Top 6 Financial Planning Issues for Americans Living in the UK

A common investment mistake made by many American expats is owning non-U.S. financial products, commonly referred to as passive foreign investment companies (PFICs). PFICs commonly include non-U.S.-listed mutual funds and non-U.S.-listed exchange-traded funds (ETFs). A U.S. taxpayer owning PFICs will face onerous taxes and compliance costs. Thus, for most U.S. citizens living abroad, owning PFICs should be avoided outside of qualified retirement accounts (IRAs, 401(k)s and U.K. company pensions).

The United Kingdom imposes additional requirements that limit tax-efficient investments available to American expats. American investors paying U.K. tax on investments should focus on owning U.S.-listed investments that are registered with the HMRC. Using these special “U.K.-reporting funds” ensures that favorable U.K. capital gain treatment is given to these investments. Investment gains from U.S. funds not registered with the HMRC will be considered offshore income gains and face the highest U.K. tax rates. There are many U.S. listed funds available that are HMRC-compliant and since they are U.S. listed, these funds (mostly ETFs) will not be classified as PFICs. American expat investors in the United Kingdom should familiarize themselves with this list of HMRC offshore reporting funds.

New pension laws in the United Kingdom require mandatory enrollment in a company-sponsored defined contribution pension for most U.K. employees. This means that many American expats in the United Kingdom need to understand the tax implications of participating in a non-U.S. pension plan. The good news is that the extensive U.S./U.K. double tax treaty allows for pre-tax contributions and tax deferral in a U.K. company-sponsored pension. This double tax treaty also simplifies the U.S. tax reporting of a U.K. company pension.

Contributing to a U.K. company pension is a great way to use excess foreign tax credits generated by higher U.K. tax rates. In addition to using a U.K. company pension, a self-invested personal pension (SIPP) may be another way for American taxpayers to utilize excess foreign tax credits. However, caution is warranted because a SIPP is not clearly defined in the U.S./U.K. double tax treaty and may require specialized tax reporting to achieve a net tax reduction in both countries. Individuals should consult with a qualified U.S./U.K. tax preparer before using a SIPP as part of a cross-border financial planning strategy.

On the other hand, a U.K. individual savings account (ISA) is not considered a pension account by the IRS. Growth and income generated by investments in an ISA for U.K. tax purposes will be tax-free, but all income and gains are taxable by the United States. Further, any collective investments such as non-U.S.-listed mutual funds or ETFs may be classified as PFICs. Owning PFICs in an ISA is an expensive mistake often made by U.S. expat investors in the United Kingdom and a large detriment to proper U.S./U.K. cross-border financial planning.

American citizens moving to the United Kingdom often arrive with a variety of U.S. retirement accounts such as 401(k)s, IRAs and Roth IRAs. U.S. expats will have no tax issues maintaining these accounts while residing in the United Kingdom. However, it is important to check if the investment custodian holding these accounts has implemented U.S. expat investment account restrictions.

In a similar fashion to the protections afforded to U.K. pensions, the extensive U.S./U.K. double tax treaty protects the tax-qualified nature of U.S. retirement accounts (including Roth IRAs). Even though these 401(k), IRA and Roth IRA accounts have tax treaty protections, it may not make sense for Americans living in the United Kingdom to continue to contribute to these accounts. Higher U.K. tax rates might make IRA contributions tax-inefficient and lead to double taxation for most American expats in the United Kingdom.

The amount of time spent in the United Kingdom dramatically impacts an American expat’s financial planning strategy. Understanding U.K. residency and domicile tax rules is essential for Americans moving to the country. There may be some advantages for newly arrived American expats to shelter some investments from U.K. taxation through special tax elections and financial planning strategies.

For a U.K. resident, non-domiciled individual, there is an option of being taxed on two bases: the arising basis and remittance basis. Arising-basis taxpayers are subject to tax on their worldwide assets and income. U.K. residents electing the remittance basis are only subject to U.K. income tax on U.K. source income (usually only U.K. wages) and gains on U.K. property as they occur. In addition, they will be subject to U.K. tax on non-U.K. source income and gains if “remitted” to the United Kingdom. The remittance basis must be expressly claimed in most cases and is subject to an annual charge after the first seven years.

Long-term residency and domicile in the United Kingdom require the most planning. For investors with significant wealth accumulated prior to moving to the United Kingdom, there are numerous strategies than can greatly reduce U.K. taxes on investments. U.K. resident, non-domiciled individuals may be able to claim the remittance basis for up to 15 years during which time significant gains may be untaxed by the HMRC. Plan ahead as many U.S. expats stay in the United Kingdom longer than originally anticipated!

It is common for long-term American expats in the United Kingdom to buy property. One difference from the U.S. tax system is that the United Kingdom does not charge any capital gains tax on the sale of principal residences. The HMRC collects revenue from property transactions by assessing a stamp duty land tax. However, an American citizen is still subject to U.S. capital gains tax on the gain from the sale of their principal residence in amounts over $250,000 ($500,000 if filing jointly) even if that residence is in the United Kingdom. One potential strategy to avoid extra tax is to divide ownership between a U.S. and non-U.S. spouse to optimize the amount that may qualify for the U.S. exemption.

The United Kingdom has much lower inheritance tax (IHT) thresholds than the United States. The exemption amount is only 325,000 GBP per person (2022/2023). The IHT rate is 40% on global assets for U.K.-domiciled or deemed-domiciled individuals. Similar to the United States, transfers between spouses are not subject to IHT. There are also several nuances to the calculation of IHT when passing a primary residence to a child or donating to charity.

Americans planning a long-term stay in the United Kingdom should consider structuring assets outside the U.K. inheritance tax net. For example, U.K.-excluded property trusts and term life insurance are powerful planning tools for individuals who may not remain in the United Kingdom permanently. In addition to planning for IHT, American expats should revisit their wills and other estate documents to ensure assets will pass as planned if they are domiciled in the United Kingdom at death. The United States and United Kingdom have similar probate laws, but it is always best to have a primary will written in a jurisdiction of primary domicile to ensure a smooth transfer of assets at death.