Understanding which country has the taxing rights is important as incorrect returns filed over several years can result in an unexpected tax liability in one country and potentially being time barred from recovering tax incorrectly paid in the other.
A UK tax resident individual is generally subject to UK income tax on worldwide income. On this basis, distributions received from US pension pots are in principle subject to UK tax. The UK-US Double Taxation Treaty has a specific article relating to pensions and social security benefits. Hence, this must be considered when deciding which country has the taxing rights in conjunction with domestic legislation.
There is a distinction drawn in the Treaty between a “lump sum” payment and what we might consider to be a regular payment. This is not a straightforward distinction and needs to be analysed as a first step.
Article 17(1)(a) of the Treaty states that pensions are generally taxable in the country of tax residence, hence the starting point for most UK residents is that the pension is taxable in the UK, however, this is not the end of the story. There is what is referred to as the “savings clause” at the start of the Treaty which allows the US Government to tax US citizens as if the Treaty did not apply. It does not apply to all articles in the treaty, but it does apply to certain parts of the pensions article.
The upshot of this is that the US Government can tax US citizens in respect of payments made from pension pots in the US to a tax resident of the UK. The UK would also seek to tax the payment based on tax residence. The primary taxing rights being determined depending upon whether the payment is a lump sum or a periodic payment.
HMRC clarified its understanding of the pensions article last year, quite some time after the Treaty came into force! This has in some cases resulted in the taxation of lump sums in the UK where previously it was assumed no liability arose.
Given that UK tax rates are generally higher than those in the US, this tax treatment of lump sums can result in an overall higher tax rate than might have been expected.
The New Foreign Income and Gains Regime (“FIG”)
More positive news is that following the introduction of the UK's new Foreign Income and Gains ("FIG") regime from 6 April 2025, some planning opportunities now exist to repatriate pension pots to the UK for minimal tax where the taxpayer has had an extended period of non UK tax residence followed by a period of UK residence.
Broadly, individuals who become UK resident after a period of non-UK residence may qualify to receive foreign income and gains free from UK tax during their first four years of UK residence, regardless of whether the funds are brought to the UK. The regime represents a significant shift in the UK's approach to internationally mobile taxpayers and can provide a unique tax planning opportunity for US pensions (and other foreign source income).
US pension income will generally constitute foreign-source income. Therefore, where an individual qualifies for the FIG regime, there may be scope for pension distributions received during the four-year FIG period to be exempt from UK income tax. Specific advice will need to be taken depending upon the facts and in some cases the US may continue to impose tax, particularly where the recipient is a US citizen.
The interaction between FIG relief and treaty provisions is likely to become an important planning area for newly arriving UK residents with substantial US retirement savings. Thought can be given to accelerating withdrawals from US pension arrangements during the FIG period.
Summary
The taxation of US pensions for UK tax residents has always required careful consideration of domestic legislation, pension classification rules and the UK-US Double Taxation Convention. The introduction of the new FIG regime adds another layer of complexity but may also create valuable planning opportunities for newly arrived UK residents.
For UK residents holding US retirement arrangements, particularly 401(k) plans, IRAs and employer-sponsored pensions, the interaction between treaty relief, foreign tax credits and FIG claims should be reviewed before significant withdrawals are made. In many cases, proactive planning during the FIG period could produce substantial long-term tax savings while avoiding unexpected double taxation.