959 / What are some of the considerations that a U.S. citizen or resident should be aware of when participating in a retirement plan while residing in a foreign country?

While many U.S. citizens and residents who are transferred abroad by multinational employers may continue to be covered by the multinational’s U.S. retirement plan, in some cases, a U.S. individual may obtain benefits under a foreign plan. Because U.S. citizens and residents are taxed on their worldwide income, benefits accrued under foreign retirement plans may be subject to U.S. taxation absent a treaty provision that provides otherwise. Most treaties provide that a pension or annuity received from a foreign employer is taxed in the country of residence under its domestic laws.¹

Treaties with some countries provide for liberalized treatment of retirement accounts—for example, the treaty between the U.S. and the U.K. provides that U.S. citizens residing in the U.K. can deduct, for U.S. tax purposes, amounts contributed to a pension plan established in the U.K.²

Further, while a U.S. individual residing abroad may exclude a portion of foreign earned income from U.S. gross income each year, the foreign earned income exclusion does not apply to income received as a pension or annuity while abroad³ ( Q 3559).

The IRS has released long-awaited proposed regulations clarifying the income tax withholding obligations when distributions from employer-sponsored plans (including pension, annuity, profit sharing, stock bonus or deferred compensation plans) are made to destinations outside the U.S. While U.S. payees can elect to forgo withholding, non-U.S. payees cannot. In general, the participant cannot elect to forgo withholding with respect to these distributions even if the participant provides a U.S. residential address, but directs funds to be delivered to a destination outside the U.S. If the participant provides a non-U.S. residential address, withholding obligations cannot be waived even if the participant directs that the funds be distributed to a U.S. financial institution. When the participant provides no residential address, withholding obligations cannot be waived.

Technically, a plan established in a foreign country cannot be “qualified” under IRC Section 401, because of the requirement that a qualified trust be organized under U.S. law.⁴ Therefore, a U.S. individual participating in a foreign retirement plan would not be entitled to defer taxation of contributions to the foreign plan in the same manner as would be available in the U.S., absent a treaty provision to the contrary.

However, plans established by certain U.S. multinationals that are established under foreign law may achieve the same tax result if the plan is otherwise qualified.⁵ IRC Section 404(a)(4) provides a special rule that allows for the qualification of a trust established outside of the U.S. if the employer contributing to the plan is a U.S. resident, corporation or other entity and the plan is otherwise qualified.

     See IRS Guidance, “The Taxation of Foreign Pensions and Annuities,” available at http://www.irs.gov/Businesses/The-Taxation-of-Foreign-Pension-and-Annuity-Distributions (last accessed June 17, 2024).

2     See the Treasury Department Technical Explanation of the Convention between the U.S. and U.K, Article 17, available at http://www.treasury.gov/resource-center/tax-policy/treaties/Documents/teus-uk.pdf (last accessed June 17, 2024).

3     IRC § 911(b)(1)(B).

4     IRC § 401(a).

5     IRC § 404(a)(4).