Top 12 Financial Planning Issues for American Citizens Living in the United Kingdom

American citizens living in the United Kingdom face a complex interaction between U.S. and U.K. tax laws when it comes to their investments and retirement savings. The U.S. government taxes American citizens on their worldwide income based upon citizenship rather than residency. In addition to paying U.S. taxes, a U.S. citizen living in the United Kingdom may be exposed to U.K. income taxes assessed by the HM Revenue & Customs (HMRC).

Prior to implementing any investment strategy, an investor must always consider the tax implications that are created by being subject to two tax jurisdictions. Traditional U.S. financial planning strategies may be counterproductive for American citizens living in the United Kingdom. It is essential to always coordinate investment and financial planning decisions with both IRS and HMRC rules. Below is a brief overview of 12 common U.S./U.K. financial planning issues that may be encountered by American investors living in the United Kingdom.

Owning U.S./U.K.-Compliant Investment Funds (U.S.-Listed HMRC Reporting Funds)

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.

Understanding U.K. Company Pensions, Personal Pensions and Individual Savings Accounts

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.

Use of U.S. Retirement Accounts While in the United Kingdom (IRAs, 401(k)s, Roth IRAs)

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.

Deciding to Claim the Arising Basis or Remittance Basis of Taxation (U.K. Domicile/Deemed Domicile) as a U.S. Taxpayer

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!

Managing Cross-Border Currency Risk for Americans in the United Kingdom

The strong U.S. dollar (USD) is great for recent UK arrivals moving funds across the Atlantic to pound sterling (GBP) to buy houses and other U.K. assets. However, uncertainty in the exchange rate also causes American expats living in the United Kingdom who are paid in GBP great stress about which currency to save and invest in. It is essential to develop a long-term plan for cash reserves and a portfolio that focuses on matching current assets with future liabilities. For example, an individual planning to retire in the United Kingdom should be more exposed to GBP investments than someone who may retire back in the United States and spend USD.

Currency swings also create tax implications for U.S./U.K. investors. An investor must calculate capital gains, interest and dividend payments in both USD and GBP. Given the appreciation of the USD against most major currencies (including GBP), investors may face unexpected U.K. capital gains tax on USD-linked investments as demonstrated below with a U.K. taxable sale of a U.S. Treasury bond:

Purchased on June 27, 2014:

U.S. Treasury Bond	USD	FX Rate	GBP
Purchased on June 27, 2014	$100,000.00	0.588235	£58,823.53
Matured/Sold March 8, 2014	$100,000.00	0.769231	£76,923.08
U.K. Capital Gain	£18,099.55

In this example, the appreciation of the USD against the GBP created a gain that will be taxed by the HMRC. Many investors and advisors (including robo-advisors and separately managed accounts) optimize investments for U.S. tax purposes but neglect to consider any U.K. tax implications of portfolio changes. This could create an unfortunate surprise at U.K. tax time!

Buying U.K. Real Estate as an American Expat

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.

Another area U.S. expatriates must be mindful of is refinancing or paying off a U.K. mortgage. Given the appreciation of the USD against the GBP, this transaction may lead to large U.S. currency gains that are taxable as ordinary income by the IRS. Below is an example showing the potential implications of a U.S. currency gain on a foreign mortgage:

Mortgage Amount	GBP	FX Rate	USD
Purchased on June 27, 2014	£1,000,000.00	1.7	$1,700,000.00
Sold/Refinanced on March 8, 2019	£1,000,000.00	1.3	$1,300,000.00
Taxable Ordinary Income	–	–	$400,000

In the above example, the IRS will see a debt relief due to the currency fluctuation that will be taxed, even if there is no sale of the asset. Be cautious with floating mortgages (shorter-term loans with variable rates), which are common in the United Kingdom to avoid the situation illustrated above!

Understand Other U.S./U.K. Cross-Border Tax Issues

There are several major structural differences between the U.S. and U.K. tax systems. The U.K. tax system uses a fiscal year that runs between April 6 and April 5 of the following year. The United States uses a calendar year for tax reporting. Unlike in the United States, there is no system of joint filing in the United Kingdom and spouses must each file their own tax declarations. On the U.S. tax side, there are numerous additional U.S. expat tax forms that must be completed annually:

• Foreign Bank and Financial Accounts (FinCEN Report 114)
• Foreign Account Tax Compliance Act (IRS Form 8938)
• Passive Foreign Investment Companies (IRS Form 8621)
• Foreign Pensions and U.K. Trusts (IRS Form 3520)

If an American expat receives equity compensation such as incentive stock options or restricted stock units, there can be significant additional complexity when filing a U.S./U.K. tax return. Preparing a tax return is even more complicated if a U.S. taxpayer owns a business classified as a controlled foreign corporation. Speak to a qualified U.S./U.K. expat tax preparer if you are in one of these more complicated situations.

Review Your U.S. Estate Plan After Moving to the United Kingdom and Pay Careful Attention to Trusts

Estate plans do not travel well across borders and U.S. estate plans utilizing trusts may create extra U.K. tax. Trusts may incur a U.K. tax charge upon entry and exit of the United Kingdom. This means that U.S. revocable living trusts (funded) and U.S. life insurance trusts have potentially serious U.K. tax ramifications. It is imperative that an American living in the United Kingdom be cautious about serving as trustee of any U.S. trust as well, as there can be drastic consequences to settling a trust while U.K. domiciled or deemed domicile.

U.S. citizens are still subject to U.S. estate taxes, even when living in the United Kingdom. The United States imposes income and transfer (estate/gift) taxes based primarily upon citizenship. The maximum rate of federal estate tax and gift tax is 40%. However, with a $12.92 million estate tax exemption (2023) for individuals, many U.S. citizens are under the exemption and not overly concerned with planning for this tax. See more on international estate planning for U.S. expats.

Planning for U.K. Probate and Inheritance Tax as a U.S. Citizen

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.

College Savings: U.S. Expat 529 Plans While in the United Kingdom

Saving for college is important for many American expat parents. The good news is that most top U.K. colleges and many European universities are eligible for 529 funds (100+ schools in the United Kingdom). However, long-term U.K. residents should be careful about maintaining 529 accounts while being a tax resident in the United Kingdom. The HMRC does not recognize the special tax-free nature of 529 college savings accounts and imposes taxes on investment gains. A potential strategy is to have a trusted person establish the 529 college savings account in the United States and make contributions as a U.S. expat living in the United Kingdom.

Planning Implications of a Non-U.S. Spouse Married to an American in the United Kingdom

Many Americans may find themselves in a mixed nationality marriage in which one spouse is not a U.S. citizen. This presents some planning opportunities and pitfalls. There may be some advantages to keeping the non-U.S. spouse outside of the U.S. tax system. The United Kingdom has some attractive capital gains relief that can be preserved by holding assets in the non-U.S. person’s name. Further, a non-U.S. spouse should take full advantage of special U.K. tax-advantaged accounts such as SIPPS and ISAs. Once a decision is made to bring a non-U.S. spouse into the U.S. tax system, the election is difficult to revoke.

Leaving the United Kingdom: The Importance of Breaking U.K. Domicile

Many American expats may decide to leave the United Kingdom one day and return to the United States or elsewhere. For an English domiciliary or deemed domiciliary to lose their English domicile status, they need to settle permanently in a new jurisdiction outside the United Kingdom.

For Americans returning home, each U.S. state is considered a different jurisdiction. Individuals need to be mindful of migration between U.S. states (i.e., moving from New York to Florida) because English domicile could revive in transit and there is a three-year tail to lose English domicile. During this three-year period, exposure to IHT remains and individuals should be very careful about engaging in estate planning with funded trusts until they are certain U.K. domicile is lost.

Making the Most of Your Time in the United Kingdom as an American Expat

U.S. taxpayers working and investing while living in the United Kingdom have unique financial planning needs. When dealing with taxation in two jurisdictions, it is vital to work with an expert American expat financial advisor who understands the interaction between the U.S. and U.K. tax systems to create a global investment strategy. The most successful outcome is a portfolio that is optimized for both U.K. and U.S. tax codes and reporting.

Financial planning for Americans abroad is complex but does not have to be overwhelming. Cerity Partners is an independent wealth advisory firm with experience in working with global families who face these complex cross-border circumstances. We coordinate investment strategy and tax planning with a goal to optimize our clients’ after-tax returns and preserve wealth. As fiduciaries, we help our U.S./U.K. expatriate clients plan and execute their finances amid the unique challenges of living abroad.

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