This article was last updated in February 2023.
There are a variety of different reasons that Americans living abroad participate in foreign pension plans. Some qualify for them after settling abroad permanently, some are granted them as part of their compensation for work done abroad.
Regardless of where they live or how they came to be there, however, all American citizens and green card holders must report their worldwide income annually on a federal US tax return. This must include income from and even sometimes contributions to foreign pension plans.
But what are the reporting requirements for foreign pensions, and how are they taxed? Is a foreign pension exempt from tax? Read below for the answer to these questions and more.
What is a foreign pension?
First things first: a foreign pension is a contribution plan based outside of the US intended to distribute payments upon retirement. You may receive a foreign pension through a foreign employer, government, trust, insurance company, or other entity. Typically, the payments you receive will come (at least in part) from contributions you or your employer have made in the past.
Common types of foreign pensions for expats
Many different countries have pension systems that are unique to them, which expats may be able to qualify for. This includes:
- The UK’s Employer Sponsored Pension Schemes & Self-Invested Personal Pensions (SIPPs)
- Canada’s Registered Retirement Savings Plan (RRSPs)
- Germany’s Pillar Pension System
- The Netherlands’ Old Age Pension (AOW)
- France’s Public Pension Fund (FRR)
- Switzerland’s Old Age and Survivor’s Insurance (OASI)
Commonly, countries will have a compulsory state-run pension system (like Social Security in the US), with options for employer-sponsored and individually-owned pensions as well.
Is a foreign pension exempt from tax?
Typically, no. Foreign pension plans are subject to US reporting requirements, and contributions, growth, and distributions are liable to US taxation. The exact way in which a pension is taxed, however, depends on how it’s classified for US tax purposes, which often varies from its classification and taxation in the country it originates in.
How the IRS classifies foreign pensions
The US government generally treats foreign pension plans as non-exempt employee trusts, which are defined by the following characteristics:
- Meets minimum participation standards and nondiscrimination requirements
- Made up of no more than 50% employee-contributed funds
- Beneficiary is not a highly-compensated employee
There are a couple of benefits associated with non-exempt employee trusts. Namely, tax deferral until payments are distributed to the pension holder, and less-stringent reporting requirements.
However, they don’t receive all of the same benefits as qualified US retirement plans. The beneficiaries of these plans must factor their employer’s contributions into the gross income they report on their US tax return. Contributions are also not tax-deductible unless they’ve been funded or vested.
Another type of minority trust classification
While most foreign pension plans are considered to be non-exempt employee trusts, there are other US tax classifications foreign pensions might fall into.
Foreign Pension Grantor Trust
Foreign pensions that fail to meet the criteria of non-exempt employee trusts will most likely be classified as Foreign Pension Grantor Trusts. Unfortunately, these are not eligible for the benefits of non-exempt employee trusts. Taxes are not deferred, and they trigger additional reporting requirements (more on that later), particularly if the trust includes foreign mutual funds.
Tax treaties & foreign pensions
Expats’ foreign pensions often run the risk of double taxation since they are typically subject to taxes in both the country in which the plan is based and the US.
Although the US does have a number of tax treaties with other countries to prevent double taxation like this in theory, they rarely work in practice (courtesy of the tricky savings clause). In the rare cases where these tax treaties do work, they mainly apply to teachers, students, and researchers. Even then, it’s far from a sure thing.
To prevent double taxation on contributions to or payments from a foreign pension, your best bet is to review your tax strategy holistically and familiarize yourself with the IRS’s tax breaks for expats.
Reporting a UK pension on a US tax return
The US/UK tax treaty is exceptional among the US’s international tax treaties where pensions are concerned. Among other reasons, this is thanks to Article 17, which provides that contributions to a pension in the UK can be tax-deferred, much like an American 401(k). Additionally, while pension distributions may be taxed, there is a double taxation article that may protect you from paying taxes twice over.
Note: While Bright!Tax exclusively specializes in filing US taxes, we may be able to recommend a tax filing provider in your country of residence – feel free to ask us if we have a recommendation!
Expat tax tool: the Foreign Tax Credit
One of the more well-known aids when filing US expat taxes is the Foreign Tax Credit, which allows you to subtract, dollar-for-dollar, the amount that you’ve paid in taxes to a foreign government from your US tax bill. The exact application of the FTC will vary from country to country, but may be especially helpful if you live in a country with no tax treaty in place with the US.
The Foreign Tax Credit and French Contribution Sociale Generalisee (CSG) and Contribution au Remboursement de la Dette Sociale (CRDS)
In 2019, the United States and France updated their Agreement on Social Security to reflect a new understanding that taxes paid to the CSG and CRDS are not social taxes (prior to 2019, they were classified as such). This means that the IRS will no longer challenge the application of the Foreign Tax Credit for CSG and CRDS payments, which may have meaningful financial implications. Namely, individual taxpayers who paid or accrued taxes relating to the CSG or CRDS can file up to 10 years of amended returns to claim a foreign tax credit or credits. Consult with an expat tax specialist at Bright!Tax today to learn how much you may be eligible for in refunds.
The Foreign Earned Income Exclusion (FEIE) – not applicable to pension income
Another common method through which expats can lower (or in some cases, eliminate owing) taxes to the IRS is via the Foreign Earned Income Exclusion (FEIE). The FEIE allows the expat taxpayer to exclude a portion of their earned income (up to $112,000 for the 2022 tax year) from taxation altogether. However, it’s important to note that the FEIE can only be applied to earned income, thereby disqualifying its application against taxes on foreign pensions. Income from foreign pensions is considered unearned income.
Determining which tax breaks will be helpful for you depends largely on your individual circumstances. Since individual circumstances can quickly become quite complex when viewed from a tax perspective, an expat tax professional can help you determine the most advantageous filing strategy for your situation.
How to report foreign pension income
By now, you know that you have to report foreign pension income. The specific way you do so, however, will differ based on how the US government classifies your pension, the value of your assets, and other factors. It can get quite complex, but these are a few of the major forms you may be expected to file:
FBAR: FinCEN Form 114
FinCEN Form 114 is mandatory for any American who holds more than $10,000 in foreign accounts at any point in the calendar year. (Note: The $10,000 threshold applies to the total value across all foreign accounts in all currencies.)
Are foreign pension accounts reportable on FBAR?
Whether or not you’re required to report pension accounts specifically depends on whether they’re part of a defined benefit plan or defined contribution plan.
Defined benefit plans are typically funded and managed by either an employer or the government rather than an individual. Technically, these do not need to be reported on the FBAR. You may want to do so anyway just to cover your bases, though, using a reasonable estimate of the cash-out value of your account.
This category typically includes social security-equivalent plans. As a rule of thumb, if a pension plan doesn’t have a designated unique account number, it isn’t considered a foreign financial account and is therefore not subject to the FBAR.
However, defined contribution plans, which individuals typically manage and co-fund (along with their employer or the government), must be reported on the FBAR if their value reaches or exceeds the reporting threshold.
FATCA: Form 8938
FATCA Form 8938 is mandatory for any US person living abroad whose foreign-registered financial assets add up to $200,000 or more per person at the end of the year, or $300,000 or more per person at any time during the year (although those figures are higher for married couples filing jointly). Any kind of foreign pension that meets or exceeds those thresholds must be reported via Form 8938.
IRS Form 3520/3520A
If your foreign pension fund is classified as a trust by the US government (as many are), you’ll need to fill out IRS Form 3520. If you’re considered a trustee of the fund, (which you will be if you are a US beneficiary of a foreign trust), you’ll also need to fill out 3520A.
Learn more about IRS Form 3520 For Expats – Reporting Foreign Trusts And Foreign Gifts.
Passive Foreign Investment Companies (PFICs) – Form 8621
Form 8621 is mandatory for expats with interests in Passive Foreign Investment Companies (PFICs). PFICs include companies where at least 75% of the income is passive (e.g. dividends, royalties, rents), or where 50% or more of their assets produce passive income. Since many pension plans have stakes in foreign mutual funds, hedge funds, and insurance products, they often fall into this category.
PFICs are harshly taxed — often enough to outweigh any financial gains they might otherwise provide — and trigger complex reporting requirements. If possible, you may want to think twice before investing in them. If you already have interests in PFICs and need to report them, you’ll likely want to consult an expat tax professional like the ones at Bright!Tax. We can match you with an expert specialized in minimizing your overall tax liability.
Get up to speed on your foreign pension tax reporting
While reporting requirements relating to foreign pensions are unavoidable, there are still strategies tax professionals can leverage to minimize your tax liability. For example, expats in countries with a higher income tax than the US can claim the Foreign Tax Credit to not only eliminate their tax bill, but also accrue credits that can be applied to foreign pension plan contributions.
Wondering how to catch up on US taxes if you’ve fallen behind?
If you’re behind on taxes you didn’t know you needed to pay while abroad, you may be able to avoid penalties through the IRS’s Streamlined Procedure amnesty program. As part of this program, you’ll need to file your last three tax returns and six FBARs (as required) as well as self-certify that your previous failure to file wasn’t willful evasion.
Whether you want to learn more about these strategies or get advice regarding your individual circumstances, the expat tax experts at Bright!Tax can help. Get started today to schedule your consultation!