Tax inefficient investments can seriously impact any gains you make from investments and are a nasty surprise for many people.
To give you an example of what you could save by planning in advance, the case study below shows how one of our clients benefited from all of the following:
- Avoided paying a 63% global tax rate on investment gains
- Saved $198,125 on global tax bills
- Minimised future global tax rate exposure to just 23.8%
This Stepping Stone also shows you:
- What are PFICs, and how you can avoid them
- How to avoid paying double taxation
- Options for withdrawing from your UK/US pensions to minimise taxation
Case study: Avoiding the 7 year tax trap
An American client of Buzzacott’s had been living in the UK for 6 years and was approaching the 7 year “remittance basis” deadline. This meant they would pay both US and UK tax on their large portfolio of US mutual funds if they sold after the deadline.
The client had decided that after 7 years they would not want to pay the annual remittance basis charge of £30,000 as it would not be worth it financially and the ability to remit current year income and gains to the UK without an additional tax at that stage was preferable.
We looked at the total taxes they would pay if they sold before or after the deadline.
Since they purchased the US mutual funds they had risen in value by over $500,000, so if they sold before the deadline, the US Capital Gains Tax and Net Investment Income Tax (NIIT) would total $119,000.
But if they delayed the sale until a future year after the deadline, they would instead need to pay 45% UK income tax when they were sold, as well as 3.8% NIIT. This would have resulted in a global tax bill of around $317,125, after taking exchange rates into consideration as well as foreign tax credits.
By pointing this out, our client decided to sell early and saved around $198,125, simply by proactive planning.
If they had left the sales until later tax years, they would have paid 63% of US dollar gains as tax!
Creating a better future
To avoid this problem in the future, Buzzacott’s Financial Planning team provided independent financial advice, resulting in our client investing their funds with investment firms that specialise in Americans living in the UK.
They ended up reinvesting into a portfolio of US mutual funds which had UK Reporting Status. This meant that any future gains would be taxable at a global rate of just 23.8%. A significant reduction!
Other Top tip’s
Avoiding Double Taxation
It is normally important to consider the timing of the UK tax payment to avoid double taxation. Generally, if UK tax is paid in the same calendar year that income is generated, it can reduce the US tax due.
Avoiding the Passive Foreign Investment Company rules (PFIC) will save you time, money and stress. Americans should be wary of investing in non-US collective investment funds which normally fall into the definition of a PFIC.
In some cases, PFICs can lead to global tax rates that could easily exceed 70%! However, there are several methods of avoiding PFICs and the regulations surrounding these. If you want more advice or examples, contact us and we’ll run you through the potential pitfalls of PFICs.
If you have US and UK pensions, there are a number of factors to take into account if you want to minimise the tax you have to pay upon withdrawing your pensions. These include how the pensions have been taxed to date and where you expect to be living when you come to take benefits from the pensions.
Considering only the US/UK tax consequences, the following is a useful overview for US citizens of how pension distributions are taxed:
To minimise your US/UK tax exposure, the pension distributions should be taken in the following order:
- 25% UK Lump Sum – (This will be tax free)
- 100% US Distribution of sum – (Tax payable to the US at 39.6%)
- UK balance – UK/US tax (If a UK resident, tax payable to the UK at 45%, if a US resident, tax payable to the US at 39.6%)
The flexibility around the pension order withdrawal will often depend on the type of pension, as some pensions require the balance to be taken at the same time as the 25% lump sum.
At Buzzacott, we can look at your circumstances and advise you on the best approach you can take to reduce your overall taxation liability on your pension funds.
More about our teams at Buzzacott
We provide joined up tax (US and UK) and financial advice. Our Expatriate Tax Services team help US and UK citizens based away from home to manage their income and reduce liabilities, ensuring compliance with local tax regimes. We know that navigating an unfamiliar tax environment can be confusing, and we’re here to simplify it. With internationally mobile clients this involves a partnership that lasts through many stages of their lives. We like to get to know our clients well, and we’re passionate about looking after them.
Our Financial Planning team are independent financial advisors, regulated by the Financial Conduct Authority. We offer guidance and create wealth management plans for private individuals seeking solutions for wealth accumulation or preservation. Whether you’re saving for retirement or managing disposals, building an investment portfolio or preparing for life abroad, we take a risk-sensitive approach to financial planning that puts you in control.
The full Stepping Stones series can be found here
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