Thun Financial Advisors Research ©| 2017 1

Thun Financial Advisors Research 2017

Thun Financial Advisors 3330 University Ave. Suite 202 Madison WI 53705 www.thunfinancial.com Skype: thunfinancial

Thun Financial Advisors, L.L.C.

is a U.S.-based, fee-only, Regis-

tered Investment Advisor that

provides investment manage-

ment and financial planning

services to Americans residing

in the U.S. and overseas.

We maximize long-term

wealth accumulation for our

clients by combining an index

allocation investment model

with strategic tax, currency,

retirement and estate plan-

ning. We guard our clients’

wealth as though it was our

own by emphasizing prudent

diversification with a focus on

wealth preservation and

growth.

The Foreign Pension Plan

Dilemma for American Expats

Executive Summary

This article addresses the chief concerns for Americans living in

foreign countries and their pension options. Provides an over-

view of:

These pension options: SIPPs from the UK, Superannuated

pensions from Australia, the Swiss Pillar pension system,

etc.

The general tax treaties governing the relationship between

local pensions and US taxation. Also describes the tax and

reporting ramifications of foreign pensions both in the US

and locally

The effects of these pensions on the overall financial plans

of American expatriates.

Introduction

American citizens living abroad often participate in foreign pension

plans, which generally have beneficial tax treatment under local country

of residence laws . Furthermore, participation might even be mandatory

and employers often make valuable pension contributions on behalf of

Thun Financial Advisors Research ©| 2017 2

their employees. However, even in light of all

these benefits, American taxpayers must remain

aware that not all foreign pension plans receive

favorable tax treatment under U.S. tax laws and

that participation could actually be detrimental to

long-term financial planning goals.

In order to avoid retirement planning pitfalls, U.S.

taxpayers with overseas pensions must carefully

examine their pension plans under relevant U.S.

tax laws and bilateral tax treaties. Foreign pen-

sions are an area that American taxpayers can no

longer ignore as the Foreign Account Tax Compli-

ance Act (FATCA) and increased cross-border tax

compliance suggests that the IRS may take a closer

look at these assets going forward (especially so-

called “offshore pension schemes”). This Thun Fi-

nancial article briefly summarizes common issues

related to foreign pension plans and demonstrates

how to integrate foreign pension plans into a com-

prehensive cross-border retirement plan.

U.S. Taxpayers and Foreign Pension Plans

Many countries allow workers to defer pre-tax

dollars into retirement accounts that then accu-

mulate tax free until retirement. These systems of

tax deferred savings and investment exist every-

where for the same reasons they exist in the Unit-

ed States : governments want to encourage work-

ers to accumulate private savings to support re-

tirement expenditures without exclusive reliance

on state pension systems.

Foreign pension plans commonly encountered by

Americans abroad include:

Swiss Pillar Pension System Canadian RRSPs Hong Kong Mandatory Provident Fund

(MPF) and Occupational Retirement Schemes Ordinance (ORSO)

Singapore Central Provident Fund (CPF) Australian Superannuation French Caisses de Retraites UK Employer Sponsored Pension Schemes

and SIPPs

Unfortunately, the U.S. worldwide system of citi-

zen-based taxation was instituted before modern

pension plans and long before the advent of an in-

ternationally mobile work force. Consequently,

current U.S. tax laws do not favor participation in

most foreign pension plans and the IRS generally

views foreign pension plans, including ones

“qualified” under local tax rules, as "nonqualified"

under U.S. tax rules.

However, there are some U.S. income tax treaties

which allow foreign pension plans to be treated as

qualified for U.S. tax purposes. One such example

is the United States-United Kingdom income tax

treaty. Unlike many tax treaties the United States

has with foreign countries, the U.S.-UK treaty ad-

dresses pensions comprehensively, with rules re-

lated to contributions, earnings, and distributions.

For example, while living in London, an American

can deduct, for U.S. tax purposes, contributions to

their UK pension plan. This deduction is only

available while the U.S. taxpayer resides in the

United Kingdom. Additionally, it applies only to

the extent the contributions or benefits qualify for

tax relief under HMRC (UK tax authority) rules

and the HRMC relief may not exceed the relief that

is allowed in the United States under IRS regula-

tions.

Thun Financial Advisors Research ©| 2017 3

Outside of the United Kingdom, these special tax

treaty provisions are rare: Most foreign pensions

do not enjoy tax favored status. For example, the

United States does not have tax treaties covering

pension contributions with many popular expat

destinations such as France, the Netherlands,

Hong Kong, and Singapore. Absent such a compre-

hensive tax treaty, an American expat participat-

ing in a foreign pension plan cannot deduct contri-

butions from their U.S. gross income and must

take extra steps to properly report the pension

assets.

Staying Compliant: Properly Report-ing Foreign Pensions as a U.S. Taxpayer

One important unintended consequence of the

FATCA law is that U.S. taxpayers participating in

foreign pension plans can no longer casually fail to

report their participation in these plans on their

U.S. tax returns. Before FATCA, participation by

American expat workers in foreign pension plans

often drew them into a pattern of systematic non-

compliance—many investors did not even think to

report these pension plans until retirement distri-

butions commenced. However, FATCA now pro-

vides the IRS with a viable mechanism to enforce

rules requiring foreign pension plans to be report-

Malta Pensions and “Offshore Pension Schemes” for Americans

Increasingly, American expats in locales such as Singapore, Hong Kong, and Dubai are being mar-

keted offshore pension schemes based in the Mediterranean island nation of Malta. Many offshore

financial advisors promote these plans as a tax efficient way for American expats to save for retire-

ment while working abroad. Although it is true that the United States and Malta recently signed a

modern double tax treaty that provides certain tax benefits, it is doubtful that the generous inter-

pretation of these tax provisions offered by plan promoters will hold up under eventual IRS scruti-

ny. Therefore, we believe that Americans investing in such schemes are taking on substantial tax

compliance and investment risk.

The U.S.-Malta double taxation treaty signed in 2010 created a flurry of activity in the U.S. expat fi-

nancial space because key provisions of the treaty appear to permit American taxpayers to accumu-

late untaxed gains in a Malta pension and then withdraw those assets tax free. There are several

problems with this attractive reading of the treaty. First, it is unlikely that the treaty was intended

to provide for a glaring exception to the main tenants of U.S. citizen-based taxation. Second, and

even more critically, these plans gloss over the issues of residency and jurisdiction. The treaty does

not cover Americans who do not reside in Malta, or at least do not reside in Malta at the time contri-

butions to the plan were made. In short, Americans living outside of Malta have no standing to

make claims under the treaty’s provisions.

Aside from the tax and compliance risk posed by these plans, the investment provisions of these

plans are highly unattractive. In general, most of these pension plans require a large ongoing finan-

cial commitment. Moreover, liquidity is low, fees are high, and the underlying investments are

opaque. Finally, there is significant concern over the regulatory and financial capacity of the small

state of Malta to thoroughly ensure the integrity and solvency of these offshore pension plans.

Thun Financial Advisors Research ©| 2017 4

ed and taxed to an extent that was not possible

before FATCA.

Luckily, FATCA regulations contain several provi-

sions designed to exempt certain foreign retire-

ment and pensions funds from FATCA reporting.

This means the pension account holders’ identities

will not be automatically reported to the IRS.

However, this does NOT mean that Americans

with foreign pensions can ignore these assets

when filing a U.S. tax return. It is essential that U.S.

taxpayers take proactive steps to report foreign

pension assets on their yearly tax returns to avoid

IRS penalties and fines.

To complicate this problem, reporting a foreign

pension properly on a U.S. tax return is a time con-

suming and expensive accounting task. Participa-

tion in a foreign pension will generally require

Form 8938, Foreign Bank Account Report (FBAR

or FinCen 114), and possibly Form 3520 relating

to U.S. owners of foreign trusts. If the pension plan

does not meet certain requirements, Form 8621

reporting for Passive Foreign Investment Compa-

nies (PFICs) may also need to be filed to report

underlying investments if the pension is classified

as a grantor trust. Proper compliance is complicat-

ed by the lack of information from the foreign pen-

sion plan sponsor and uncertainty regarding the

best reporting methods among tax preparers.

There is also significant uncertainty amongst tax

experts on the application of U.S. tax rules and tax

treaties to such nonqualified plans. However, sev-

eral broad generalizations can be made about for-

eign pension tax compliance. First, the taxpayer

generally must include the amount of vested pen-

sion contributions made by the employer and the

employee in their gross income. They may also be

required to include in gross income the invest-

ment earnings on plan assets even if unrealized.

Finally, depending on the country and method

used, taxes might need to be paid upon final distri-

bution from the pension plan.

Incorporating Foreign Pensions into a Comprehensive Retirement Plan

The absence of treaty protection and lack of tax

qualified status does not automatically make par-

ticipation in a foreign pension plan a bad idea.

Several strategies can be used to make invest-

ments within pension plans U.S. tax compliant and

efficient. Whatever reporting method used, it is

essential to keep the tax treatment consistent be-

tween different filing years. Using different meth-

ods to file and report the pension year-to-year cre-

ates a risk that double taxation may occur.

If an American investor resides in a country with

income tax rates that are higher than correspond-

ing U.S. rates, excess foreign tax credits are likely

to accrue. Furthermore, if no treaty provision ex-

ists to provide a U.S. tax deduction for local pen-

sion contributions, contributions will only reduce

local country current taxation. However, because

there are still sufficient foreign tax credits availa-

ble to offset all the corresponding U.S. tax on these

contributions, contributing to the plan reduces net

current taxation. Furthermore, for U.S. tax ac-

counting purposes, the pension plan now has a tax

basis equal to the original contribution amounts.

In retirement, the return of this basis as a part of

normal pension distributions will therefore be tax

free for U.S. purposes. Hence, where no treaty

provision exists to qualify the local pension for

U.S. tax purposes, optimal planning would require

contributions to the local pension in an amount

that results in an equalization of the local tax due

with U.S tax, leaving no excess foreign tax credits.

This approach has the virtue of using up foreign

tax credits (which otherwise may never be used)

and reducing the level of U.S. taxation on future

distributions. Finally, even where net U.S. and lo-

cal taxation of pension plans is unfavorable, gener-

Thun Financial Advisors Research ©| 2017 5

ous employer contributions and employer tax equalization policies may still make pension plan partici-

pation worthwhile for highly compensated U.S. expats.

A common misconception is that funds from a foreign pension plan may be rolled over into a U.S. quali-

fied retirement plan such as a 401k, IRA, or Roth IRA account. However, this is never possible with any

type of foreign retirement account. A much more common scenario is that the foreign country will allow

an expat to withdraw funds when they permanently leave the country. The ability to withdraw funds

from a local plan is very country specific. This option must be examined under local country of residence

law with the assistance of a local legal/tax expert.

Conclusion: What to do with Foreign Pensions?

FATCA is essentially forcing the IRS to confront the fact that the U.S. system of global taxation is incon-

sistent with normal participation in traditional methods of retirement and investing for American work-

ers abroad . However, because these problems with FATCA have not yet been resolved, US taxpayers

don’t have the option of ignoring foreign pensions. American expatriates need to become familiar with

the relevant tax laws that effect their foreign pensions. Given the potential tax exposure and large penal-

ties, it is important to plan ahead to understand the tax treatment of these pension plans and their tax

reporting requirements. In order to avoid future problems, Americans living abroad should also be

aware of the tax treatment of contributions to and distributions from these foreign plans—taxation of

distributions must be minimized, fees reduced, and the investment options of the pension plan must be

analyzed. After a careful analysis, it might not be efficient for an American abroad to participate in a for-

eign pension plan or for them to simply maximize their contributions. Careful asset allocation across dif-

ferent accounts such as a taxable brokerage, 401k, IRA, Roth IRA, and a foreign pension is essential to

achieve tax efficiency and maximum after-tax returns for successful retirement saving and greater over-

all wealth accumulation. Ultimately, most Americans abroad will find that U.S. onshore investments,

managed with an eye on tax efficiency and cross-border tax compliance are the best way to build wealth.

Thun Financial Advisors Research is the leading provider of financial planning research for cross-border and American

expatriate investors. Based in Madison, Wisconsin, David Kuenzi and Thun Financial Advisors’ Research have been featured in

the Wall Street Journal, Emerging Money, Investment News, International Advisor, Financial Planning Magazine and Wealth

Management among other publications.

Thun Financial Advisors Research ©| 2017 6

DISCLAIMER FOR THUN FINANCIAL ADVISORS, L.L.C., THE INVESTMENT ADVISOR

Thun Financial Advisors L.L.C. (the “Advisor”) is an investment adviser registered with the United States Securities and Exchange Commission

(SEC). Such registration does not imply that the SEC has sponsored, recommended or approved of the Advisor. Information contained in this re-

search is for informational purposes only, does not constitute investment advice, and is not an advertisement or an offer of investment advisory services

or a solicitation to become a client of the Advisor. The information is obtained from sources believed to be reliable, however, accuracy and complete-

ness are not guaranteed by the Advisor.

The representations herein reflect model performance and are therefore not a record of any actual investment result. Past performance does not guar-

antee future performance will be similar. Future results may be affected by changing market circumstances, economic and business conditions, fees,

taxes, and other factors. Investors should not make any investment decision based solely on this presentation. Actual investor results may vary. Simi-

lar investments may result in a loss of in investment capital.

Contact Us Thun Financial Advisors 3330 University Ave Suite 202 Madison, WI 53705 608-237-1318

Visit us on the web at

www.thunfinancial.com

Skype: thunfinancial.com

david.kuenzi@thunfinancial.com