UK Taxation of HSAs

I'm a dual US/UK citizen planning to return to the UK in 2022 (after 18 years in the US). I have a US Health Savings Account (HSA) that is completely tax free in the US.

The non-authoritative answer (lots of google searching, very few hits) is that the UK doesn't recognize HSAs, and as such it will be treated as an unwrapped savings/brokerage account. i.e. tax on dividends, interest, and capital gains.

Does anyone have any experience (actual or anecdotal) of dealing with a HSA in the UK? I'm thinking tracking the dividends and interest payments will be a nightmare since the US HSA provider won't be producing tax summaries for HSA account since nothing is taxable in the US. Should I just avoid the hassle and cash the thing out (which would be very expensive as it would count as income and subject to early withdrawal penalties)?

My current plan is to keep the HSA, but to reset the cost basis by selling and repurchasing the shares while still in the US. This will also allows me to convert the mutual funds in the HSA over to HRMC reporting ETF funds. Actually, I'll probably put everything into a single ETF to simplify dividend / interest tracking, and depend on my other accounts to provide diversification.

I shot a couple of specific question on HSA taxation in the UK to HRMC, but I expect nothing back other than the usual link to the download location for the US/UK tax treaty. In about 2 months.

I actually closed my HSA, paid the 10% under 65 penalty prior to moving to the U.K. Although I had taken a hit on the distributed amount, the alternative of HMRC reporting was not something I wanted to do. I maxed out IRA contributions in that year and upped the 401(k) too. Ultimately it all worked out fine, effectively I didn’t see an additional tax burden. If you intend moving back to the U.S. convert HSA to simple interest to avoid otherwise complex reporting. You need way up your future of medical needs too, can you spend the balance and eliminate the 10% penalty. Will you work stateside again, how close are
you to Medicare… HSA balance and so on.

We don't know your income circumstances or plans when you return to the UK - but an alternative consideration is (as @Barcrest states) is to take the 10% hit but maybe look at investing it into a SIPP in the UK (assuming earnings will permit this) - get the tax relief out of it from HMRC.

I returned to the UK many decades ago, cashed in a 401k, paid the penalty (I think 10% or 20%) and rolled it into an employers' AVC receiving 40% tax relief out of the deal - ended up with more in the AVC than I had (gross) in the 401k. - sadly times have changed - that was when you could put up to £255k per annum in a pension (not that I ever had that much to invest!)

My current plan is to keep the HSA, but to reset the cost basis by selling and repurchasing the shares while still in the US. This will also allows me to convert the mutual funds in the HSA over to HRMC reporting ETF funds. Actually, I'll probably put everything into a single ETF to simplify dividend / interest tracking, and depend on my other accounts to provide diversification.

I think this is the best solution.  Before moving back to the UK I converted our taxable mutual funds to HMRC recognized ETF's. Some MFs had direct ETF equivalents so no tax hit but I did have one where i had to sell the shares, take the capital gain hit, and buy ETFs so that on return to the UK ongoing dividends and capital gains were recognized and treated as such.

First off, thanks all for your replies. I'm continually impressed by this forums willingness to engage and help.


@Barcrest
Simplification is always good, but the penalty for early withdrawal is now 20% (it used to 10%, they upped it), plus the withdrawal is classified as income and subject to income tax. I expect to have no earned income this year (I retired at the end of last year) so the income tax rate here would be very low, but because I'm already in the 23.8% band for capital gains this year, any increase in income is effectively pushing an equivalent amount of unrelated money into the 23.8% capital gains bracket. If I had less in the HSA account, I'd definitely trade the loss for the simplification. I need to keep reminding myself that I only have these problems because I have money, and therefore these problems are good problems to have :-)

@Smitch
I did the FIRE thing (https://en.wikipedia.org/wiki/FIRE_movement) almost by accident (I won't pretend I didn't get lucky - my tech job moved to the US, tripling my effective compensation almost overnight, while my living expenses, adjusted for inflation, remained around the same). I've retired early and my income is now entirely passive income (stock growth, dividends, and rental property). With no plans to get a job in the UK, I won't be eligible for a SIPP.

@durhamlad
Turns out I have to liquidate the shares anyway. When I finished work, I was automatically transferred to the HSA provider from hell (I won't name them). Apart from nickel and diming me to death, they aren't set up to support non-residents, and they don't offer any HRMC reporting funds. So I opened a HSA with Fidelity, tried to transfer the account, only for nickel and dime HSA to say they don't support stock transfers - only cash transfers and I need to liquidate everything first. Of course, finding that out took two hours on the phone to 4 different support people.

[Begin Rant]
The reason they don't support stock transfers? My insurer provided HSA is provided by a third party (the web site is insurer branded, with a smaller logo saying 'powered by ConnectYourCare'). But ConnectYourCare don't manage the stock themselves. No, they just do the websites and cash management. They outsource the investment side to a company called Devenir (who I've never heard of). But wait! Denevir only does the record keeping. They in turn outsource all the actual brokerage operations to Charles Schwab!

So rather than unwrap all that for a HSA-to-HSA stock transfer, my insurer's HSA only supports the liquidate and HSA-to-HSA cash transfer option.
[End Rant - wow, I feel so much better!]

Because of the triple tax advantages of HSA accounts, I've always paid out of pocket rather than from the HSA. So one slight improvement to my plan: I'm going to add all those payments up and claim them back tax free from the HSA before returning to the UK. I'm also leaving everything until the end of quarter (5 days from now) since the mutual funds I'm currently invested in have a habit of issuing unannounced dividends and/or capital gains at the end of random quarters.

It sounds like you have been through the ringer getting all the options sorted out. Wow!

I shouldn’t sweat the dividends thing too much trying to time it exactly right because there really isn’t much in it as the share price of a stock or fund (NAV) always goes down when a dividend pays out. For example if a share is worth $100 and then pays a dividend of 2% the share price drops 2% to $98 so at the end of the day the total of dividend + share price is $100.  This fact is best known when buying shares, with the mantra “don’t buy the dividend”, because if you buy buy shares just before they pay out a dividend you end up with fewer shares without the benefit of getting the dividend.

I agree with not trying to time the market, and with the market already baking the cost of the dividend into the stock price.

My issue is zombie accounts ^{rising from the grave} :-)

I once tried to close a Morgan Stanley ESPP account (my employer had changed broker, and I was consolidating my accounts). I wasn't aware when I cleared out the account that I was past the ex-dividend date for the stock. Since dividends are paid on the dividend date to whoever was the holder/brokerage of record at the ex-dividend date, when the dividend was paid, it resurrected the the Morgan Stanley account!

So I do another transfer and request the account be closed again...

But a few weeks later, the account is resurrected again... with a balance of $0.01!

Morgan Stanley had paid me interest for the portion of the month I'd had cash in the account.

Anyway, it's left me somewhat paranoid! In theory, I should be able to find the ex-dividend date for each stock (I saw in my feed this morning, one's just paid), but it's easier to just wait until the end of the quarter (June 30th).

For the benefit of the thread and for search engines:

HRMC confirmed to me HSAs are not recognized in the UK. Exact (and complete) wording was:

"Yes you are correct, the UK does not recognise the HSA wrapper.
Capital Gains tax is the difference between the sale price and the purchase price. The UK uses the purchase price rather than the residency date."

I think that also confirms selling and repurchasing the stock before returning to the UK will reset the stock price for UK capital gains purposes, but just to be sure, I've asked a follow up in a more direct 'yes/no' way.

For the benefit of the thread and for search engines:

HRMC confirmed to me HSAs are not recognized in the UK. Exact (and complete) wording was:
I think that also confirms selling and repurchasing the stock before returning to the UK will reset the stock price for UK capital gains purposes, but just to be sure, I've asked a follow up in a more direct 'yes/no' way.

Thanks for posting this confirmation of what the rules are.

I’m sure that selling and repurchasing the stocks before returning to the UK will reset the price. If in future some stocks are sold then the calculation of capital gain will be from the price of the stock when it was purchased, in £s of course, the exchange rate on the day of purchase being important.

Just resurrecting this one if DaveB is still around. I was curious on the outcome?

Similar to DaveB I am also looking at a potential move back to the UK next year (I'm a dual citizen), and have a pretty good amount in an HSA with Fidelity. I expect some qualifying expenses in the UK, but they're only likely to reach the balance of the account if we incur big qualifying expenses later in life (care homes etc.). Based on what's described above, as a minimum it sounds like resetting the cost basis is prudent - ideally into HMRC Reporting ETFs if they're available. I assume there would then be annual UK tax payable on dividends/gains, and further UK tax on gains at the point of distribution when used for qualifying expenses.

However, I'd prefer to be able to treat non-qualifying distributions after 65 as similar to distributions from a Tradition IRA i.e. paying US tax but without the 20% penalty. However, I'm not clear if the UK would allow a tax credit for the US tax paid i.e. whether the UK would look through the HSA wrapper to the underlying funds. If not, I think I'm looking at options of either leaving the HSA as an emergency fund for medical expenses, or to cash all of it in before moving to the UK and suffer the penalty.

Thanks
Martin

Just resurrecting this one if DaveB is still around. I was curious on the outcome?

Similar to DaveB I am also looking at a potential move back to the UK next year (I'm a dual citizen), and have a pretty good amount in an HSA with Fidelity. I expect some qualifying expenses in the UK, but they're only likely to reach the balance of the account if we incur big qualifying expenses later in life (care homes etc.). Based on what's described above, as a minimum it sounds like resetting the cost basis is prudent - ideally into HMRC Reporting ETFs if they're available. I assume there would then be annual UK tax payable on dividends/gains, and further UK tax on gains at the point of distribution when used for qualifying expenses.

However, I'd prefer to be able to treat non-qualifying distributions after 65 as similar to distributions from a Tradition IRA i.e. paying US tax but without the 20% penalty. However, I'm not clear if the UK would allow a tax credit for the US tax paid i.e. whether the UK would look through the HSA wrapper to the underlying funds. If not, I think I'm looking at options of either leaving the HSA as an emergency fund for medical expenses, or to cash all of it in before moving to the UK and suffer the penalty.

Thanks
Martin

We never had an HSA but did have mutual funds that were not HMRC Reporting so we sold/converted those funds to HMRC Reporting funds before we moved back.  We also transferred the ownership to my wife’s name only as she is in a lower HMRC tax bracket than I am.

The annual tax from the ETF is much lower on dividends, and sale of shares are also taxed at the lower capital gains rate. Since the ETF is new the capital gain tax is calculated from the much newer date of the purchases.

Just resurrecting this one if DaveB is still around. I was curious on the outcome?

I'm alive, just not very active in the community post-relocation, tax filing in both countries, and my UK-Yankee subscription expiring. I got a e-mail notifying me of your post, so I resubbed and jumped on to reply.

I encountered no issues resetting the HSA cost basis, so I highly recommend that.

I had one issue with the Fidelity HSA that is silly and completely avoidable. Due to a timing issue, I had a small 'cash' balance in the HSA (about $20 if I recall correctly). While it's labelled as cash in the UI of the time (and in many places still), it turns out Fidelity does not actually allow a HSA to contain cash and what it is actually holding cash as is 'FIDELITY GOVERNMENT CASH RESERVES (FDRXX)'. Which is a money market fund, A.K.A. something that is NOT a HMRC reporting fund, and hence subject to the UK equivalent of PFIC. Since the UK version only kicks in on 'sale' I'm just going to leave it there forever rather than work out the actual taxed owed.

Last UK tax year was my first year back filing as UK resident. Getting the HSA information needed for my UK tax return was actually relatively easy (in Fidelity, Profile -> Select your HSA from the accounts list on the left -> Activities & Orders -> Dividends/Interest -> CSV Export -> Fiddle with in Excel).

As expected, Fidelity restricted the HSA similar to the way it restricts Brokerage Accounts while abroad. Here's the full body the letter they send me when I changed address (I got a similar letter, but less restrictive, for my Fidelity brokerage account and IRAs, but not my 401k).

Dear [REDACTED]:

At Fidelity, we are committed to keeping you informed of any changes that may affect the way you do business with us. We are writing to notify you of a sequence of changes that will significantly impact your account(s) referenced above. You are subject to these changes because an address associated with your account — provided by you or by someone authorized to access it — now falls outside the United States.

Effective immediately:

● Fidelity will no longer accept orders to purchase or exchange additional shares of Fidelity and non-Fidelity mutual funds. While you will no longer be able to purchase mutual funds, you can still elect to reinvest your dividends.

● If you are enrolled in an automatic investment plan or directed dividend program, those purchases will be discontinued. Any recurring deposits from your bank that are connected to an automatic investment plan will continue, but the funds will remain uninvested in your account.

Effective in 60 days:

● Your Fidelity account includes a core account that holds assets awaiting investment or withdrawal. If your core account is either a money market mutual fund or the FDIC-Insured Deposit Sweep, any cash deposits and proceeds from sales will no longer post to the core. Instead, they will be held in a free credit balance, which will generate interest as outlined in your customer agreement.

● Fidelity will no longer accept orders to purchase any new holdings or allow additional deposits of cash or securities into the account(s) referenced above. You will need to discontinue any recurring deposits, such as direct deposits, into your account(s).

● You will still have access to existing cash management features, such as checkwriting, debit cards, and Fidelity BillPay®, allowing you to withdraw available cash.

These changes will not affect any workplace savings plans, such as 401(k) and 403(b) plans serviced by Fidelity.

Please know that customers and authorized individuals who reside within the U.S. and have only U.S. addresses associated with their accounts are not subject to these changes. Let us know if your individual circumstances change, and we will be happy to remove the limitations referenced above from your account.

If you have any questions, please call us at 800-544-6666, 24 hours a day, 7 days a week, or visit Fidelity.com/contactus for the international phone numbers available for your country.

We apologize for any inconvenience caused by these changes and, as always, thank you for choosing Fidelity.

Sincerely,

Fidelity Investments

* Edit: Corrected list of other account I got letters for.

Thanks DaveB - I appreciate you jumping back on.

Are you just planning to use your HSA funds for qualifying medical expenses only? Or are you planning on treating it similar to a Traditional IRA after 65? If the latter, did you find any advice on whether the UK would allow a tax credit for the US tax on withdrawals?

Thanks
Martin

When I was doing my exit planning, I worked through a dozen scenarios and since HSA is not a significant part of my dosh I just decided to kick the can down the road and leave the account alone for the next 20 years. Nothing has changed on my side since then, and there's always the hope the Double Taxation Agreement will be updated sometime in the next two decades.

I don't believe that the US allowing IRA style withdrawals after age 65 changes anything in the eyes of HMRC, but it's not something I've asked my advisor.

My main reasons for keeping the HSA was (a) returning to the US, (b) avoiding the withdrawal penalty, and (c) (due to compounding) capital gains delayed is capital gains reduced.

For the rest of this post, I'm talking well outside the limits of my knowledge. Consider it speculation.

HMRC views HSAs as vanilla brokerage accounts and therefore we can can offset some portion of 'like' US taxes. As the US taxes are zero pre-65 non-medical withdrawal, there's nothing to offset against UK taxes.

Withdrawing for non-medical purposes after age 65 potentially generates US income tax. This can be offset against any UK income tax on the same amount. However, I would argue there is no UK income tax on the withdrawal because, from the HMRC point of view, it's cash you've already paid UK capital gains / dividends / income tax (interest) on. Just like any cash withdrawal from a brokerage account.

In short, I don't think the withdrawal would be taxable in the UK at all. However, the capital gains, dividends and interest that provided the cash for that withdrawal would be. Since these are different buckets, we don't get to offset the tax, and we're taxed in both countries with no offset.

Thanks DaveB - yes, I see what you mean (although maybe some overlap on sale when crystallizing unrealized capital gains). In that case, providing paying the annual UK tax on realized gains and dividends isn't too much of a drain on my other income, I'll probably leave alone as an emergency fund, on the basis that it could be used for care homes etc. later in life.

So I think my plan will be to withdraw anything I can for past qualifying expenses not yet recovered, reset the cost basis for everything that remains - hopefully into HMRC Reporting Funds if they are available in my HRA (Fidelity), and then leave the rest alone until needed for healthcare or an emergency.

Many thanks for helping me to think it through!