Starting up and funding a ROTH IRA

OK, as US citizens not claiming the remittance basis (I guess all of us of normal means who are more-or-less permanently resident in the UK), we have a problem:

1. We cannot (or should not) own US mutual funds outside of a tax-deferred wrapper (such as a traditional or Roth IRA, 401(k) etc.) because HMRC will tax us punitively.

2. We cannot own UK unit trusts (=britspeak for mutual fund) outside of a tax deferred wrapper (such as an occupational or personal pension) because they will almost invariably be PFIC's which the IRS will tax punitively.

3. The IRS does not recognize an ISA as a pension for purposes of Article 17 of the treaty.  Apparently, this is because the HMRC doesn't recognize an ISA as a pension either.  Hence, a stocks-and-shares ISA is, at least theoretically, very dangerous for US citizens.

4. However!! The HMRC recognizes a ROTH IRA as a pension (see http://www.hmrc.gov.uk/cnr/res-dom-faqs.htm#e ).  This is, of course, logically inconsistent since an ISA and a ROTH IRA are practically identical in every way.  I think the reason for this inconsistency is because the IRS explicitly refers to a ROTH IRA as a pension for purposes of Article 17 in the treaty notes (http://www.ustreas.gov/offices/tax-policy/library/teus-uk.pdf). 

5. Accordingly, we should be able to put money into a ROTH IRA and invest in US mutual funds and get the benefits that we would have if were UK (only) citizens who owned a stocks-and-shares ISA. The treaty protects us from HMRC if we own US mutual funds in the ROTH IRA.

6. Some of you have gotten the impression that only US-sourced earned income can be contributed to a ROTH IRA.  THIS IS WRONG!! (see http://www.irs.gov/pub/irs-pdf/p590.pdf).  The confusion arises because you cannot contribute earned income that is part of the income you have excluded on 2555 (foreign earned income exclusion). If you earn less than $91400 and exclude it all, then you have no eligible income to contribute (but hold on, the solution follows..).    If you earn  more than $91400, then you will have earned income that is eligible for contribution (as long as your modified AGI is not over the limit).  It doesn't matter if it is foreign!! Now, if you earn less than $91,400, what do you do?  Simple: don't use the foreign earned income exclusion (form 2555); use the foreign tax credit (1116) instead.  Then,  all of your income is eligible and you will be able to contribute the max to your ROTH.  Actually, the benefits of using 1116 are myriad...For example, you get additional child tax credits (I get $2000 a year just for passing go..) and you accumulate unused foreign tax credit.  If you are within 10 years of retirement, you will seriously need the unused tax credits to offset the US tax liability on your UK-tax-free 25% lump sum distribution on your UK personal or occupational pension.  Anyways, that's another thread..

7. The problem is that it seems to be hard to open a ROTH IRA without a US residential address.  Wells Fargo was totally stupid (I'm trying to get them to change their rules but I doubt if I'll succeed).  However, Fidelity had no problem (you just couldn't use the on-line form as it couldn't handle UK postcodes and the fact that you don't live in a state.  However, the print-out form is fine.)

8. There one thing I'm not entirely clear about (and this is big..).  As far as I can tell, HMRC is fine with not taxing gains from ROTH IRA's that have been opened after you establish residency here .  Just for clarifcation: the same is not true with a traditional IRA where one is deducting contributions from taxable income.  Such deductions from UK taxable income would only be allowed if the traditional IRA was established prior to arrival in the UK (see Article 18 of the treaty).  Moreover, HMRC will tax distributions from a traditional IRA but not from a ROTH (again see http://www.hmrc.gov.uk/cnr/res-dom-faqs.htm#e). Fair enough.  The reason I'm a little paranoid about the ROTH situation is that the US/Canada tax treaty explicitly makes gains from contributions to Roth IRA's made by a US citizen after he has moved to Canada be taxable upon distribution.  "The pension bifurcates(!) into two pensions.."  However,  it doesn't seem that the US/UK tax treaty has this problem.  I've actually asked HMRC about this but I somehow doubt if I'll ever get an answer.  I hope I haven't given them any clever ideas..
However, there is nothing in Article 17 that would allow the UK to do what Canada does in their treaty with the US.

Anyways,  I'd be grateful any comments on all this.  I'd also be interested to hear about experience people have had from various financial advisors and brokerage houses about opening ROTH IRA's from the UK.

I too understand a lot of the issues you mention about the Roth IRA.  I’ve been contributing to a Roth since 2004, all the while also excluding all my income through the Foreign Earned Income Exclusion.  I only just realised that you are not allowed to do this and how it never caught up with me, I’ll never know.  Anyway I’ve just spent the past few weeks filing amended returns going back to 2004 claiming the Foreign Tax Credit instead.  (Thankfully you can file amended returns for up to ten years to claim the Foreign Tax Credit)

3. The IRS does not recognize an ISA as a pension for purposes of Article 17 of the treaty.  Apparently, this is because the HMRC doesn't recognize an ISA as a pension either.  Hence, a stocks-and-shares ISA is, at least theoretically, very dangerous for US citizens.

While an ISA and a Roth IRA work in similar ways, I think perhaps the reason that an ISA is not viewed as a pension is that you do not have to be any particular age in order to withdraw from it (unlike a Roth).
I do find it very annoying that I feel like my hands are tied with so many different types of investments.  I feel a bit “cheated” that I can’t contribute to an ISA for example.

If you are within 10 years of retirement, you will seriously need the unused tax credits to offset the US tax liability on your UK-tax-free 25% lump sum distribution on your UK personal or occupational pension.  Anyways, that's another thread..

Very good point.  Certainly something I’d never even thought about until now.

8. There one thing I'm not entirely clear about (and this is big..).  As far as I can tell, HMRC is fine with not taxing gains from ROTH IRA's that have been opened after you establish residency here .  Just for clarifcation: the same is not true with a traditional IRA where one is deducting contributions from taxable income.  Such deductions from UK taxable income would only be allowed if the traditional IRA was established prior to arrival in the UK (see Article 18 of the treaty). 

Not sure I understood your last paragraph.  Are you saying then that after having lived here in the UK for several years, if I should now decide to open a traditional IRA, HMRC would not allow me to deduct the contributions from taxable income?  But regardless of that point, the earnings in the traditional IRA would presumably still be tax deferred until I withdraw it, at which point I would then be taxed on the distributions.

I recently transfered to a self-directed Roth IRA with Equity Trust Company.  They had no problem that I lived overseas.  But yes, I had the same problem with using the online forms.

I too would be interested in hearing anyone’s experiences regarding Roth IRA’s as there does seem to be a lot of confusion out there.

1. We cannot (or should not) own US mutual funds outside of a tax-deferred wrapper (such as a traditional or Roth IRA, 401(k) etc.) because HMRC will tax us punitively.

Not all US mutual funds. If the fund has distributor status, it will receive regular cap gains treatment.  You can find the list here:  http://www.hmrc.gov.uk/offshorefunds/dist_fund.htm

It is important to note that the list will not always have the most recently approved funds.  In addition, it is expected for the list to increase significantly in the next year because it really wasn't the aim to include US mutual funds in punitive offshore fund treatment.

Finally, by definition, all US mutual funds are eligible for distributor status -- based on SEC rules for mutual funds.  If your US mutual fund isn't already on the list, you can apply for the distributor status yourself.

2. We cannot own UK unit trusts (=britspeak for mutual fund) outside of a tax deferred wrapper (such as an occupational or personal pension) because they will almost invariably be PFIC's which the IRS will tax punitively.

Going to provide an alternate point.  The conservative view point is that the treaty allows for US pension treatment on UK employer based pensions not all UK pensions.  Thus from a US perspective a personal pension is also a PFIC.  Again, this is conservative and others may be more generous.  At least, it is something for people to consider when they invest.

3. The IRS does not recognize an ISA as a pension for purposes of Article 17 of the treaty.  Apparently, this is because the HMRC doesn't recognize an ISA as a pension either.  Hence, a stocks-and-shares ISA is, at least theoretically, very dangerous for US citizens.

Correct.  Because it isn't recognised as a pension in the UK, it isn't a pension by US standards under the treaty.  Irrespective of how similar it may be to an IRA.  Funamentally an ISA is not a pension.  As was said above, you can withdrawal at any time.  It just means it is a tax advantageous savings vehicle.

7. The problem is that it seems to be hard to open a ROTH IRA without a US residential address.  Wells Fargo was totally stupid (I'm trying to get them to change their rules but I doubt if I'll succeed).  However, Fidelity had no problem (you just couldn't use the on-line form as it couldn't handle UK postcodes and the fact that you don't live in a state.  However, the print-out form is fine.)

Hard but not impossible.  Vanguard was also fine with the whole foreign aspect.



I was going to comment on your last points but am going to have to run for a bit.  Am travelling tomorrow morning and need to pack!!!

Not all US mutual funds. If the fund has distributor status, it will receive regular cap gains treatment.  You can find the list here:  http://www.hmrc.gov.uk/offshorefunds/dist_fund.htm

It is important to note that the list will not always have the most recently approved funds.  In addition, it is expected for the list to increase significantly in the next year because it really wasn't the aim to include US mutual funds in punitive offshore fund treatment.

Thanks Sarah, but as far as I can tell,  none of those funds are offered for sale to US customers (e.g., the Fidelity funds on the list all seem to come from Fidelity International).  As such, it seems to me that they are all potential PFIC's for IRS purposes.  I hope the list increases as you say..

Finally, by definition, all US mutual funds are eligible for distributor status -- based on SEC rules for mutual funds.  If your US mutual fund isn't already on the list, you can apply for the distributor status yourself.

How would an individual investor apply for getting distributor status of a fund?  This would be the ultimate in DIY finance and I'd get a kick out of having a go at this (although I should be doing my real job instead...).  Frankly, all I want to do is invest some inherited money into an index fund that won't get me in trouble with IRS or HMRC. 

To follow up on point 8 of my original post: I contacted the overseas pensions group at HMRC and got confirmation that there is no problem with starting up a Roth IRA after you became a UK resident.  That is, the growth and gains within the Roth IRA will still be tax-free in the UK and in the US.  (Being a Roth IRA, of course, the contributions receive no tax relief in the US or UK).  Again, just to clarify:  if you establish a TRADITIONAL IRA after you become resident in the UK, then the contributions will not be eligible for UK tax relief by HMRC (this is spelled out explicitly in the tax treaty).

I am completely confused. I have ROTH IRA that I have been contributing to each year. As I was doing my taxes, turbo tax told me I had over contributed since I am now married and filing separately. I didn't realize that I would be penalized for this and after spending some time on the phone with my investment company, I had to correct this and basically take that money out and correct the excess contribution.
So now I too am wondering how I will be able to contribute to the Roth if my husband is British and will therefore not be filing a US tax form...ugh.

A Roth does nothing much to save UK taxes unless you elect the remittance basis or the the treaty on every annual UK return.  Most folks would do better by reducing UK taxes - e.g. by putting money aside in an ISA.

A Roth does nothing much to save UK taxes unless you elect the remittance basis or the the treaty on every annual UK return.  Most folks would do better by reducing UK taxes - e.g. by putting money aside in an ISA.

I suppose that really depends on your tax bracket and the relative taxation rates in the US and UK. It might be advantageous to limit UK tax by using an ISA, but wouldn't the investment choices be limited to cash and individual stocks if you wanted a simple life. I'd choose the ROTH option and invoke the treaty because of the wide range of investments available and low fees of Fidelity and Vanguard.

OK, as US citizens not claiming the remittance basis (I guess all of us of normal means who are more-or-less permanently resident in the UK), we have a problem:

1. We cannot (or should not) own US mutual funds outside of a tax-deferred wrapper (such as a traditional or Roth IRA, 401(k) etc.) because HMRC will tax us punitively.

2. We cannot own UK unit trusts (=britspeak for mutual fund) outside of a tax deferred wrapper (such as an occupational or personal pension) because they will almost invariably be PFIC's which the IRS will tax punitively.

Wow thanks for this post. A while back I asked questions about the catch 22 of expatriate after tax investing. The ROTH route is good, but it still doesn't solve the issue of what to do with after tax money that you don't want to put specifically towards retirement and what if you have more to invest than the ROTH limit. In the end I think a simple thing to do is make extra mortgage payments (if you have one) or just put it into a Vanguard Index fund and deal with having any gains that you remit to the UK being taxed as income. I asked Vanguard US if they would ever apply for UK distributor status and got the expected "when hell freezes over" reply - I paraphrased.

I wanted to bump this topic to see if there were any updated considerations in recent years for a US citizen UK resident thinking of opening a Roth IRA.

Given the original premises of this thread which still seem accurate, namely that US citizens should not hold non-US funds, an investment ISA cannot hold US funds, a UK taxpayer should not hold non-reporting funds etc. it seems to me the simplest option for a US citizen UK resident looking to do some modest tax-advantaged investing in low cost passive funds is a Roth IRA. It seems to be more or less equivalent (apart from the age restriction) to the ISA, and I understand it is fully recognised in the UK (ie can hold non-reporting funds with no problems, gains and distributions will be tax free).

The only consideration seems to be that one should use Foreign Tax Credits rather than Earned Income Exclusion to ensure enough earnings. Actually in my case there is the additional consideration that since I am married filing separately (my wife understandably wants nothing to do with the US system) I cannot contribute directly to a Roth, but I understand I can use the "Roth Backdoor" by making a non-deducted contribution to a Traditional IRA and converting immediately.

Are there any problems with this approach?

A Roth does nothing much to save UK taxes unless you elect the remittance basis or the the treaty on every annual UK return.  Most folks would do better by reducing UK taxes - e.g. by putting money aside in an ISA.

I didn't really understand this. I thought a Roth IRA is recognised by the UK and so does function as a tax-exempt wrapper the same way as an ISA would? Putting money aside is an ISA is OK but one is limited to cash or individual stocks (usually with prohibitive transaction fees from UK brokers for small investments).

I don't file a UK return. Would having a Roth IRA trigger a requirement to do so? Or could I just assume given it is a tax-free account under the treaty I would remain below UK filing requirement limits.

The US-UK Treaty permits one slight loophole with respect to IRAs. Provided that you were making traditional IRA contributions before becoming UK resident, you can claim UK tax relief on traditional IRA contributions you make afterwards. In addition, the UK doesn't tax Roth conversions, so you can immediately roll the money into a Roth without giving up the tax relief you received on the contributions. A self assessment return must be filed (look for "contributions to a foreign pension"). Unfortunately, as far as I know, you cannot use this route if you started making traditional IRA contributions after coming to the UK.

The numbers are not insubstantial - a higher rate taxpayer who meets the treaty conditions and contributes the maximum $5,500 to an IRA (and then converts to a Roth) would be able to reduce their UK tax bill by the sterling equivalent of $2,200 every year.

The numbers are not insubstantial - a higher rate taxpayer who meets the treaty conditions and contributes the maximum $5,500 to an IRA (and then converts to a Roth) would be able to reduce their UK tax bill by the sterling equivalent of $2,200 every year.

Thanks for the reply. I didn't realise it could be possible to have pre-tax income end up in a Roth (surely US taxes would be due on the rollover?). But it doesn't apply in my case because I have never lived in the US, and because of my Married Filing Seperately status I am over the income limits for pre-tax traditional IRA contributions.

What I was thinking of was making a post-tax traditional IRA contribution - and then converting it to a Roth (this seems to be referred to online as a "backdoor Roth"). I guess I am just looking over the 1116 form and am a little worried about the complexity and whether this is worth doing.

Thanks for the reply. I didn't realise it could be possible to have pre-tax income end up in a Roth (surely US taxes would be due on the rollover?). But it doesn't apply in my case because I have never lived in the US, and because of my Married Filing Seperately status I am over the income limits for pre-tax traditional IRA contributions.

What I was thinking of was making a post-tax traditional IRA contribution - and then converting it to a Roth (this seems to be referred to online as a "backdoor Roth"). I guess I am just looking over the 1116 form and am a little worried about the complexity and whether this is worth doing.

My remarks were general in nature and not intended to apply in your specific case.

The "backdoor Roth" method should not over-complicate your US filing - in fact I personally use this method. You won't get the upfront UK tax relief provided by the Treaty, but you get the benefit of the growth being free of both US and UK tax, and any distributions similarly being tax free.

If you are comparing using 1116 vs 2555 - most tax software can do the 1116 pretty easily so I wouldn't worry too much about the filing being tricky. Make your decision based on the numbers and not the ease of filing.