How Do Roth IRAs Work for US Taxpayers in the UK?

Written by David Kelly-Eades

For Americans living in the UK, retirement planning often involves navigating two very different financial systems. Each side of the pond has its own tax treatments, retirement vehicles and cross-border nuances, making multi-jurisdictional planning a complex task. One question we frequently get asked is: How does a Roth IRA fit into retirement planning for US expats in the UK?

Below we will explore how Roth IRAs work for expats, the differences between Roth IRAs and UK pensions, and possible strategies for managing cross-border retirement accounts.

1. Understanding Roth IRAs for Expats

What is a Roth IRA?

A Roth IRA is a US-based retirement account that is typically funded through post-tax contributions. Their key benefits include:

• Tax-free growth of investments over time, allowing for the powers of compound interest (cue the usual Albert Einstein reference…!).
• Tax-free withdrawals in retirement, provided certain rules are met to make the withdrawals “qualified”.
• No required minimum distributions (RMDs) during the account owner’s lifetime.
• Roth IRAs can be a powerful legacy planning tool. Whilst Roth IRAs are assessed as part of one’s estate for US estate taxes, they can be passed on to beneficiaries as a tax-free savings vehicle (though subject to certain withdrawal requirements for 10 years if the beneficiary is not considered to be eligible for stretching distributions over their lifetime).

How it works for Americans living in the UK:

• Generally speaking, you can contribute to a Roth IRA as long as you have earned income that isn’t excluded by the foreign earned income exclusion (FEIE) and do not have income above certain income thresholds based on filing status.
• As contributions are made with after-tax dollars, there is no upfront tax deduction from a US perspective.

Challenges for expats:

• If the foreign earned income exclusion (FEIE) is claimed, then one’s income is excluded and therefore not considered taxable earned income for Roth IRA purposes.
• If an expat is married to a non-American spouse and files Married Filing Separate, the income threshold for qualifying to contribute is $10,000 so in this case, direct contributions will often not be allowed as income levels are usually too high.
• Currency fluctuations between USD and GBP can impact investment growth and retirement income.

Q: Can I contribute to a Roth IRA while living abroad?
Yes, though your ability to contribute directly depends on your US taxable earned income, overall income levels and filing status.

Where direct contributions may not be allowed based on exceeding income thresholds, it may sometimes be possible to contribute via a backdoor method by making a Traditional IRA contribution and subsequently converting that contribution over into a Roth IRA. The qualification and steps to do this are not addressed here. Advice should be sought if this is something you need to consider for your own situation.

2. Roth IRA vs UK Pension: Key Differences

When planning for retirement abroad, Americans often ask whether they should prioritise a Roth IRA or a UK pension.

UK Pensions for Americans in the UK generally include workplace pensions and personal pensions. Key features of such plans include:

• Contributions may qualify for UK tax relief at the individual’s marginal rate of income tax. The limit for tax-relievable contributions is generally 100% of your relevant UK earnings or £60,000 (whichever is higher).
• The funds within the pension wrapper grow free from income and capital gains tax (i.e. they grow tax-deferred).
• Withdrawals can generally be subject to UK tax and US tax, with primary taxation rights depending on the US-UK income tax treaty.

Comparing the two at a glance:

• Roth IRAs use after-tax US dollars, whereas UK pensions can be funded by pre-tax and / or post-tax earnings.
• Roth IRA investments grow tax-free in the US. UK pensions are tax-deferred, meaning you’ll pay tax when you withdraw.
• Withdrawals from Roth IRAs are generally tax free provided certain conditions are met. UK pensions are typically taxable at the individual’s marginal rate of tax.
• Roth IRAs don’t require RMDs (required minimum distributions). Whilst UK pensions don’t have a required amount that needs to be taken each year, there are additional complexities to navigate such as the Lump Sum Allowance.

Q: Should I focus on a Roth IRA or UK pension?
It depends on your long-term residence, retirement timeline, and tax situation. Many choose to utilise both types of accounts for diversification and flexibility. Importantly, Roth IRAs have a contribution limit of $7,000 ($8,000 for those over 50), whereas UK pensions have higher limits (up to £60,000 per annum).

3. Cross-Border Retirement Accounts

Managing retirement accounts across two countries requires careful planning, and there is often a lot of nuance involved. Below are a few strategies and considerations:

• Maintaining both US-based accounts (like a Roth IRA) and UK pensions can spread risk across currencies and tax systems, thus diversifying your accounts.
• The US-UK tax treaty can help minimise double taxation on withdrawals, so seeking and obtaining professional advice is worthwhile.
• Consider residency, US income, and how claiming the FEIE may affect eligibility for Roth IRA contributions. Moreover, consider where you view your life being long term (i.e. which jurisdiction).

4. Withdrawal Considerations for Expats

Q: When can I access my Roth IRA?
Withdrawals are generally allowed at age 59½ and must satisfy the five-year rule for tax-free treatment.

Q: How are Roth IRA withdrawals taxed in the UK?
Qualified withdrawals are generally considered tax-free in both the US and the UK under the US-UK income tax treaty.

5. Practical Steps for Americans in the UK

It is important to revisit your retirement strategy periodically, even if it is a long way off. However, it can sometimes be difficult to know where to start so below we look at practical steps that could be followed:

• List your US and UK accounts and understand their contribution limits, tax treatments, and withdrawal rules. How much have you contributed so far? How often do you assess your retirement accounts?
• Review your US earned income and the impact of the Foreign Earned Income Exclusion. Could you be making contributions? If your modified adjusted gross income (MAGI) exceeds certain amounts (i.e. $165,000 if you file on a single basis), then the backdoor contribution method may be available to you if you do not have other existing Traditional IRA assets.
• Use the US-UK tax treaty to reduce double taxation and plan withdrawals strategically. Use it to your advantage.
• Diversify your investments. Roth IRAs can generally only be invested in USD denominated assets. Use the different tax wrappers to diversify your portfolio, and consider currency risk.
• Ensure you are staying compliant from a US and UK tax filing perspective.

6. Key Takeaways for Retirement Planning

• Roth IRAs are an exceptionally powerful tool for expats that offer tax-free growth in the US and UK (based on current legislation).
• Roth IRAs should generally make up part of your holistic wealth planning, providing you are able to contribute to them. Having a pool of capital that is tax-free to draw from in your arsenal can provide an income diversifier during retirement and help you manage your overall tax position as you drawdown your assets in the future.
• Retirement planning in the UK requires an understanding of both US and UK rules, as well as tax treaties and product structures.
• Seek guidance where necessary to ensure you are optimising the use of Roth IRAs from a tax and investment perspective.

For Americans living in the UK, balancing Roth IRAs and UK pensions is a nuanced task, but with careful planning, you can create a tax-efficient, flexible, and diversified retirement strategy to help you achieve the retirement you deserve.

All investments involve risk and may lose value.  The value of your investment can go down depending upon market conditions and you may not get back the original amount invested. Your capital is always at risk.

MASECO Private Wealth is not a tax specialist. This article does not take into account the specific goals or requirements of individuals and is not intended to be, nor should be construed as, investment or tax advice. You should carefully consider the suitability of any strategies along with your financial situation prior to making any decisions on an appropriate strategy. Information about potential tax benefits, including the levels, bases of and reliefs, from taxation is based on our understanding of current tax law and practise and may be subject to change. We strongly recommend that every client seeks their own tax advice prior to acting on any of the tax mitigation opportunities described in this article. The tax treatment depends on the individual circumstances of each individual and may be subject to change in the future.

MASECO LLP (trading as MASECO Private Wealth and MASECO Institutional) is established as a limited liability partnership under the laws of England and Wales (Companies House No. OC337650) and has its registered office at The Kodak Building, 11 Keeley Street, London, WC2B 4BA.  For your protection and for training and monitoring purposes, calls are usually recorded.