Navigating Tax-Free Investment Options for US Expats in the UK

Written by Alex Dolton

Understanding ISAs for US Expatriates

ISAs offer a tax-efficient investment route for UK residents, permitting contributions of up to £20,000 annually from after-tax income. While there are various types of ISAs, including Cash, Lifetime, and Junior ISAs, this discussion will focus on Stocks and Shares ISAs. These accounts allow investments in equities, bonds, and funds with the growth and withdrawals being UK tax-free, providing a flexible option for investors looking towards medium to long-term horizons. The potential for tax-free compounding growth makes them an attractive choice, though it’s essential to consider the risk and volatility associated with your investment choices.

 

The US Tax Perspective on ISAs

For US persons required to file US taxes, the benefits of ISAs are unfortunately offset by the US tax treatment of these accounts. The US Internal Revenue Service (IRS) views ISAs as regular brokerage accounts, meaning any income or gains earned within an ISA are subject to US taxation. Furthermore, investments in funds within ISAs may be classified as Passive Foreign Investment Companies (PFICs), leading to punitive tax consequences under US law. Therefore, investing in individual stocks and bonds may be a preferable route, albeit still subject to US taxation.

 

Roth IRA: A Tax-Free Investing Alternative

A viable alternative for US persons seeking tax-free investment opportunities is the Roth Individual Retirement Account (Roth IRA). Similar to an ISA, a Roth IRA is funded with after-tax dollars and offers tax-exempt growth*, with contributions limited to cash only. However, eligibility to contribute into a Roth IRA depends on one’s earned income, filing status, and Modified Adjusted Gross Income (MAGI), with specific thresholds outlined on the IRS website.1

For 2024, contributions of up to $7,000 (or $8,000 for those aged 50 and over) are permitted, subject to income limits. For individuals exceeding these limits, a ‘backdoor’ Roth IRA contribution might provide an alternative pathway to tax-exempt savings. This involves making a non-deductible contribution to a Traditional IRA and subsequently converting it to a Roth IRA, avoiding additional income tax in the process. This is only available to those who do not have other existing IRA balances

Importantly, the US/UK tax treaty recognises Roth IRAs, mitigating concerns about the tax treatment of underlying investments from both a UK and US tax perspective.

 

Final Thoughts

While Stocks and Shares ISAs represent a valuable saving tool for UK residents, US expatriates face additional complexity due to the differing tax treatments by the IRS. For those eligible, contributing to a Roth IRA offers a compelling tax-exempt investment growth opportunity, aligning with the financial goals of US persons in the UK. It’s essential to consult with a tax professional experienced in cross-border taxation to ensure compliance and optimisation of your investment strategy.

For more insights and guidance on tax-efficient investment options for US expatriates, visit IRS official website.

Remember, investing involves risks, including the potential loss of principal. This article is for informational purposes only and should not be construed as tax, investment, or legal advice. If you have any further questions, please do get in touch with your wealth manager.

 

References

1. https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2023

 

Notes

*Qualified distributions – to avoid being subject to a 10% early withdrawal penalty, withdrawals must be 1) taken after age 59.5 and 2) taken after a five-year holding period

 

The Legal Stuff

The information is intended for clients of MASECO LLP and should not be reproduced, copied or made available to others, in whole or in part, without MASECO’s prior written consent.

• Nothing in this document constitutes investment, legal or fiscal advice and should not be construed as such.
• This document is provided for information purposes only and is not intended to be relied upon as a forecast, research or investment advice.
• This document does not take into account the specific goals or requirements of any particular individual.
• MASECO gives no assurance or guarantee that the information is accurate or complete and it should not be relied upon as such.
• MASECO is not a tax specialist and we recommend that anyone considering investing seeks their own tax advice.

MASECO LLP (trading as MASECO Private Wealth and MASECO Institutional) is established as a limited liability partnership in England and Wales (Companies House No. OC337650) and has its registered office at The Kodak Building 11 Keeley Street, London, WC2B 4BA.

MASECO LLP is authorised and regulated by the Financial Conduct Authority for the conduct of investment business in the UK and is registered with the US Securities and Exchange Commission as a Registered Investment Advisor.