If you don't (or can't) take the treaty exemption and include your UK tax deferred contributions and employer contributions on your 1040 and pay US tax on them, how do you then treat gains and the eventual pension income for US tax purposes?
My understanding: (As always, it could be wrong.)
If you declare your contributions on 1040 each year, and pay(?) tax on them, when you start claiming the pension you can deduct your previous taxed contributions as 'costs' to reduce the reportable amount of the pension for tax. You'll be able to take credits for the contributions when made, and reduce taxable income when retired.
If you don't pay tax on your contributions as they arise, when you retire you can not deduct your previous contribution amounts to reduce the taxable pension (as I read 939).
The other consideration at time of retirement is which method do you use to claim the 'costs', the general rule or the simplified method. This is determined by a foreign pension being qualified, or not, for the purposes of the simplified method. Generally, foreign pensions are not qualified, so you use the general rule (Publication 939). But, you may feel that the US/UK Treaty says that foreign pensions similar to US qualified pensions are deemed qualified. Back to interpretation of the Treaty.Some
feel it easier just to use the general rule, thereby avoiding any discussion of the Treaty (and its proper/acceptable use), since in the end there may be little between the results for the two methods.
Currency fluctuations will play a part regardless of which method you use, since calculations are tied to the first year of retirement. Because of what is, or more importantly isn't, in the text of the general rule, it could be yield a better result long term. If the pension has a survivors clause, that will also impact calculations for both methods.
As for the handling of the employers contribution after retirement, I've found an IRS interpretation doesn't always agree with a professional opinion. One method may be to declare your contributions, but invoke the Treaty for the employers contributions since you
haven't paid any foreign tax on it and the employer hasn't paid any tax on it to the US (the sticking point for the IRS). I'm sure there may be further comments on this from others.