Roth IRA Conversion while UK resident

I am a dual UK/US citizen, now returned to the UK after 20 years in the US.

I am some years from drawing on my retirement funds and am considering converting my US IRA into a Roth IRA.  All the funds in the IRA were contributed while I lived and worked in the US (into an employer 401k I later rolled into the IRA).  I don’t currently work in the UK and I would plan to convert to the Roth over several years, maximizing the benefit of my low US tax bracket on the tax I would owe.

My question is whether an IRA to Roth conversion is taxable in the UK?

I have trawled the posts I can find on this forum and broadly found two possible conclusions –

1.   The conversion is not taxable in the UK under the tax treaty, which generally excludes UK taxation of inter pension fund transfers that happen in the US.  Or...
2.   The conversion is treated as a lump sum pension distribution by the UK and not taxed for that reason.  But, with a conversion done piecemeal over several years, it’s important not to make the lump sums look like periodic payments.  One post I read suggested a conversion made not more frequently than every other year would be required to ensure that.

Is there a current view on this?

Thanks

A lump sum conversion every other year is what my wife have been doing. Two more conversions to go before it is all Roth for both of us.

Thanks for the reply, durhamlad.

So it's UK tax years that count.  If I move quickly to get it in the 2019 US tax year, my next opportunity would be during the UK 2021-22 tax year?

And the rationale is to take advantage of generally lower US tax brackets during the conversion so when I later draw on the Roth, it's tax free in both the UK and the US?  It seems a good strategy.

Thanks



 

Thanks for the reply, durhamlad.

So it's UK tax years that count.  If I move quickly to get it in the 2019 US tax year, my next opportunity would be during the UK 2021-22 tax year?

And the rationale is to take advantage of generally lower US tax brackets during the conversion so when I later draw on the Roth, it's tax free in both the UK and the US?  It seems a good strategy.

Thanks

That’s right. Once State pensions (UK and US) and RMD’s start I will be well into the UK 40% bracket so paying US taxes at less than 20% on those conversions is well worth it.

That’s right. Once State pensions (UK and US) and RMD’s start I will be well into the UK 40% bracket so paying US taxes at less than 20% on those conversions is well worth it.

Thanks - that makes sense.

I now have a different issue related to the conversion, having researched further.  Although a US citizen, as we have a UK address, it seems the IRS mandate a 10% withholding on the conversion.  That 10% is treated as a distribution, attracting income tax and a 10% penalty (as I am under 59.5). 

If I convert say $50k, I then assume I would pay tax on the $45k that ends up in the Roth (which the withholding goes toward) and I also pay tax + 10% penalty on the $5k withholding itself.   It seems this is unavoidable - am I missing something?  Perhaps I should wait until I am older to start this. 

Hopefully the withholding doesn't have any impact on UK taxes, as HMRC treat the whole conversion as a lump sum distribution, wherever it ends up. 

Thanks - that makes sense.

I now have a different issue related to the conversion, having researched further.  Although a US citizen, as we have a UK address, it seems the IRS mandate a 10% withholding on the conversion.  That 10% is treated as a distribution, attracting income tax and a 10% penalty (as I am under 59.5). 

If I convert say $50k, I then assume I would pay tax on the $45k that ends up in the Roth (which the withholding goes toward) and I also pay tax + 10% penalty on the $5k withholding itself.   It seems this is unavoidable - am I missing something?  Perhaps I should wait until I am older to start this. 

Hopefully the withholding doesn't have any impact on UK taxes, as HMRC treat the whole conversion as a lump sum distribution, wherever it ends up.

I have done several IRA to Roth conversions from our Vanguard accounts and  never  been required to have a 10% withholding. I pay the taxes out of taxable money and use the IRS eftps site to make payments from our US bank account.
https://www.eftps.gov/eftps/

We are both US citizens living in the UK with a UK address.

I have done several IRA to Roth conversions from our Vanguard accounts and  never  been required to have a 10% withholding.

That's interesting.  Schwab want to withhold the 10%.   I guess it may depend on the brokerage how they interpret the rules and I am with the wrong one.

That's interesting.  Schwab want to withhold the 10%.   I guess it may depend on the brokerage how they interpret the rules and I am with the wrong one.

My wife’s IRAs were with Fidelity and mine were with Vanguard. When I researched which one would serve us best once we were resident in the UK I decided that Vanguard were better and my wife moved her IRAs to Vanguard before we made the move.

I have done several IRA to Roth conversions from our Vanguard accounts and never been required to have a 10% withholding.

So if I cannot avoid a brokerage charging 10% withholding on a Roth conversion because of my UK address, can I make good, under the 60 day rollover rule? Normally I would have 60 days to deposit funds when rolling over from one retirement account to another.  Can I do the same with a Roth conversion? 

For example, I convert $50k from an IRA to a Roth.  $5k gets wittheld and $45k is deposited.  Can I pay $5k from non retirement funds into the Roth, to make up the full $50k.  Will this also avoid the 10% early withdrawal penalty on the $5k?

$5k has still gone to the IRS, so I factor that into tax I owe on the conversion? It’s less convenient, but the net result is the same as if no withholding was made.  Sound reasonable?

So if I cannot avoid a brokerage charging 10% withholding on a Roth conversion because of my UK address, can I make good, under the 60 day rollover rule? Normally I would have 60 days to deposit funds when rolling over from one retirement account to another.  Can I do the same with a Roth conversion? 

For example, I convert $50k from an IRA to a Roth.  $5k gets wittheld and $45k is deposited.  Can I pay $5k from non retirement funds into the Roth, to make up the full $50k.  Will this also avoid the 10% early withdrawal penalty on the $5k?

$5k has still gone to the IRS, so I factor that into tax I owe on the conversion? It’s less convenient, but the net result is the same as if no withholding was made.  Sound reasonable?

My brokerage, Vanguard,  never does a withholding when I do a conversion to a Roth and I pay the taxes due  from a taxable account, which is exactly what I want.

A brokerage may make a mandatory 10% withholding but that is not a “charge “, it is a payment to the IRS of potential taxes owed which  you report on your IRS tax return and claim all or some of it back.

PS
Vanguard does have my UK address and knows I am resident in the UK. Possibly because I a US/UK citizen is why they don’t do a mandatory withholding but I’m not sure.

A brokerage may make a mandatory 10% withholding but that is not a “charge “, it is a payment to the IRS of potential taxes owed which  you report on your IRS tax return and claim all or some of it back.

Thanks - I see the withholding is not a charge as such, but I would prefer to pay tax out of other funds too.  The withholding hurts in two ways - by reducing the amount converted to continue growing tax free, and as I am under 59.5, the withholding attracts a 10% penalty as it is considered an early distribution. 

If I cannot avoid withholding at my brokerage, by making an equivalent payment directly to the Roth to offset the withholding (within the 60 day IRA rollover window) I hope to reach almost the same state as having no withholding - and avoid the early distribution penalty.  Assets may have to be sold to fund the withholding in the first place, but the Roth funds can at least be replaced.  The IRS still has the withholding, but that will be accounted for when I file my taxes.

It feels logical, I wondered if anyone else has done this? 

Thanks - I see the withholding is not a charge as such, but I would prefer to pay tax out of other funds too.  The withholding hurts in two ways - by reducing the amount converted to continue growing tax free, and as I am under 59.5, the withholding attracts a 10% penalty as it is considered an early distribution. 

If I cannot avoid withholding at my brokerage, by making an equivalent payment directly to the Roth to offset the withholding (within the 60 day IRA rollover window) I hope to reach almost the same state as having no withholding - and avoid the early distribution penalty.  Assets may have to be sold to fund the withholding in the first place, but the Roth funds can at least be replaced.  The IRS still has the withholding, but that will be accounted for when I file my taxes.

It feels logical, I wondered if anyone else has done this?

I’ve been doing Roth conversions since age 55 and never had to do forced withholding. If that forced withholding incurs the added 10% penalty then that really sucks big time. By paying the taxes out of taxable income it is essentially the same as adding more money to the Roth. I sell equities to fund the taxes of the conversion so I do have cap gains to pay on the funds sold.

If that forced withholding incurs the added 10% penalty then that really sucks big time.

Yep.  I am trying to think of a reason for forced withholding, such as anti tax evasion, but US citizens pay tax wherever they are in any case.

But If I can make up the difference, I could tolerate it. 

I just read IRS tax topic 413 on rollovers.  It seems to say I could offset the withholding (and therefore avoid the penalty).  It uses a 20% withholding as an example.  Its the last part that seems messed up for US citizens outside the US.

Any taxable eligible rollover distribution paid to you from an employer-sponsored retirement plan is subject to a mandatory income tax withholding of 20%, even if you intend to roll it over later. If you do roll it over, and want to defer tax on the entire taxable portion, you'll have to add funds from other sources equal to the amount withheld. You can choose instead a direct rollover, in which you have the payer transfer a distribution directly to another eligible retirement plan (including an IRA). The 20% mandatory withholding doesn't apply in a direct rollover.

Yep.  I am trying to think of a reason for forced withholding, such as anti tax evasion, but US citizens pay tax wherever they are in any case.

But If I can make up the difference, I could tolerate it. 

I just read IRS tax topic 413 on rollovers.  It seems to say I could offset the withholding (and therefore avoid the penalty).  It uses a 20% withholding as an example.  Its the last part that seems messed up for US citizens outside the US.

Any taxable eligible rollover distribution paid to you from an employer-sponsored retirement plan is subject to a mandatory income tax withholding of 20%, even if you intend to roll it over later. If you do roll it over, and want to defer tax on the entire taxable portion, you'll have to add funds from other sources equal to the amount withheld. You can choose instead a direct rollover, in which you have the payer transfer a distribution directly to another eligible retirement plan (including an IRA). The 20% mandatory withholding doesn't apply in a direct rollover.

The important words in that passage you quoted is “paid to you”.

 If the rollover is paid directly to the brokerage receiving  it then no  withholding is mandated. If the rollover goes to you and you then pay it into a receiving IRA then there is always the chance  that you keep the distribution and don’t roll it over. I have done rollovers for myself, wife and son and in every case the money went direct to the receiving brokerage. In my case the 401k plan administrators would not send the distribution anywhere except my address so I had them  write the check payable to my Vanguard IRA account and on receiving the check immediately sent it by Fedex to Vanguard. I had to do this to avoid the mandatory withholding.

With my Roth conversions they go from my IRA to my Roth within the same brokerage so it is as simple as can be and easily done online each year.

The important words in that passage you quoted is “paid to you”.  If the rollover is paid directly to the brokerage receiving  it then no  withholding is mandated.

You would hope, I agree, but for some reason, even for Roth conversions between accounts within a brokerage, some brokerages seem to interpret that as being different to an IRA rollover in terms of withholding. 

I have done IRA rollovers too, while living in the UK, in the way you describe and was never subject to withholding.  In topic 413, the IRS include Roths in the concept of a rollover - and they say that rollovers are tax free, except for a rollover to a Roth (a conversion).  That is possibly the difference causing the problem, an IRA to IRA rollover is not taxable, where a Roth conversion can be, so the withholding rules are different.  Or some brokerages have taken a conservative view and decided a conversion is the same as a distribution, regardless of how it is done.  And distributions are subject to withholding if you live outside the US.  That's not how I interpret the IRS guidance on retirement plan rollovers, but that doesn't make any difference of course!

I should add, my last post was not so much about whether withholding was warranted, but if it is unavoidable, I can at least make up the funds in the Roth and avoid a penalty.