As you can probably tell from recent posts, I’m moving away from “Personal Finance 101” topics and on to more complex topics around investing, taxes, and retirement. These topics can be straightforward if you live and work in one country, but they become infinitely more complex when you are trying to deal with two different tax jurisdictions.
To help me understand the nuances, I’ve been reading a lot of the advice published by Thun Financial (see the end of my previous post What I’ve learned about investing as a US expat for links to my favorite articles). I recently joined a webinar hosted by Keith Poniewaz on when it makes sense to convert retirement funds held in a traditional IRA to a Roth IRA (high level answer: when you live in a low tax jurisdiction like Dubai, or have a low-tax year, such as when switching jobs and taking substantial time off).
While it’s not the right move for me at this point, Keith very helpfully agreed to get on the phone and talk through some of the other financial considerations that should be on my radar as a US expat living in the UK. Here’s what I learned – if any of it sounds counter to what you think is true, please let me know so we can get to the bottom of it!
(1) Reduce UK tax liability as much as possible
Because we pay so much more tax in the UK than we would owe in the US, it’s common to build up a massive set of tax credits that can be carried forward for up to 10 years. These tax credits can be used to reduce the amount of tax owed to the US for earned income only. For most people, this means that we’ll end up with a bank of US tax credits that go unused, unless:
- You move to a low-income tax jurisdiction (like Dubai or Singapore) – then you can use your tax credits to reduce the amount of income tax you would owe in the US
- You are over 55 and take the 25% tax-free lump sum distribution from your UK pension (for which you would generally owe tax in the US)
Therefore, it’s best to try and reduce the amount of UK tax you pay as much as possible, to reduce that bank of tax credits more generally (since they are likely going to go unused). The two best ways to do this are:
- Contributing to your UK pension plan (more below)
- Making charitable donations
(2) Pay into your UK pension
Due to the tax agreements between the UK and the US, your UK pension is treated exactly the same as your US 401(k). Treat this as your primary retirement account – you will be able to make withdrawals from it the same way you would from a traditional IRA.
It definitely doesn’t make sense to pay into a traditional IRA in the US, because you’d be paying in after-tax income (taxed in the UK), and the amount would be taxed again when you withdraw it at retirement. And if you earn over $135,000/year, you can’t contribute to a Roth anyway.
(3) Be mindful about your UK taxes (arising vs. remittance basis)
Most people who pay UK tax do so on an arising basis, which means that if you’re resident in the UK, you are meant to pay tax on your worldwide income (including foreign investment income and capital gains). However, if you are resident but not domiciled in the UK (most expats who have been here for <15 years), you can pay on a remittance basis, which means that foreign investment income and capital gains are excluded.
This has been a bit tricky to research, but here’s where I’m at:
- Remittance basis definitely makes sense if your foreign income is <£2,000/year.
- If it’s more than £2,000/year, you may need to look at your options more carefully. If you file under a remittance basis and your foreign income is more than £2,000, you lose your UK personal allowance (£11,000 of tax-free income) – so basically, the tax you’d have to pay on your personal allowance would have to be less than the tax you’d owe on your foreign investment income in order for the remittance basis to make sense.
- You can claim the remittance basis for up to 15 years of living in the UK; however, after 6 years of being resident here, you’ll have to pay a remittance charge of £30,000 – meaning, it only makes sense to file on a remittance basis if the tax you’d owe on your foreign income is MORE than £30,000.
- If you choose to file under the remittance basis, you CANNOT use the HMRC website to file your taxes – you have to use tax preparation software. I’m still researching these, but according to different reviews I’ve read, the two best options seem to be TaxCalc and ABC Self Assessment.
Don’t open an ISA
ISAs are great for UK citizens, since all your investments grow tax-free. However, they are NOT recognized by the IRS (and yes, you are legally required to report them). Even worse, any investments in non-US domiciled funds will be deemed PFICs and taxed at punitive rates. If that’s not enough to stop you, also remember that your financial statements will not be reported in a US tax-compliant manner, making accounting and US tax preparation an absolute nightmare. I’ve decided to open a brokerage account in the US for all my personal investing.
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I hope this has been helpful, or at least raises some discrepancies that we should work through! Please share anything else you’re learning that I may have missed 🙂
Austerity Kate 