# 401k options for soon-to-renounce US citizen



## guacamarlo (2 d ago)

Hi there

I'm hoping someone with experience and/or factual knowledge can offer some advice.

I am a dual US/UK citizen (US by birth; UK by naturalization). I am renouncing US citizenship in early Feb. I don't expect to be a covered expatriate.

I have a relatively modest amount ($35k) in a 401k that I stopped contributing to when I left the US 20+ years ago. I am 10+ years away from retirement age.

I'd like to cash out the 401k account, accepting that there will be a hefty US tax penalty. My rationale is that I'll offset that penalty with a lump sum payment to my mortgage (thereby saving on overall mortgage interest).

What's not clear to me is if/how the UK will tax that 401k withdrawal; either before or after I renounce. I'm assuming it would be more beneficial to cash out while I'm a dual citizen, to take advantage of the US-UK tax treaty; but despite several hours of online research, I'm none the wiser about a sensible approach.

Can anyone offer any words of wisdom (ideally backed up by facts)?

Many thanks in advance.


----------



## JustLurking (Mar 25, 2015)

guacamarlo said:


> I'd like to cash out the 401k account, accepting that there will be a hefty US tax penalty. My rationale is that I'll offset that penalty with a lump sum payment to my mortgage (thereby saving on overall mortgage interest).


By "penalty", I assume you mean the 10% US early withdrawal penalty. If yes, there _may_ be a way to bypass that. See below.



guacamarlo said:


> What's not clear to me is if/how the UK will tax that 401k withdrawal; either before or after I renounce. I'm assuming it would be more beneficial to cash out while I'm a dual citizen, to take advantage of the US-UK tax treaty; but despite several hours of online research, I'm none the wiser about a sensible approach.


Here is where some quality time with the US/UK tax treaty, including its Technical Explanation, might prove useful.

Firstly, it's unclear why you think you need be be a dual citizen to use the treaty; can you explain your thinking on that point? There is nothing in the treaty that requires you to be a US citizen. In fact, for US citizens specifically, the US's trademark 'saving clause', Article 1 paragraph 4, effectively eviscerates most of the treaty. So in a very real sense, the treaty is _far_ more useful to UK residents who are _non-US citizens_ than to US citizens.

Now, how might this help? Take a look at Article 17 paragraph 1(a). This restricts tax on pension withdrawals to country of residence. The US 'saving clause' negates this for US citizens, but not for a non-US citizen (including ex-US citizens). So once free of US citizenship, only the UK can tax a 401k withdrawal.

Does this mean you escape the 10% US early withdrawal penalty? Here, we run into one of several gray areas that revolve around treaty interpretation. There are however several respectable sources that have concluded that yes, it does. The withdrawal penalty is strictly a tax under US law, and so the treaty prevents its application.

Bingo. No US tax penalty. Although, depending on your UK tax bracket, this may feel like a hollow victory. The UK will tax withdrawals as ordinary income.

With all that said, beware treaty Article 17 paragraph 2. This reverses everything for 'lump sums'. Of course, we now have to decide what is a 'lump sum'. Another treaty gray area, unfortunately. The treaty doesn't define it, and the different countries use the term in differing ways. A full one-shot withdrawal is _probably_ a lump sum, but opinions have been known to vary. 



guacamarlo said:


> Can anyone offer any words of wisdom (ideally backed up by facts)?


Probably fewer facts above than you were looking for. Unfortunately, US tax treaties are often leaky, and sometimes poorly drafted, and neither the IRS nor HMRC are definitive on the gray areas in this one. So all we can go on is the interpretations of assorted experts, some professional, some not, most well-meaning, but certainly not all correct (because they differ!).


----------



## guacamarlo (2 d ago)

Firstly, thanks very much the comments



JustLurking said:


> By "penalty", I assume you mean the 10% US early withdrawal penalty.


Yes, I meant the early withdrawal penalty, in addition to the funds being taxed as income by the US (which I believe would take the total tax up to 30%). Presumably this would only apply if I withdraw while a US citizen?



JustLurking said:


> Firstly, it's unclear why you think you need be be a dual citizen to use the treaty; can you explain your thinking on that point?


I actually can't explain my thinking.  It has been a naive, unfounded assumption that I never thought to confirm or correct. Duly corrected now, thank you!



JustLurking said:


> This restricts tax on pension withdrawals to country of residence.


Another assumption I've had is that there would be different rules for early withdrawal than for standard post-retirement withdrawal (again, I can't explain my thinking).



JustLurking said:


> The UK will tax withdrawals as ordinary income.


This answers my most fundamental question. So it sounds like the funds would be added to my total income and taxed as such by the UK, and (if I withdraw after renouncing) may or may not be taxed the 10% penalty by the US.



JustLurking said:


> Probably fewer facts above than you were looking for.


On the contrary, very helpful for the basics and pointing me to the treaty technical explanation - thanks again!


----------

