UK Taxation of 401(k) Distributions

[JWK]

US employer sends some employees who are US citizens to United Kingdom for 3 year periods of overseas service. During their period of employment in the UK, these employees continue to make elective deferrals to US company's 401(k) plan. Plan just received notice from UK Dept. of Inland Revenue, requiring plan administrator to sign following statement:

"The Plan Administrator hereby confirms that the individuals listed below have not/will not use the in-service withdrawal or loan provisions of this Plan to withdraw or borrow any contributions which were paid into their accounts during their service in the United Kingdom."

The plan allows both loans and post age 59.5 in-service withdrawals. If they sign this statement, they'll have to track these amounts separately--not the end of the world, but a hassle.

Has anyone seen this before? Has the plan administrator signed? I reviewed the 2001 UK/US tax treaty and don't see where this is supported in the text of that treaty (but I'm definitely not an expert in treaties). Any ideas?

[Guest Harry O]

Your US 401(k) plan is not a "qualified" plan in the UK. This means that the elective deferrals and earnings for the US citizens working in the UK are taxable (because these workers are residents and subject to UK tax). The Inland Revenue is actually doing you a favor by granting your employees a UK tax exemption (as if the plan was qualified in the UK) contingent on your employees not taking current withdrawals or loans. This is not in the current treaty but the US and UK will recognize a corresponding exemption of pension plans in a recently negotiated treaty change that is awaiting approval by the Senate.

The problem with these statements (if one thinks about it long enough) is that it is a prohibited cutback in withdrawal rights. I have worked to get the Inland Revenue to accept a statement from the employer that it will notify the Inland Revenue if an employee makes a w/d or requests a loan.

This is something that you ought to find a way to get done. Otherwise, the employee's deferrals are included in UK income and most employer's tax equalization policies will require the company to "gross up" this UK tax liability.

[mbozek]

A cursory reading of the restriction indicates that it applies only to contributions attributable to service in UK. Not to other amounts or earnings on such contributions in the 401(k) plan which would be available for loans/withdrawals. All that is tracked are the contributions which can be subtracted from the account balance. If tracking is difficult the employer could make a loan to the employee from its general account if the employee really needs the money, subject to repayment upon return to the US when the employee can borrow from the 401(k) plan. Finally I dont see how a loan could be construed as a distribution under UK law if there is a legal obligation to pay it back.

[JWK]

Mbozek: thank you for your reply. I understand that only the amounts deferred during the UK service have to be tracked, but that makes the task harder rather than easier. Also, although your loan argument might or might not work, there's still the problem of the 59.5 in-service withdrawals. I think Harry O's suggestion makes sense from a strict compliance perspective, but I wonder if Inland Revenue would ever find out about these in-service "distributions" if we didn't tell them about them. Does anyone know if Inland Revenue has access to 1099-R information?

[mbozek]

Inland Revenue probably has the right to audit the employer/plan/ participant under UK law ( does part. have to file a UK tax return?) and may have access to 1099 info under an agreement with the IRS-- I dont know for sure. The way to avoid the withdrawal issue is to offer the participant a better deal, i.e., a low interest rate loan in lieu of electing a distribution.

[Guest Harry O]

The problem is that UK approved "schemes" generally prohibit employee access to funds prior to termination or retirement. This is why they object to in-service withdrawals and loans. Every major accounting firm that does expat tax work is familiar with this issue and can work with you to get around it.

[Guest carsca]

As a practical matter, should every 401(k) plan that covers UK employees be submitted for a UK "Determination letter"-like review with the Inland Service?

[mbozek]

Why would the er want to do that? What happens if inland revenue demands prvisions which would disqualfy the plan?

[Guest carsca]

The er would want to do that in order to help UK employees participating in a US plan avoid double taxation.

[mbozek]

I dont understand how helping UK employees avoid UK taxation should have priority over the tax deferral for US employees in the plan. As previously noted UK law may require provisions which are inconsistent with provisions under IRC/ ERISA. It would be better to exclude UK employees then make changes in the plan to conform to provisions required under UK law. What are the provisions that would be required under UK law? Second would a US pension plan be eligible to qualify under UK law? For example only a domestic trust established in the US is eligible to be used to fund a plan qualified under the IRC and the plan must maintain the indicia of ownership of all assets within the jurisdiction of the US cts.