US Tax on UK Pension Contributions

How should I treat contributions to a UK pension plan on my US taxes?  I currently contribute 5% which gets a 10% match by my employer both of which are tax-free as far as UK taxes are concerned (until retirement).

I plan on subtracting this income from my wages on my 1040 as these are similar to a 401k plan back in the US which is also excluded from income and taxed only at retirement.

Do I have this right?

This is a treaty issue.  You will need to speak with a specialist, who can outline all your options.  It is NOT black and white, there are multiple methods of treatment depending on whether you invoke the treaty or not, and there are large tax consequences down the line based on the choice you make today.

I do not see why this should be a treaty issue.

mb has said that s/he plans on reducing reported taxable wages by 5% and not recording as taxable the 10% cash payments from her/his employers.  This sounds rather as if mb feels s/he has some justification under the Internal Revenue Code for failing to record 15% of income.  I know of no such rule.

The entire wages, including the 15% are reportable currently in the US.  Until 2006, most US folks living here would not have owed US taxes in any case because of the foreign earned income exclusion and foreign tax credits.  Why therefore would one do anything other than recording these amounts as taxable?

Guya,

Treaty article 18 allows the contributions to a pension, whether by an employee or an employer, to be tax-exempt in limited circumstances.  To make this claim requires the filing of Form 8833, and the amount claimable is limited to the amount allowable in an equivalent US plan.   The savings clause (article 1 paragraph 5 (a)) specifically permits this.

However, it has tax consequences down the line at withdrawal time, and it is optional whether one invokes the treaty or not.  Even if it is deemed a great idea to deduct the pension contributions, it would require expert advice to determine what an equivalent plan in the US might be (Simple?  401k? Defined Benefit Keogh?  Money Purchase Keogh?).  Details and particulars of the UK plan would need to be compared with each of these plans to determine the one with the closest fit.  These plans have a variety of maximum annual contributions.  Many UK plans meet the US definition of discriminatory, and that may affect the maximum annual contribution allowed or allowable.  Any excess contributions would be taxable income in the current year, offset by foreign tax credits.  Excess employee contributions can also be offset by Foreign Earned Income Exclusion, but employer contributions are specifically exempt from FEIE and can only be offset by foreign tax credits.

Hence, my recommendation that mbmasters seeks some specific US tax advice prior to making such a claim. 

IRS Circular 230 Disclosure:  To ensure compliance with requirements imposed by the U.S. Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein.

Guya,

I forgot to mention in the last bit...  Usually, it makes most sense to tax currently, but I have had a few clients where it saved them a few quid, mostly because they didn't have sufficient tax credits to offset the pension.  With the new UK pension contribution limits being sky-high compared to the US, this is going to be more of an issue in the future.  Also, with the new tax law ratcheting up the brackets irrespective of the FEIE, claiming a pension contribution may substantially reduce current year income by reducing FEIE Modified Taxable Income for purposes of determining which tax bracket someone is in.

But if I were to just toss the dice and guess without a look at any of mbmasters personal details, I'd guess s/he'd be better off not claiming the deduction.  I wouldn't want to bet on a guess if I were him/her.

IRS Circular 230 Disclosure:  To ensure compliance with requirements imposed by the U.S. Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein.

Thanks for the advice. Based on your first response Lizzit I downloaded the treaty and read the Pension Scheme section and realized that I would have to cap at US limits.  This doesn't impact me in 2005 as I only just began contributing but in 2006 I will certainly exceed US limits.

I think I will include these amounts as income this year as it only raises my US taxes by $150 due to the increase in my effective tax rate applied to US income.  I'd rather tax this today and not have to pay anything when I withdraw it as I know you can take a large tax-free lump sum when you retire in the UK, if I remember right it's 25%.

However, I think I will get some advice on my return this year, I've got a lot of odd things going on!

Yes, it's 25%, but I don't know how far in the future you retire. The rules may change by then, particularly with people's pension funds now having to last them 20+ years.