UFPLS good for US/UK tax efficiency?

Hi

For background, I'm a US/UK dual citizen considering retiring and relocating back to the UK from the US next year.

Reading through the documentation from the administrators of my UK defined contribution pension scheme, it looks like they have an option which I believe is aligned with the Uncrystallised Funds Pension Lump Sum (UFPLS) option for distributions. Unlike a typical withdrawal, with a 25% tax free lump sum up front, my understanding is that under UFPLS you effectively take multiple lump sums whenever you want, each one of which has a 25% tax free element.

For simplicity, let's assume a reasonable chunk of my distributions would be at the 40% higher rate in the UK.

As I look at optimizing tax strategies across the UK and US, it seems like UFPLS could be a good option. Consensus is that the 25% tax free lump sum would be taxable in the US because of the Savings clause, so the IRS would take a reasonable chunk of any traditional up-front 25% tax free lump sum.

However, under UFPLS, my effective marginal tax rate on the distribution in the UK would be 30% (i.e. 75% of the distribution would be taxed at 40%, and 25% would be tax free, giving an effective rate of 30%). Although the US would tax the full amount, it would likely be below the effective UK rate of 30%, and so the foreign tax credit on my US return would mean no additional US tax to pay. Therefore I'd retain full benefit from the tax free amount in the UK.

All this is predicated on grouping together all lump sum distributions (and the foreign tax on them) together on Form 1116, rather than needing one 1116 for the tax free part and another for the taxable portion. However, from my initial reading, nothing in the instructions or the form seems to suggest I'd need to do that.

If anyone else has experience of completing Form 1116 to get credit for UK tax on lump sum distributions, I'd appreciate your thoughts on whether this appears to make sense?

Many thanks
Martin

I think your plan looks sound, although I have no actual experience. I live in the UK

I receive a UK pension each year and it is taxable in both countries so I file a 1116 to recover the UK taxes paid on it as my tax rate is higher in the UK than US.

You could do the same thing using USPFL. Suppose you withdrew $10k. In the UK you would pay UK taxes on $10k of which 25% is tax free, and in the US you would pay US taxes on $10k where none of it is tax free,  and you would file a 1116 to get a credit for the taxes paid in the UK. If your marginal rate is 40% then you will have paid $3k UK taxes that you can offset against the US taxes reducing the US taxes to zero on that withdrawal.

It looks like a good plan. Part of tax planning is to use the differing UK and US tax brackets sensibly. I'm also thinking about a move back to the UK from the US and part of my planning will involve managing IRA to ROTH conversions which can get expensive if the 40% UK income tax kicks in.

Thanks durhamlad & nun. Nice to know I'm at least not obviously off base with this.

I'll probably share a few more extracts from my tax planning where it would make sense to get some validation, or where it's worth sharing.

Nun - I also plan some Roth conversions to avoid the higher rate of UK tax. As durhamlad has previously advised, I also need to switch some of my investments to HMRC Reporting funds, and to sell and re-buy to reset the cost basis for UK capital gains tax purposes. All of that buying and selling of investments (plus a likely large taxable capital gain on the sale of our house) means I need to watch my tax brackets in the US. With hindsight I'd have started this earlier to spread those gains across multiple years....

All that said, from my research to date, Roth conversions appear not to be treated as taxable events by HMRC, so I'll probably wait to do those until after I'm in the UK. That was based on this post here (although I do approach the HMRC forums with some scepticism): https://community.hmrc.gov.uk/customerforums/sa/11e35ca5-032a-ee11-a81c-000d3a8751e3#019bd194-b9ea-ee11-a1fe-00224841f8a9

If you are able to convert before becoming UK resident, that might be more prudent.

We started doing Roth conversions the year we retired, 2010. By 2017 we still had some conversions to do and we’re back in England. We continued alternating years to each do a lump sum Roth conversion, paying only US taxes. Last conversion was 2022 so we are 100% Roth now.

Thanks durhamlad & nun. Nice to know I'm at least not obviously off base with this.

I'll probably share a few more extracts from my tax planning where it would make sense to get some validation, or where it's worth sharing.

Nun - I also plan some Roth conversions to avoid the higher rate of UK tax. As durhamlad has previously advised, I also need to switch some of my investments to HMRC Reporting funds, and to sell and re-buy to reset the cost basis for UK capital gains tax purposes. All of that buying and selling of investments (plus a likely large taxable capital gain on the sale of our house) means I need to watch my tax brackets in the US. With hindsight I'd have started this earlier to spread those gains across multiple years....

All that said, from my research to date, Roth conversions appear not to be treated as taxable events by HMRC, so I'll probably wait to do those until after I'm in the UK. That was based on this post here (although I do approach the HMRC forums with some scepticism): https://community.hmrc.gov.uk/customerforums/sa/11e35ca5-032a-ee11-a81c-000d3a8751e3#019bd194-b9ea-ee11-a1fe-00224841f8a9

If you are able to convert before becoming UK resident, that might be more prudent.

You need to factor ROTH conversions in with your other income and your tax brackets. I'm filling the 24% tax bracket as much as possible each year to get my IRAs into a US and UK tax free account. I think Durhamlad did conversions every other year to have a good argument that they were not periodic payments and thus not UK taxable. If I end up bound for the UK I'll sell the house, sell funds outside of pensions and buy the equivalent ETFs so that all capital gains etc are paid to US before I become UK resident.

You need to factor ROTH conversions in with your other income and your tax brackets. I'm filling the 24% tax bracket as much as possible each year to get my IRAs into a US and UK tax free account. I think Durhamlad did conversions every other year to have a good argument that they were not periodic payments and thus not UK taxable. If I end up bound for the UK I'll sell the house, sell funds outside of pensions and buy the equivalent ETFs so that all capital gains etc are paid to US before I become UK resident.

Yes - agreed on that front. For me, Roth conversions plus gain on house sale plus selling/repurchasing brokerage funds plus income to live on would unfortunately (or fortunately perhaps!) blow through into the 20% long term capital gains rate for me, hence I'm leaving the conversions to a later date. Most likely that'll be when I'll be relying more on sale of brokerage funds to live on, and so will have relatively little being taxed as income.

Good idea to avoid making those conversions looking like periodic payments as well (which in reality they would not be).