts Roth IRA distributions from taxation, the UK should seemingly be obliged to do the same for periodic pension payments under the Treaty.
In the case of lump-sum payments, Article 17(2) states more simply that any lump-sum payment derived by a resident of a Contracting State (in our case, the UK) from a pension scheme established in the other Contracting State shall be taxable only in that other State (in our case, the U.S.). Thus, since a Roth IRA is established in the U.S., it apparently cannot be taxed in the UK under the Treaty.
Tax Treaty Expertise – How We Can Help You
As always, we caveat our above discussion by acknowledging that treaty analysis and interpretation, especially when overriding domestic or local law, can be quite nuanced and, therefore, the details of each individual situation needs to be examined before coming to a firm conclusion on the tax consequences of cross-border activities.
In this regard, Expat Tax Professionals is uniquely positioned to harness our thorough U.S. tax expertise, our U.S. tax treaty knowledge, and our strategic relationships with professional colleagues abroad, to provide our clients with a holistic approach to tax challenges.
Contact us today for information on how we can help you.
