US & UK Tax on Traditional to Roth Conversions

I’m working on a series of posts about retirement withdrawal strategies and managing US and UK taxes in retirement, and I keep drafting a comment that “I’ll do a post on Roth conversions in the future” – I’m just going to do it now 🙂

There’s already a lot out there about a Roth Conversion Ladder – I recommend this Mad Fientist post. The quick and dirty for Americans who live in the US is:

  1. Start with a Traditional IRA – this can be from contributions to the IRA, or from rolling over your 401(k) (or similar, like a 403(b) or TSP) to a Traditional IRA. There’s no tax or penalties on this rollover.
  2. Convert some or all of your Traditional IRA to a Roth IRA. This is taxable – the amount you convert gets added to your US taxable income and is taxed like wages, not capital gains (makes sense, since you previously deferred tax on the income you used to fund the 401(k), or took a tax deduction for contributions to the Traditional IRA – now the IRS gets paid).
    • If your other taxable income is low enough, the tax rate might be 0%, though
  3. Wait five years, for your conversion money to turn into contributions within your Roth IRA
    • You can do more conversions in following years while you’re waiting
  4. After five years, you can withdraw the conversions tax and penalty free – they’re now treated as Roth IRA contributions.

This way, you can do two important things:

  1. Get to the money that’s locked away in your Traditional 401(k) or IRA before you turn 59.5 – this can help you bridge from early retirement to a more typical retirement age.
  2. Gets the money out of the grasp of Required Minimum Distributions. RMDs are a ticking time bomb in your Traditional 401(k)/IRA.

Of course, this assumes that you already have Traditional IRA or 401(k) savings when you move to the UK, or build them up when you’re in the UK (less common). If you don’t, this won’t help you much, I’m afraid.

Side Note: Required Minimum Distributions

Until I started the research for this post and the upcoming series on withdrawal strategies, I was vaguely aware of RMDs but kind of thought of them as a problem to worry about for the future, not too big a deal. Turns out, they’re potentially huge!

Quick example: say you retire at 52 with $250,000 in your Traditional 401(k) or IRA – pretty reasonable if you maxed out your 401(k) for several years in the US, then moved to the UK and let it grow untouched. You still don’t touch it until you have to take RMDs at 72 – at only a 5% real growth rate, that’s now more than $600,000. When you turn 72, you have to take over $23k a year out of that, and that only grows every year. Social Security and the State Pension could easily fill your UK personal allowance (£12,300 – can’t share it with a spouse), so now you’re paying 20% tax on all of that RMD – $4,600 a year and climbing. If you live to 94 (and you have about a 25% chance of living that long if you’ve made it to 72), you’ll pay over $165k in UK taxes on your RMDs:

With Roth Conversions, you can anticipate and manage RMDs, instead of being stuck with whatever you get at age 72. With the right planning, you can get the RMDs to match the amount you actually want to take out, or you can get your Traditional balance to zero and not worry about them at all (there are no RMDs on Roth balances).

Done right, you’ll manage the tax on the Roth Conversions, so that instead of paying 20% you pay 0% or a smidge more – that’s $165k more you can spend, pass on, or do whatever you want with.

Roth Conversions and the UK

Everything above applies to Americans in the US, but how does the UK treat Roth Conversions? I have very good news (probably): Roth Conversions are completely tax free in the UK.

I say probably, because, while I completely understand the logic, and have found numerous reports of people actually doing this, there’s nothing in black and white from HMRC that clearly says yes. If you have any doubt, seek professional advice – with the sums that could be involved if you have a large 401(k), you don’t want to mess this up.

The logic is fairly straightforward, thinking back to our exploration of the US/UK tax treaty:

  • Article 18 Paragraph 1 says, in part: “income earned by the pension scheme may be taxed as income of that individual only when…it is paid to…that individual from the pension scheme (and not transferred to another pension scheme) (emphais mine)
  • Article 18 Paragraph 1 is not excluded by the Savings Clause
  • A transfer from a Traditional IRA to a Roth IRA is a transfer from one pension scheme to another.

There are some other arguments that get to the same point, mostly using the lump sum clause – this is the one that holds the most water to me, though.

There’s nowhere to include the conversion in your Self Assessment, but I’ve seen people put a note along the lines of “During the yyyy tax year, I transferred a lump sum from my Traditional IRA Pension Fund to my Roth Pension Fund totaling $xx,xxx.xx. Since this is a transfer of a lump sum between pension schemes, it is exempt from UK tax and has therefore not been included in this return.”

It seems prudent to include some kind of statement, so that you can never be accused of trying to hide it if HMRC decides they don’t agree that Roth conversions aren’t taxed in the UK.

I’ve also seen some advice to do the conversions at most every other year, and not in the same value every time. This is based on an argument around the conversions being a “lump sum”, which isn’t taxed by the UK. The arguments aren’t mutually exclusive (can be both a transfer and a lump sum) – if you’re feeling cautious, there’s not much harm in spacing out the conversions in different values, anyway.

Using Roth Conversions

What does this mean for you? It means that if you have significant savings in a 401(k) or Traditional IRA, you can convert it into a tax-free Roth IRA, without paying UK taxes and, through some prior planning, paying no or minimal US taxes.

The amount of the conversion winds up in your taxable income on your US tax return, before any deductions. If your total taxable income is less than the standard deduction, you’ll pay nothing. Depending on your specific situation, you may be able to go above the standard deduction and cancel it out with credits, still paying no tax. Or even if you pay taxes, you start in the 10% bracket, not the 20% basic rate in the UK.

I’ll look at how this fits in to an overall retirement withdrawal strategy in the upcoming series, but it can be a key part of reducing tax if you have a substantial Traditional balance.

Advanced Mode: Roth Conversions and Foreign Tax Credits

I feel pretty confident about what’s above – this section is where I feel like we’re on a little bit of uncertain ground. Basically, there are some sources saying that not only can you pay zero UK tax on your Roth conversion, but also can use Foreign Tax Credits (from other income) to offset some or all of the conversion on your US taxes, even if they’re over the standard deduction.

The typical American in the UK who is earning an income will have excess general category Foreign Tax Credits, because the UK tax on earned income is essentially always higher than the US tax. The excess FTCs can be carried over for up to 10 years – this is all very clear. Where it gets less clear is whether you can use these general category FTCs against Roth conversions.

There’s an argument that this only applies to the portion of your conversion that is composed of contributions form foreign source general category income. This paper spells that position out pretty clearly, and it makes logical sense – you’ve contributed foreign income to this pension and were already taxed on that income, so you can use the FTCs from that tax on the conversion. This feels like reasonably solid ground, although limited applicability – it only helps for the portion of your Traditional IRA or 401(k) that you funded from foreign earned income. That may well be zero (it is for me).

There’s another argument that you can use any general category FTCs against the whole of the conversion, not just any portion that’s attributable to foreign earned income. I can’t find anything clearly saying you can’t do this, but it feels a little dicey. You’re basically saying that you haven’t paid foreign income tax on either the income that funded the 401(k)/IRA (because it’s from US income before moving to the UK, for our purposes), and you didn’t pay foreign income tax on the conversion itself (because it’s not taxable in the UK), but you’re going to use FTCs that came from other income to offset the US tax on the conversion. It feels like cherrypicking, trying to make the US tax system that doesn’t quite make sense.

I’m not willing to dismiss it out of hand, though – if any of you have a clear argument for how this works, I’d love to hear it!

Side Note: 72(t) SEPP

If you read the Mad Fientist article at the top, he also discusses a 72(t) Substantially Equal Periodic Payments (SEPP) option, instead of a Roth conversion, so that you can withdraw from a Traditional IRA prior to reaching age 59.5.

Three quick thoughts on this option for Americans in the UK:

  • I’m confident this is UK-taxable income – it’s clearly a periodic payment, right there in the name. I don’t see any reason why it would be penalized beyond being normal income – still gets taxed at the higher UK tax rates, though.
  • I could make an argument that it shouldn’t be US-taxable income, because it’s a periodic payment from a US pension to a UK resident. In practice, it doesn’t really matter – the UK tax will almost certainly be higher than the US anyway, so Foreign Tax Credits would wipe it out.
  • It helps you get money early, and in so doing reduces your Traditional balance, helping with the RMD time bomb.

Therefore, it’s probably an option for getting to your money early, if you a) want to deal with the complexity, b) have a pretty good idea how much you’ll need and don’t expect that to change, and c) don’t mind paying the higher UK tax on it.

For me, I think Roth conversions are the better deal, due to paying US rather than UK tax, and are simpler.

Social Security & State Pension

This is the last of my series on account types that Americans in the UK might use to save for retirement. US Social Security and the UK State Pension maybe aren’t accounts, strictly speaking, but they’re certainly worth understanding and considering how you’ll use them in your planning.

I’ll start with an overview and comparison of the two systems, then a few notes on how the systems can interact, both to your advantage and disadvantage. I’ll wrap up with some quick thoughts on how Social Security benefits get calculated and how to be most efficient, and on long-term futures for these programs.

For the purposes of this post, I’m using values that make sense for somebody who hasn’t retired yet, and is in their 30s or 40s. There might be slight differences depending on age – the biggest one would be that there’s a different UK state pension system if you’re born before 1951 (men) or 1953 (women) – I’m not even going to touch on that system.

I’m also only going to discuss retirement benefits, not disability, blindness, etc.

These are both fairly complicated systems – this is just a high-level overview, and there’s a ton of nuance and specifics. I might do future posts on some of the details, if there’s interest.

Overview & Comparison

AttributeUS Social SecurityUK State Pension
How do you qualify?40 work credits – typically 4 per year of employment, so 10 years of working and paying Social Security tax10 qualifying years on your National Insurance record (not necessarily in a row – typically from working, credits for unemployment or parenting, or paying voluntary contributions)
When can you get it?62 at the earliest, for a reduced amount. 67 is “full”68 (if you were born after 06 April 1978, somewhat earlier if before)
How much do you get?Based on your highest 35 years of eligible Social Security earnings (typically not including foreign earnings where you aren’t paying Social Security tax) and when you choose to start getting paid (between age 62 and 70, the longer you wait the more you get)

At 67 (full retirement age), the benefit replaces roughly 75% of your income for very low earners, about 40% for medium earners, and about 27% for very high earners.
Based on how many qualifying years you have – maximum benefit at 35 qualifying years.

Straight proportion of the full benefit – e.g. if you have 20 qualifying years, you get the (full benefit divided by 35 years) x 20 qualifying years. That is, (£175,20/35)*20 = £100.11

Does not depend on your income
What’s the maximum benefit (2021)?Age 62: $2,324/month
Age 67: $3,113/month
Age 70: $3,895/month

These assume that you’ve maxed out your earnings for 35 years – the max is $142,800 in 2021, indexed for inflation (anything above that level doesn’t have SS tax taken out and is ignored for SS calculations)
Full benefit is £175.20/week – this can be increased by delaying claiming the pension, which increases it by 1% for every 9 weeks you defer (about 5.8% a year)

Example: if you defer to age 70, you could increase £175.20/wk to about £196/wk (plus any inflation adjustments in those 2 years).

For comparison, full benefit is about £761 per month – $1,053 at today’s exchange rate. State pension is potentially much less money than social security, if you have a moderate to high US earning record.
What’s a typical benefit (2021)?Estimated average of about $1,543 a month.

For somebody who averaged $60,000/year over a 35 year career, it’s about $2,178.

To get to about the same $1,053 monthly benefit as the UK state pension, you’d need to average about $18,000 per year (or a higher value for fewer years).
As long as you’ve achieved the full 35 qualifying years, you get the full benefit of £175.20/week (about $1,053/month).
Can your spouse benefit?Yes – typically up to half of your benefit (or their own benefit, if that’s higher from their employment history). This typically includes foreign spouses and divorced spouses if you were married for 10 years and they haven’t remarried.Typically not, under the new (2016) rules. There are some legacy rules that don’t apply moving forward, but could still affect some people.
Your spouse would need to qualify based on their own National Insurance record.
Can your widow/widower benefit?Yes – can take some benefits from both their own and their deceased spouses benefitsTypically not, under the new (2016) rules. There are some legacy rules that don’t apply moving forward, but could still affect some people.
Can you keep working?Yes, but benefits are be reduced depending how much you earn over the annual limit (reduced by $1 for every $2 over $18,960 while under 67, reduced by $1 for every $3 over $50,520 in the months before your birthday of the year you turn 67). Once you turn 67, there’s no reduction.Yes, with no penalties. You can defer claiming state pension to allow the benefit to increase.
Are your benefits taxable?Yes – but for Americans in the UK, they will only be taxed by the UK due to the tax treatyYes, they are treated as earned income by the UK and the US (probably no US tax due, because of Foreign Tax Credits).
How much is the tax while working?6.2% from you, 6.2% from your employer (if you’re self employed, you pay both), up to the maximum taxable income ($142,800 in 2021)While employed, National Insurance is 12% from £797 to £4,189 a month, and 2% above that.
If self employed, you also pay National Insurance – the amount depends on your profits
You can choose to pay voluntary contributions if you’re not working/self-employed
Does my work in the other country count?Generally no – you won’t be paying Social Security tax, earning SS credits, or building up SS earnings for UK employment.

If you’re self-employed and still paying Social Security tax, this will count.

If you wouldn’t otherwise have enough SS credits to qualify, you can get UK credits to count, so you get to your 40 total credits (10 years of work). This reduces your benefit but lets you get something.
Only to get you to the minimum 10 years to qualify – the benefits will be prorated based on your time in the UK. For example, if you have 7 years in the UK but 10 in the US, the UK will count 3 of the US years to allow you to qualify. But, you’ll only get 7/35 (20%) of the full amount of £175.20/week
Interactions between Social Security & State Pension

Quick answer to the most common question: yes, you can get paid by both Social Security and the State Pension! But, the devil is in the details…

There are two main ways Social Security & the State pension can interact: Totalization and the Windfall Elimination Provision.

Totalization

Totalization is briefly mentioned in the last line of the table above – basically, if you’re short of the 10 years you need to qualify for either system, but have enough years in the other system to get to a total of 10, you’ll be treated as eligible (at a prorated benefit – you only get paid for the years you’re actually paying into the system or getting credits).

The most likely scenarios for this are if you left the US early in your career and then stayed in the UK permanently, or if you only stayed in the UK temporarily.

As a quick example of working in the relevant country for 9 years, and only being 1 year short of qualifying without needing totalization:

  • US Social Security: If you come to the US, earn more than the maximum social security income for every year, and then leave, you’d be eligible for about $1,400 per month – pretty substantial! Even at a more common $50,000/year income, you’re looking at about $900 a month. This hopefully won’t be the bulk of your retirement even in the leanest of retirement scenarios, but it can help.
  • UK State Pension: the most you could qualify for is 9/35 of the full amount (£175.20/week) – that’s £45/week or about £195 a month. Nice to have, but not the foundation of your retirement!

Obviously these are the most generous cases, since you were only 1 year short – the benefit amounts go down the less you were in the country. But the bottom line is, if you ever paid in to Social Security or the State Pension, and you’ve got a total of 10 years combined between the systems, you should be able to get something out of both of them, even if it isn’t much.

Windfall Elimination Provision

This one only applies to Social Security, there isn’t a corresponding State Pension provision that I’m aware of.

The idea is that, if you’re getting benefits by another retirement system like the UK State Pension, Social Security will reduce your SS benefit, so that you’re not getting a “windfall” due to getting double benefits.

The maximum reduction is half the amount of the monthly pension that is based on work not covered by Social Security – in our case, half the amount of the State Pension that you’re receiving.

WEP doesn’t apply if you have 30 or more years of substantial earnings covered by Social Security – but for many people leaving the US in their early or mid careers, it will apply.

Let’s walk through an example – I’ll use my own numbers here, because I think I’m a reasonably typical example of somebody who leaves the US mid-career and plans on staying in the UK permanently.

WEP Example

This example is based on the official WEP calculator and my estimates for my State Pension. All values are current year – obviously will be much inflated over the decades.

State Pension first: I expect that I’ll have about 15 qualifying years for the State Pension when I retire (early). So my State Pension is 15/35 (42.9%) of the full State Pension. 42.9% * £175.20 = £75.09/week. The SS calculator wants this in monthly dollars; let’s call it $455/month at a $1.40 to the pound.

For reference, I had 12 years of SS earnings, plus a little bit in college. My earnings are all over the place – half that time I was in the Navy, so my social security earnings were relatively low (a good chunk of military pay are non-taxable allowances). There’s a couple years where I maxed out social security earnings. On average, it’s just under $70k a year – fairly typical for an American with a college degree.

When I plug my data into the WEP calculator, it spits out a monthly retirement benefit of $1,083 at age 67. My non-WEP, “normal” benefit would be $1,311 at the same age, so it’s taking out $228 a month due to the WEP – that’s half of the $455/month I’d get for State Pension.

If I delay to 70, it goes up to $1,343, compared to a normal benefit of $1,626. Taken early at 62, it’s $763 instead of $923 – however, WEP won’t apply until I start getting the State Pension, so I’d actually get the $923 until State Pension age at 68.

When I’m closer to taking these two, I’ll do some more detailed math to figure out when it makes sense for both me and my wife to take Social Security and State Pension – lots of variables there.

Bottom line, you’ll still wind up with more money by having both Social Security & State Pension, but you’ll lose out on about half the value of the State Pension by having it taken it out of SS.

Social Security Benefits & Income

The way that Social Security calculates your benefit amount is pretty complicated – it’s easy to Google if you really want to know, or start here from the horse’s mouth. Honestly, just use the calculators on the SS website if you want to play around with the variables.

But, there’s a very important underlying concept – Social Security is a highly progressive program. It helps people with lower lifetime incomes a lot, but as your lifetime income gets higher, it helps proportionally less and less.

The calculation starts with your Average Indexed Monthly Earnings – basically, sum up your top 35 years of earnings, adjusted for inflation, and divide by 420 (35 years x 12 months). Based on your monthly average, your Primary Insurance Amount is calculated – the amount you get at full retirement age (no adjustments for early or late retirement). In 2021 dollars:

  • From $0 to $996 of monthly earnings, you get 90% added to your Primary Insurance Amount – up to about $896 a month
  • From $996 to $6,002 of monthly earnings, you get 32% added to your PIA – an additional up to $1601 a month
  • From $6,002 on up, you get 15% added to your PIA, until you hit the cap (if you’ve maxed out your social security income for 35 years – well done!)

What does that mean for us? There’s a pretty good return on all your income up to $996 AIME – that’s about $418k over 35 years. If you live for 20 years after age 67, you’ll get about $215k in SS benefits but have paid about $26k in SS taxes (8.3x return, albeit with a really long holding period)

But, it doesn’t have to be over 35 years – if you hit that $418k in just 3 years, with each year around the $142,800 maximum earnings cap, you get the same benefit as somebody who make about $12k/year for 35 years (all numbers are a little rough with the inflation calcs – think of them as 2021 numbers). You’d need 7 more years of credits to qualify, of course, but that could be from the UK or very low income.

For a more middle scenario, if you have about $42k of social security wages for 10 years or $84k for 5 years, you’ve maxed out that 90% bracket. If you are able to hit this level before leaving the US, it probably makes sense – you’re getting the biggest bank for your buck.

After the 90% bracket, the return drops dramatically. As a quick example, I plugged 10 years of $42k earnings into the official SS calculator – you get a monthly retirement benefit of $935 (not adjusting for WEP). But double that to 10 years of $84k earnings, and your monthly benefit goes up to $1,294. Double the income (double the work?) for only a 38% increase in benefit. And, if you live for 20 years, you get about $310k, and paid about $52k in SS taxes (down to 6x return).

Depending where you are in life, you may already be in this 32% bracket when you decide to move to the UK. It’s up to you, but once you get out of the 90% bracket, I don’t see this as a factor in timing the move. And especially once you’ve reached the 15% bracket (about $2.5 million in SS eligible lifetime earnings, in 2021 dollars), that extra 15% doesn’t do much for me!

Will Social Security & the State Pension Still Be There?

Without a crystal ball, there’s no way of knowing for sure. But for me, I can’t see them disappearing completely. Far too many people have little to no retirement savings, and having hordes of old people unable to feed and house themselves, especially when they tend to be active voters, doesn’t sound like something that will happen.

I could see one or both of them being means tested, and I could see the benefits amounts being eroded by inflation. Those seem plausible – “tax the fat cats” usually goes down reasonably well, and people don’t notice as much when their checks get bigger, but by less than inflation.

Personally, I include both Social Security and the State Pension in my retirement planning, but I discount both by 50%. That feels reasonable to me, and is close enough for now – if I have some extra money in retirement, I will find ways of spending it, or doing some kind of good with it. Do what lets you trust your planning and sleep at night!

Intro to Buying a House in the UK

This post is a quick guide on purchasing a primary residence in the UK, focusing on the issues that are specific to US citizens living in the UK. I’m not going to cover second homes, buy-to-let, US properties, etc., nor will I go through the details of the UK homebuying process that aren’t unique to Americans. A few good places to start understanding that basic process (which is somewhat different from the US system!):

To me, there are four key areas where Americans need to be aware of specific considerations when buying their home in the UK – I’ll cover each in turn:

  • Getting a Mortgage – Credit History
  • Getting a Mortgage – Immigration Status
  • Tax Implications – Capital Gains
  • Tax Implications – Foreign Currency Gains

Getting a Mortgage – Credit History

The US and UK credit history & scoring systems are essentially completely separate. No matter how good (or bad!) your credit was in the US, when you move to the UK you’re starting over from scratch. MoneySavingExpert has a good guide on UK credit scoring to get you started – it can even be difficult to check your UK credit report at all without three years of address history, because you won’t pass the automated ID checks!

That doesn’t mean you can’t get a mortgage until you’ve been in the UK 3 years, though. I got my first mortgage after a year of renting, and I know there are people who have bought upon arrival, including a mortgage. I do usually recommend renting for a year for most people, to give you time to get to know the area, establish your UK finances, and deal with all the homebuying stuff while actually in the country (it’s enough of a faff when you’re here; doing it from abroad is possible, but adding that stress to an already stressful transatlantic move doesn’t sound like fun to me).

There are a lot of things you can do to start building credit once you’re in the UK. This is not an exhaustive list, and in no particular order – you don’t have to do everything here, but doing several should start to get your credit building:

  • Pay all your bills on time
  • Try to get some credit, even if it’s just a small amount like a mobile phone contract
  • If you have an American Express credit card in the US, they will take this into account an help you open a UK Amex. You might not get the same credit limit (I only got £1,000 when I first arrived), but its much better than nothing.
  • If you can’t get an Amex, try to get a credit card for building credit. You’ll get a very low limit (often a few hundred pounds), but it starts building history. You may find that you can’t even get through the application screens without 3 years of UK address history, but try a few different options. MoneySavingExpert has a good list to start with.
  • You can register to get your rent payments applied to your credit history, through Experian or Credit Ladder
  • LoqBox is a product specifically designed to build credit. Basically, you take out a small 0% interest loan but they keep the money, so they aren’t worried about whether you’ll pay it back. As you pay it back, you build up a savings account, and the loan repayments get reported to the credit companies.
    • Quick example: you take out a 12 month loan for £600 at 0%, but you don’t actually get any money – LoqBox keeps the £600. You pay back the loan at £50 per month, which builds up as savings.
    • Once the loan is repaid, you transfer the money out. You can either open a banking account with one of LoqBox’s partners (they get a fee from this, but if you don’t like the account you could just transfer from the new account and close it), or you can pay £30 to transfer the savings to one of your existing accounts.
  • It’s commonly recommended to get on the “electoral roll” to help your credit. However, you can’t do this unless you’re eligible to vote. A few options:
    • You might actually be eligible to register to vote. In Scotland & Wales, if you have an appropriate visa you should be able to register. In England & Northern Ireland, you’re usually only eligible if you’re a UK, EU, or Commonwealth citizen.
    • You can send the credit reporting agencies proof of residency, instead of registering to vote. I’ve seen this recommended, but also seen anecdotes of it backfiring and somehow making it harder to get credit.

Personally, I did a combination – I used my US Amex to get a UK Amex, I used a rent payment reporting service (for a little while, then it broke – it’s been replaced by the ones listed above), I used LoqBox, and I paid all my bills on time. I can’t say which one, or which combination, was effective, but I didn’t have any challenges getting a mortgage because of my credit history. I may also have been helped because my wife/co-applicant was an EU citizen with a very old and fairly small UK credit history from before she moved to the US.

Getting a Mortgage – Immigration Status

Some UK lenders are less willing to work with immigrants, compared to UK citizens, and the specifics of your immigration status can matter (visa type, leave to remain, etc.). Basically, they’re concerned about your ability to stay in the UK and keep paying the mortgage, and maybe about the possibility of you skipping the country and abandoning the mortgage.

Because of this, it’s probably best to use a mortgage broker to help search the breadth of the UK mortgage marketplace, narrowing down to lenders that will work with you. MoneySavingExpert has a list of recommended brokers. Personally, I used London & Country for my first mortgage and Habito for a recent remortgage, and have no problem recommending either of them, I’d used them both again (I checked with both of them and they came up with the exact same recommendations, so it was basically a coin toss as to who to actually use).

Mortgage brokers get paid by the bank issuing the mortgage, no direct cost to you, although I’m sure their fees are baked into the mortgage.

Tax Implications – Capital Gains

Easy part first – the UK generally does not impost capital gains tax on the sale of your home (there are a few exceptions, if you rent it out, bought it just as an investment, it’s really big, etc.).

The US makes things more complicated – capital gains on the sale of a primary residence are taxable in the US, but with a significant exclusion of $250,000 ($500,000 for married filing jointly). This applies only to the gains – if you bought for $600,000 and sold for $700,000, the gain is only $100,000, so it’s under the exclusion. There are some conditions for the exclusion as well – mostly, you need to have owned it and lived in it for at least 2 of the last 5 years, although it can get more complicated.

For many people, that will reduce the tax to zero, but if you’ve lived in a house for a long time and/or house prices have gone up significantly, you could be above this and liable to pay capital gains tax.

Big caveat: the US tax calculations will be done in US dollars, at the exchange rate at the time of purchase and the time of sale. Therefore, it’s possible to have a gain in dollars that is larger than in pounds, or even a dollar gain but a pound loss. As a hypothetical example:

  • Buy a house for £500,o00 while the exchange rate is $1.25 to the pound – to the IRS, you bought the house for $625,000
  • Sell the same house 5 years later for £500,000 while the exchange rate has gone up to $1.50 to the pound – to the IRS, you’ve now sold the house for $750,000
  • The IRS sees a $125,000 gain, even though you didn’t make any money in pounds and will have lost some through stamp duty, legal fees, etc. (some of these expenses you may be able to include in your basis, see the IRS link above).
  • This example is under the $250,000/$500,000 exemption, but with an increase in house prices or bigger changes in the exchange rate, you could exceed the exemption.

There’s not really a way around this – all your US taxes are done in US dollars. You could sell your house whenever you get close to the $250,000/$500,000 exclusion, but that has plenty of other costs. You can try to time buying and selling with highs and lows in the exchange rate, but you still need somewhere to live!

Tax Implications – Foreign Currency Gains

This one only applies to US taxes, nothing to think about for UK taxes.

To the IRS, every transaction you make is made in US dollars, regardless of the currency that it is actually used. So for the purchase of a house using a mortgage, the IRS actually sees two separate transactions:

  1. Exchanging USD for a real asset (the house)
  2. Receiving USD in exchange for a promise to pay the money back, with interest (the mortgage)

We talked about #1 above, but #2 can have it’s own pitfalls – you can have a taxable USD gain on the mortgage, regardless of what happens to the value of the house. This is best explained in a couple of examples:

Example 1 – Mortgage Refinancing

UK mortgages are frequently on a 2 or 5 year fixed rate, after which they change to a “standard variable rate”, which is typically much higher. So it’s completely normal to get a new mortgage in the UK every 2 or 5 years.

You take out a mortgage for £100,000 while the exchange rate is $1.50 to the pound. Let’s call it an interest only mortgage just for the sake of simple calculations – the principle still applies if it’s also repaying principal.

  • The IRS sees this as you receiving $150,000 in exchange for a promise to pay it back plus interest.

You then refinance that mortgage 2 years later, for another £100,000. But, the exchange rate has dropped to $1.25 to the pound (a dramatic drop, but actually happened after the Brexit vote).

  • The IRS sees this as you having exchanged a debt of $150,000 for a debt of $125,000 – you’ve made $25,000 on the exchange! That’s taxable income to the IRS, even though your financial situation in GBP hasn’t changed at all.
  • That income is foreign passive income, typically taxed at income rates (not lower capital gains rates). It can be offset by the Foreign Tax Credit, but only if you have excess FTCs in your “passive” category bucket that covers UK tax on interest, dividends, & capital gains, not the “general” one for UK income tax on salary. You might or might not have enough passive FTCs to cover it, in which case you’re paying real $$$ to the IRS.

Sadly, the reverse example doesn’t help you – if the exchange rates were swapped and you “lost” $25,000, you can’t deduct that from your US taxes.

This example could just as easily be on the sale of the house, rather than a remortage – if you only pay back $125,000 when you sell the house after taking out a $150,000 mortgage (both of which are actually £100,000), you still get this gain, and it’s not excluded as part of the $250,000/$500,000 exclusion – the mortgage transactions are separate from the purchase and sale of the house.

There isn’t a ton you can do to mitigate this, either. If you have a non-US spouse who doesn’t file US taxes, you only need to report your half of the gain, which helps. And when you buy the house, you may be able to structure it so the non-US spouse owns most or all of it – this can get complicated, and is probably worth seeking professional advice if you want to pursue.

You could get a longer fixed mortgage (there are now options up to 40 years, more like the traditional US 30 year mortgage) – this mostly delays the pain, but could avoid it if you happen to be due for a remortgage at the time of a temporary exchange rate swing. But you’ll typically pay a higher interest rate for a longer fixed term, all else equal.

Other than that, if the exchange rate has moved in the “wrong” direction while you have your mortgage, you may be stuck between paying the higher “standard variable rate” to the mortgage company or paying income tax to the IRS 😦

Example 2 – Mortgage Payments

This foreign currency gain tax could even apply on your normal monthly payments. There’s an exception of $200 per transaction that can help avoid this on smaller mortgages, but with big exchange rate changes and/or large mortgages, each mortgage payment could exceed the $200 limit.

For example, you’re repaying a mortgage where your monthly payments are £1,000 of interest and £1,000 of principal. You started the mortgage with an exchange rate of $1.50 to the pound, so each month you’re paying off $1,500 of principal (there’s nothing to worry about for the interest).

However, the exchange rate now drops to $1.25 to the pound – you’re now repaying $1,500 of principal but only spending $1,250 a month to do it. To you, this looks like paying £1,000 a month, exactly what you agreed to in the mortgage. But to the IRS, it looks like you’re getting a $250 gain every month due to your clever foreign exchange trading.

This is something you should be tracking and reporting on your US income taxes – I’d be curious how any of you are actually doing this tracking. I haven’t done it for my own mortgage, just because the exchange rate has been going up, not down (I took out my mortgage near the depths of the post-Brexit exchange rate drop), and the principal part of my mortgage is small enough that the exchange rate would have to drop below parity before I’d be above the $200 limit – this could happen, but we’re nowhere close to it.

Intro to US & UK Inheritance Taxes

Cross-border estate and gift tax planning is extremely complex. The intent of this post is really to give you some background information so that you can walk into a meeting with an estate planning professional knowing the basics of the systems, not to give you enough knowledge to do it yourself!

Estate planning is not something I do independently, especially when I’m considering two countries, kids, etc. But, I find it’s a lot better use of time (and thus money) to have a conversation with a professional when you already know the basics of how the systems work, familiar with the vocabulary, maybe know some of the common pain points, etc.

Quick note on terminology: the US calls this tax an estate tax, the UK an inheritance tax. Some people like to sensationalize them as a “death tax”. It’s all the same general idea – when you die, your estate may need to pay some taxes prior to passing your assets to your heirs. I’ll generically refer to them as “inheritance taxes”, unless I’m talking specifically about the US “estate tax.”

Both countries also have a gift tax, which is for gifts you give before your death – basically making sure you don’t decide to just give everything away before you die and get out of paying inheritance taxes.

When do I need to worry about inheritance taxes?

As a US citizen living in the UK, there’s three main thresholds where inheritance taxes become a concern:

  • If your estate is over £325,000, you should be planning for UK inheritance taxes. That probably applies to most readers here. There are ways of raising that threshold, which we’ll talk about later, but that’s the point where you need to start thinking about it.
  • If your estate is over about $11.7 million (single) or $23.4 million (married), you need to plan for US inheritance taxes. You should definitely seek professional help from somebody who understands how both systems work and interact with each other – this post might help with some background, but at that level you absolutely should get professional advice. Also, if your non-US citizen spouse has more than $60,000 in US assets, inheritance tax can apply to them.
    • There is discussion of lowering this exemption to something more like $5 million or lower.
  • If you’re giving gifts above £3,000 per year (in total, not per person), you’ll also want to be aware of the UK gift tax rules. Above $15,000 per year per person, and you’ll also need to consider US gift tax reporting. In both cases, you’re unlikely to need to pay anything, but should be familiar with the requirements.

Quick Note – Receiving Gifts & Inheritances

Don’t stress about receiving inheritances, whether from the US or the UK. Any taxes due will be paid by the estate, not by you.

Mostly the same story with gifts – these are generally not taxable, and if they are taxable, the giver almost always pays the tax. Two exceptions to be aware of:

  • For the UK, if you receive a gift above the typical £3,000 annual exemption from a UK taxpayer and the giver dies within 7 years, you may need to pay a portion of the inheritance tax.
  • For the US, there’s a possible election to have the receiver pay, instead of the giver. Talk to a professional if you consider taking this option.

The US/UK Estate Tax Treaty of 1979

I am not going to go through this in detail, like I did with the income tax treaty – it’s probably enough to just know a few high level concepts. These are just my layman’s interpretation, to give you a head start on understanding it if you need to:

  • The treaty contains rules on whether you will be treated as US or UK domiciled. For the most part, if you live in the UK permanently, you’ll be treated as UK domiciled, even if you’re a US citizen.
  • The country of domicile is the only one that gets to tax the person who dies, with the exception of Real Property (real estate, generally taxed in the country where the property physically is) and fixed Business Property (generally taxed wherever the business is permanently established) – but this doesn’t apply if you’re a citizen of the other country.
  • In our typical case, of a US citizen domiciled in the UK, both the US and UK get to tax your estate. The US must grant a credit for the UK tax paid, to avoid double taxation.
  • In practice, given that the US inheritance tax exemption is much higher than the UK (£325k vs $11.6 million), this often won’t come into play anyway.
  • If you’re above the US exemption and UK domiciled, I strongly recommend talking to a professional!

Background – UK Inheritance Tax

The UK bases inheritance tax on the deceased being domiciled in the UK – since taxes are paid by the estate of the deceased, this doesn’t apply to Americans in the UK who are inheriting from the US or a third country.

If you’ve been in the UK long term, like 15 of the prior 20 years, you’ll be deemed to have a UK domicile. Even if you’ve been in the UK a shorter time, you might have a UK domicile – determining this can get complicated. For our purposes today, let’s assume you’re UK domiciled – if you’re trying to stay US domiciled while living in the UK, your situation is complicated enough you likely want professional advice.

The UK inheritance tax has a relatively low £325,000 threshold – some quick notes on that:

  • If your estate is below £325,000, there’s no inheritance tax to pay
  • You can increase the threshold to £500,000 if you give your home to your children or grandchildren and your total estate is worth less than £2 million
  • There’s no tax if everything above £325,000 is passed to your spouse/civil partner, charity, or a community amateur sports club.
  • You can pass your home to your spouse/civil partner without incurring Inheritance Tax
  • If you don’t use all your threshold, you can pass the unused portion to your spouse/civil partner – their threshold could be up to £1 million in that case (basically, leave everything including a family house to them, then they can leave £650,000 to whoever they like and £350,000 worth of the family home to kids/grandchildren, before needing to pay tax)
  • Everything above the threshold is taxed at a standard rate of 40% – this can be reduced to 36% on some assets if 10% or more of the net value is left to charity (incentive to make charitable gifts in your will)
  • Inheritance generally resets the basis for Capital Gains tax to the the value of the asset at death – this avoids double taxation for both inheritance & capital gains
  • Pensions are generally protected from inheritance tax, although income tax will be owed by the recipient. There’s an exception if the owner dies before age 75, which usually means there will be no tax at all.
  • ISAs are not protected from inheritance tax – they will be part of your estate and taxable

Edit 07 April 2021: Reader Jeffrey Beranek pointed out there’s another potentially useful exemption: gifting from “excess income” or, in HMRC-ese, a “normal expenditure out of income”. Basically, if you give a regular (routine, periodic) gift out of your income (not assets) that is excess to what you need to maintain your standard of living, this can be exempted from inheritance tax, even if you die within 7 years. This requires that you have excess income, but the income could come from lots of places – employment, rental properties, pensions, dividends, interest, etc., anything that isn’t “capital.” More information from HMRC.

Background – US Estate Tax

US estate tax applies above about $11.7 million for an individual estate – I’ll say it again, if your estate is large enough to worry about US estate tax, you should definitely be getting professional advice!

A few quick background notes so you know a bit of what you’re getting in to:

  • Above the $11.7 million exemption, there’s a progressive tax applied, ranging from 18% to 40% (the 40% tax rate starts from about $12.6 million)
  • If your spouse is a US citizen, there’s no inheritance tax due on what you leave him/her. You can also combine lifetime allowances.
  • If your spouse is not a US citizen, there’s no special allowance for inheritance tax – if you’re over the exemption, this could be taxable even if you leave everything to your non-US spouse. However, depending how you read the US/UK Estate Tax Treaty (article 8 paragraph 2), the non-US spouse may benefit from an exemption.
    • I haven’t found anybody mentioning this treaty provision, but it’s hard to search for these kinds of details. Worth talking to a professional if you’re close to the exemption and would leave a large amount to your spouse.
  • There is a larger annual gift allowance for a non-US spouse, $159,000 in 2021 – this could be used with some advance planning, it gets complicated.
  • For non-US citizens with US property, the exemption is only $60,000 – if you have a non-US citizen spouse with US property, this could easily be you. However, the US/UK Estate Tax Treaty gives protection here – you should benefit from the same $11.7 million exemption as a person with a US domicile (article 8 paragraph 5)
  • Cost basis for capital gains is generally reset to the value upon inheritance.

Background – UK Gift Tax

The vast majority of gifts are not taxable in the UK. This includes any gifts, of any amount, given more than 7 years before your death, as well as gifts within 7 years of death that fall under certain exemptions.

Two simple rules that would avoid any taxes, then I’ll go on about the details:

  • Don’t give away more than £3,000 in a year
  • If you do give away more than £3,000 in a year, don’t die for another 7 years

There are a few higher caveats to the exemptions (weddings, living costs, gifts to charities & political parties, etc.), but typically any gifts totaling less than £3,000 per year are not taxable, regardless of when they’re given. You can carry this forward for a year, as well. In addition, you can give as many gifts up to £250 per person as you like without counting against the exemption, as long as you haven’t used an exemption with that person. For example, if you give £3,000 to person A and £200 to people B, C, and D, that’s ok, but if you give £3,000 to person A and then another £200 to person A, that extra £200 would be liable for tax if you die within 7 years.

If you give gifts over the exemption (typically £3,000) and then die within 7 years of the gift, the recipient may owe inheritance tax, depending on the value of your estate and amount of gifts you’ve given within those 7 years. This tax rate is tapered, ranging from 8% in year 6 before your death to 40% if given less than 3 years before death.

Generally, gifting resets the basis of any assets – if you give a recipient stock that has gained since purchase, the cost is reset to the value at the time of the gift.

Background – US Gift Tax

Just like the UK, the vast majority of gifts are not taxable in the US. The concept works a little differently though – there are still annual exemptions, but instead of a 7 year time horizon, there’s a lifetime exemption:

  • Gifts under $15,000 per giver, per recipient, per year are neither taxable nor reportable.
  • Gifts over the $15,000 limit start to count against your $11.7 million lifetime exemption from estate tax. You don’t have to pay tax on them as long as your lifetime gifts don’t exceed your lifetime exemption, but you do need to report them on your US taxes (Form 709).
    • If you’re planning on giving more than $11.7 million in gifts over your lifetime, definitely talk to a professional!
  • Transfers to a US citizen spouse don’t count as gifts – give as much as you want
  • Transfer from a US citizen to a non-US citizen spouse have a higher annual limit, $159,000 in 2021. Above this limit, it counts against your lifetime exemption and requires reporting on your US taxes.

Gifting typically does not reset the basis of assets – when the recipient sells the asset, they will need to report and possibly pay tax on the value based on the original price of the asset.

Further Reading

This is a very complex subject – I’ve tried to give a high-level overview above, but if you notice any areas where I’ve missed important nuances or just plain wrong, I’d be eager to hear from you (and will happily edit the post to be clear and correct). Thanks!

Gov.uk: UK Inheritance and Gift Tax

IRS: US Estate & Gift Tax

Saving & Investing for Kids

We know that 529s aren’t typically a great option for Americans in the UK, but you want to save some money for your kids – maybe for university, a first home deposit, or other long term goals, right? And maybe their grandparents want to start some kind of savings for them, too?

I’ve put together the options that I think make the most sense to explore further. Which makes the most sense will depend on the specific situation and goals, but hopefully this gets your started.

Saving or Investing?

First thing you need to decide if you’re saving or investing for you kids. Saving means that you don’t want to risk the capital, but you’ll be accepting lower interest rates – think savings accounts. Investing puts the capital at risk, in exchange for hopefully higher returns – think stocks.

Typically, you would consider investing for longer time horizons (maybe over 5 years), and saving for shorter ones, but your individual risk tolerance needs to be considered here. You can certainly do a mix, as well.

Savings Options

Interest rates tend to be pretty low on these, but a normal savings account is fine. There are specific accounts for kids, some with relatively good interest rates. Premium bonds are another good option that happen to be UK tax free.

You could look at a cash ISA (either your own, or a junior one in the child’s name), but between the low interest rates and UK tax allowances on savings, I’d rather use my ISA allowance for investing.

US savings bonds are another one that could be worth considering for long term savings – series EE bonds are guaranteed to double in value after 20 years, about a 3.5% interest rate, which is pretty good these days – if you take the money out before that, it’s a much lower rate, 0.1% as I write this. Obviously you’re locking up money for a long time at a moderate interest rate, and they’re taxable in both the US and UK, but could be a part of the solution. Sadly, you also have to deal with the archaic TreasuryDirect website…

UK savings bonds (gilts) might be worth looking at too, but don’t have the same guarantee, and interest rates are pretty low these days (writing in April 2021).

Investing Options

A few different options here – honestly, all have pros and cons, there’s no clear winner, so what is best for you will depend on exactly what you want to do:

  • Junior ISA in your kid’s name: UK tax advantaged, need to have US-friendly investments (probably individual stocks) and are US taxable. Can’t get the money out before the child turns 18 (barring death/terminal illness), and once they turn 18, the money is theirs to do with as they please. Separate £9k/year allowance from your adult ISA allowance.
  • Adult S&S ISA in your name: UK tax advantaged, need to have US-friendly investments, and are US taxable. Big advantages over the junior ISA are that you can get to the money any time, penalty-free, and you control the money – it’ll be a gift to your kid as and when you give it to them. If they’re blowing it all on partying, you can turn off the tap. Big con is that you’re using your £20k/year allowance for this, instead of your own retirement saving (only really an issue if you’re maxing out your ISA anyway)
  • Taxable brokerage: US vs UK has pros and cons (see the link). No tax advantages, but no limits on how much you can invest or when you can get the money. Be careful that what you invest in is both US and UK tax friendly (HMRC reporting, PFICs, etc.)
  • UK SIPP: As long as you are convinced a SIPP is a pension under the tax treaty, this can work for really long term investment – age 55 or 57, and that may go up further in the decades your child owns it. You could also use your own SIPP, if you’ll be at the right age when you want to give the money to your child.
  • IRA‘s require earned income, so typically don’t work for this

Gift, Inheritance, & Estate Taxes

This all gets pretty complicated (I want to put together an intro in a future post), but the good news is that for most of the kinds of gifts that most people would be giving to kids, it’s not a big deal.

For gifts from US taxpayers, there’s an annual exclusion of $15,000 per recipient, per giver. If you do go over this, it will start to count against the $11 milllion+ lifetime exemption. Only once you exceed that do you need to worry about tax – if anybody involved has an estate approaching $11 million, seek professional advice!

For gifts from UK taxpayers, the system is a little different. There’s an annual exemption of £3,000 per recipient, per giver, and anything above this limit counts as part of the givers estate (there are a few other exemptions, the UK government has a good quick intro). But as long as the giver doesn’t die in the 7 years after the gift, there’s no tax due. If they do die within 7 years, it’s a tapered calculation, and depending on the overall size of their estate, there may be taxes due. Keep gifts under £3k a year or stay alive for 7 more years, and there’s nothing to worry about!

In both countries, gift and inheritance taxes are paid by the givers, not the recipients (with an exception in the UK, if you receive a gift and the giver dies within 7 years of giving it). Typically, there’s nothing required at all by the recipients, and no taxes payable.

What am I doing?

Not that you should necessarily copy me, but here’s my current thinking:

  • All my current savings for my daughters is in a US taxable brokerage account – this is the proceeds from closing the 529 it used to be in, which happened to be a the same provider. Not an entirely deliberate decision, but a perfectly reasonable place for now.
  • Depending how my S&S ISA experiment goes, I’ll consider ISAs for the girls as well, whether in mine or in a junior ISA. They’re too young for now to have any guess as to how mature they will be at 18, so I’m hesitant to do a junior ISA.
  • In the future, I’ll also open child savings accounts for them, and probably use them as a component of their allowance/pocket money. I haven’t done much research yet – the older one is just realizing the concept of money, so this is a ways off (she knows not to buy Paw Patrol episodes on Amazon now, at least!)

UK Junior ISA (Account Options)

This is a really quick one for completeness. A Junior ISA won’t be part of your own retirement/FIRE planning, but maybe something you consider for your kids. They come in both cash and Stocks & Shares (S&S) flavors – the rules are almost the same as adult ISAs. I’ve only called out the handful of differences below, for more details see the cash ISA and S&S ISA pages.

Synopsis

Child versions of cash and S&S ISAs – potentially a good way of saving for your kids’ futures.

Priority

If you’re trying to save for your children, this can make sense, particularly the S&S version, as long as you’re comfortable investing in individual stocks on their behalf. You get partial tax advantages (UK only) and the chance of a higher return than a savings account.

I don’t see much value in the cash version, because of the generous personal and savings allowances. You’re probably better off just opening a savings account, where you’ll get equal or better interest and you can get they money when you need it.

Eligibility

UK residents age 0 to 17. The child is the account holder – once they turn 18, it’s their money and they can do whatever they want with it. You might want them to pay for university housing, but they might want to blow it all clubbing in Ibiza and you can’t stop them.

Note that there is overlap here with the adult cash ISA – kids aged 16 and 17 can have both a junior ISA and an adult cash ISA.

Withdrawal Options

Until the child turns 18, you can’t touch the money. The only exceptions are death or terminal illness of the child, which we’re all certainly hoping won’t happen.

Once the child turns 18, the account turns into an adult ISA and the money can be withdrawn as needed.

Contributions LImit

£9,000 per year, per child – this can be split between cash and S&S or all in one.

Tax & Fees

Basically all the same as an adult cash or S&S ISA.

Further Reading

MoneySavingExpert on Junior ISAs

Alternative Minimum Tax & Americans Overseas

I just finished my 2020 US taxes, and while reviewing them noticed that I had a chunk of Alternative Minimum Tax, over $600! Fortunately, it was offset by my child tax credits (thanks girls!), so I didn’t actually owe any tax, but it got me to thinking. My kids are growing up fast, and there will come a time when I won’t have child tax credits – will I actually wind up paying AMT to the US government, despite my UK foreign tax credits?

This post explores what the AMT is and how it applies to Americans living outside the US – the example uses UK numbers for the amount of foreign tax paid, but the concept applies anywhere that has generally higher tax rates than the US.

Caveat up front: the Alternative Minimum Tax and the Foreign Tax Credit are both very complicated bits of the US tax system – mash them together, and my head starts to hurt quickly. I am not a tax professional, and I’m not going to try to explain AMT or FTC in any detail; this is not a guide on how to file your taxes. What I want to explore is why AMT is showing up on my 1040 and how it might apply to you, at a conceptual level.

Personally, I think FTC + AMT is right about the limit of what a non-specialist person is reasonably capable of doing for their taxes – typical tax software doesn’t help much in guiding you, and if you aren’t eager to read a lot of IRS instructions, it might be time to get help.

As I wrote this post, I realized that I was making a sub-optimal decision around the “simplified limitation election” – this fairly arcane term could end up costing you money if you aren’t careful. I’ve learned my lesson, and it’s not the end of the world to fix (I think), but I wanted to share my missteps with you. This stuff is complicated, and the more we can share our learnings, the better prepared we all are.

Bottom line up front: If you have a moderately high income (about $113k+ for MFJ) and are having to do AMT calculations, you probably do not want to elect to use the “simplified limitation election”, or at the least you want to calculate it out both ways the first time you do. Otherwise, you could wind up actually paying AMT.

I’m going to try to keep this discussion reasonably high level, but a certain amount of discussion of forms and schedules and the like is unavoidable in trying to make sense of this subject – it really is the details that matter. Sorry!

It might help to open the relevant forms and follow along:

Quick Background on the AMT & FTC

The AMT is designed to “catch” US taxpayers who have lots of credits, deductions, exemptions, etc. and make them pay their “fair share.” It was originally designed for very high income people, but has drifted down to more average taxpayers over the years.

If you claim the FTC (like most people should, in countries with generally higher tax rates than the US), the form 1040 instructions require you to fill in Form 6251, “Alternative Minimum Tax – Individuals”. That doesn’t necessarily mean you owe AMT, but you need to calculate it to see.

The AMT form 6251 is basically an abbreviated version of your whole tax return, adding back in a bunch of deductions that are included in your “regular” tax calculations but excluded from AMT calculations. This includes recalculating your foreign tax credits, using the AMT numbers. These calculations result in an “alternative minimum taxable income” (AMTI) which is subject to AMT tax rates. If this AMTI is greater than the AMT exemption (for 2020, $113,400 for married filing jointly, $72,900 for single), then AMT tax gets imposed at a 26% rate (28% for AMTI over $98,950 above the exemption).

Following that? Me neither – let’s work through an example, that helps it make a lot more sense.

Meet Prosperous Polly (again)

You remember Polly from my post on US vs US taxes, right?

  • Polly earns £100,000 from her wages, and contributes 5% to her UK pension which is matched at 5% from her employer
  • She’s married to Pat – we’ll assume that Pat doesn’t have any income for this example (we previously assumed some self-employment, but that just muddies the conceptual waters for AMT & FTC)
  • Polly and Pat don’t have any other income – no interest, dividends, capital gains, etc. I know most people will have some of this, but it doesn’t make a material difference here and simplifies the story, so go with it
  • Polly and Pat are US citizens living in the UK
  • Assume a pound buys $1.40

Let’s walk through calculating Polly & Pat’s taxes – not line by line, but at least in conceptual chunks. I’m using the 2020 versions of all the forms; line numbers might change a bit from year to year.

Form 1040 – Income & “Regular” Tax
  • Line 1 – Wages – $147,000 (£100,000 + £5,000 converted to dollars, and assuming that Polly is not taking the treaty position to exclude her or her employer’s pension contributions)
  • Line 12 – Standard Deduction – $24,800 (Polly & Pat don’t have any deductions worth itemizing, like most of us these days)
  • Line 15 – Taxable Income – $122,200 (just $147,000 wages minus the $24,800 standard deduction)
  • Line 16 – “Regular” Tax – $18,464 (there’s a simple formula to get here, taking account for the progressive tax system – Polly & Pat are in the 22% bracket, so pay 22% on their last dollar)

So far, so simple – a basic, boring 1040 tax return for just wage income. But then we get to line 17: “Amount from Schedule 2, line 3”.

Schedule 2, line 3 is the sum of two other taxes: alternative minimum tax and “excess advance premium tax credit repayment.” Polly & Pat don’t have any of the latter, it’s to do with health insurance purchased on the US insurance marketplace, but they do need to calculate the AMT.

Form 6251 Part 1 – Alternative Minimum Taxable Income
  • Line 1 – Taxable Income – $122,200, just copied from form 1040 line 15
  • Line 2a – Standard Deduction – $24,800
  • Lines 2b through 2t and 3 are all kinds of other deductions and adjustments that get added back in. Polly & Pat don’t have any investment interest expense, mining costs, intangible drilling costs, or any of the other stuff on this list.
  • Line 4 – Alternative minimum taxable income (AMTI) – $147,000 (just Polly’s wages & employer pension match, right back where we started)

AMTI is the income that the AMT will be based on. In Polly’s simple case, it’s just her income, without subtracting off the standard deduction.

Form 6251 Part 2 – Alternative Minimum Tax
  • Line 5 – Exemption – $113,400 (this is the exemption for married filing jointly, unless AMTI is over $1,036,800 – it takes the place of the standard deduction for AMT purposes, only income over this exemption amount is subject to AMT)
  • Line 6 – Alternative minimum taxable income over the exemption – $33,600 (just AMTI minus the exemption)
  • Line 7 – Alternative minimum tax before the AMT FTC – $8,736 (in Polly’s simple case, this is simply 26% of the income over the exemption. With capital gains, dividends, or the Foreign Earned Income Exclusion, this gets more complicated. The rate goes up to 28% above $197,900 of taxable income over the exemption)
  • Line 8 – Alternative minimum foreign tax credit

This is just a single line, but now it pushes us into a whole new form, Form 1116, “Foreign Tax Credit.” We’ll wind up doing this form twice, once for “regular” taxes and again for the AMT; let’s start with the regular version and then we can see how it’s different for AMT, because that’s where the real impact can be for Americans abroad.

Form 1116 Part 1 – Taxable Income from Outside the US

Form 1116 is set up so that you must do one form for each “category” of income, including up to three countries per form. In Polly’s case, she only has one category (General) and one country (the UK).

Many Americans overseas will also have Passive category income (interest, dividends, capital gains, etc.), the others are less typical. For the AMT, you have to do each category twice, so a typical tax return for an American overseas could have four copies of the form 1116.

One twist is the “simplified limitation election” – that allows you to use the Part 1 numbers for your AMT version without calculating them again. If you’re using tax software like me, there wasn’t much background on this – I just kind of figured “simple is good” and went for it. Bad move, it turns out, but we’ll see why in a bit. The fun of this is whether you pick simple or non-simple, you’re stuck with that forever, unless you ask the IRS’s consent to change.

  • Line 1a – Gross income from the UK – $147,000 (Polly’s is simple – all her General category income is from the UK, and she only has General category income)
  • Line 3a – Standard Deduction – $24,800
  • Line 6 – Total deductions & losses $24,800 (there are some calculations to get here, basically apportioning your deductions and losses to the category and to the country. Polly’s case makes this simple – she only has the standard deduction, only has one country, and only has General category income).
  • Line 7 – Taxable income from sources outside the US for this category – $122,200 (just Polly’s gross income minus the standard deduction)
Form 1116 – Part II – Foreign Taxes Paid or Accrued
  • Boxes (j) and (k) – Paid or Accrued? Polly has to option to select that she has either paid or accrued her UK taxes. She’s had UK tax taken out of her paychecks throughout the year, so she’s paid HMRC with every paycheck. She’s kept all her paystubs, so can do some quick math to add it all up. You can’t rely on the UK’s end of year tax documentation, like a P60, because the US and UK use different tax years (the US uses 01 Jan to 31 Dec, the UK uses 06 Apr to 05 Apr).
    • Polly selects “Paid”
    • This is another long-lasting selection – if you pick “Accrued”, you have to stay with it forever. If you pick “Paid”, you can later change to “Accrued”. I won’t go into the pros and cons today – at least for the UK, it typically doesn’t make much difference in the end, and Paid is easier to keep track of.
  • Line 8 – Foreign taxes paid/accrued for this category – $38,360 (Polly’s £27,400 UK taxes converted to dollars)
Form 1116 – Part III – Figuring the “Regular” Credit

Here’s where the Regular and AMT calculations diverge, under the simplified limitation. It’s the same form, but using slightly different numbers. Let’s do the regular FTC first.

  • Line 9 – Foreign taxes paid/accrued for this category – $38,360 (copy from line 8)
  • Line 10 – Carryback or Carryover – $0 (we’ll assume Polly doesn’t have any carryover from previous years – it doesn’t make a difference here anyway, she’ll have more than enough foreign taxes paid that she can’t use them all)
  • Line 14 – Foreign taxes available for credit – $38,360 (total of lines 9, 10, 12, and 13; we skipped lines 12 and 13, they don’t apply to Polly)
  • Line 15 – Taxable income from sources outside the US for this category – $122,200 (copy from line 7 – copy this down to line 17, because line 16 doesn’t apply to Polly)
  • Line 18 – Taxable income – $122,200 (copy from form 1040 line 15, this is just Polly’s income minus the standard deduction)
  • Line 19 – Divide line 17 by line 18 – 1.0000 (this is calculating what percentage of your taxable income came from this foreign category – for Polly, it’s 100%. If you have any income in another category or from the US, this number will be less than 1).
  • Line 20 – Regular Tax – $18,464 (copied from form 1040 line 16, this is Polly’s “normal” tax without considering the AMT).
  • Line 21 – Maximum FTC for this category – $18,464 (line 19 times line 20; conceptually, you can only take a credit up to the percentage of the tax you owe that is coming from this foreign category. For example, if 80% of your income is foreign general category income and 20% is US general category income, you can only take a FTC to offset 80% of your tax, the IRS wants to get paid for the 20% that came from the US. We’ll skip line 22 and also use this for line 23).
  • Line 24 – Foreign tax credit for this category – $18,464 (the smaller of line 23, the maximum FTC for this category, and line 14, the actual foreign taxes paid for this category. You can’t take a credit for more taxes than you paid! In Polly’s case, and for most UK residents, you’ll have paid more tax to HMRC than you’re allowed to claim, because the UK income tax rate is higher than US federal income tax rates).

At the end of all that, what we’ve calculated is that Polly can take a “regular” foreign tax credit for $18,464 – exactly the amount of “regular” tax that she would have owed the IRS without the credit, reducing her tax to zero.

There is a Part IV that totals together different categories of FTC – this won’t make any difference to Polly, since she has only one category of FTC. If you have more than one category, the note here is that you can still only take a credit up to the amount of your “regular” tax – if your general and passive FTCs add up to more than your regular tax, you’re capped at taking the regular tax to zero. The FTC isn’t refundable, the IRS will not pay you back for what you’ve paid to HMRC 😦

Form 1116 – Part III – Figuring the AMT Credit using the Simplified Limitation Election
  • Line 14 – Foreign taxes available for credit – $38,360 (same as the regular FTC)
  • Line 17 – Net foreign source taxable income – $122,200 (for the simplified limitation, you just copy this from line 17 of the regular form 1116)
  • Line 18 – Taxable income – $147,000 (this is the big difference from the regular FTC, where it was $122,200. There’s a “worksheet for line 18” to get to this number, but for Polly’s simple situation without qualified dividends or capital gains, this number is her total income, before taking off the standard deduction. For the regular FTC, it’s after taking off the standard deduction)
  • Line 19 – Divide line 17 by line 18 – 0.8313 (the difference carries on – because line 17 is net foreign source taxable income after taking off the standard deduction, but line 18 is taxable income before taking off the standard deduction, line 17 will always be less than line 18, limiting the credit)
  • Line 20 – Alternative Minimum Tax before the AMT FTC – $8,736 (copy from way back, form 6251 line 7. This is different from the regular FTC, because we’re going to figure out how much of the AMT we can apply the credit against, not how much regular tax we can offset).
  • Line 21 – Maximum AMT FTC for this category – $7,262 (line 19 times line 20. Because line 19 is always less than 1.0, this amount will always be less than the AMT before the FTC – Polly will owe AMT. Copy this down to line 23, because line 22 doesn’t apply to Polly)
  • Line 24 – AMT Foreign tax credit for this category – $7,262 (the lesser of the maximum AMT FTC or the actual foreign taxes paid. For the UK, this will almost always be the maximum AMT FTC).

Now we finally have our AMT FTC, we can go back to the AMT calculations and apply it. If Polly had more than one category of FTC to calculate, we’d do that in Part IV, but since she only has general category foreign taxes, it’s the same value as line 24.

Form 6251 – Part II – Alternative Minimum Tax (continued)
  • Line 8 – Alternative minimum tax foreign tax credit – $7,262 (from line 24 on form 1116)
  • Line 9 – Tentative minimum tax – $1,474 (line 7, the AMT before the FTC, minus line 8)
  • Line 10 – Regular Tax minus regular foreign tax credit – $0 – (this makes sense – under the regular tax system, Polly’s foreign tax credit completely offsets her regular taxes)
  • Line 11 – Alternative minimum tax – $1,474 (line 9 minus line 10)

This $1,474 is what Polly & Pat will actually owe in Alternative Minimum Tax. This shows up back on form 1040 on line 17 as an additional amount of tax, above their “normal” tax. There’s only a handful of lines after this before you get to what you actually owe: child tax credit is probably the most common. If Polly & Pat have kids, they can wipe out the AMT amount and they wind up owing nothing (or even get paid by the IRS). But without kids or a few other credits, Polly & Pat could actually pay the IRS, despite all their foreign tax credits!

Obviously, Polly & Pat don’t want to do this, and neither do I. So, let’s go back a bit and revisit that “simplified limitation election” – we’ll recalculate Polly & Pat’s AMT FTC using the non-simplified method.

Form 1116 – Part I & II – Taxable Income from Outside the US & Foreign Taxes (AMT non-simplified limitation)

Basically, the non-simplified method requires you to redo the whole foreign tax credit form 1116, but only using income and deductions that are both allowed for the AMT and attributable to sources outside the US. This can get complicated, but it’s not too bad for Polly & Pat:

  • Line 1a – Gross Income from the UK – $147,000 (still the same, this hasn’t changed)
  • Line 3a – Standard Deduction – $0 (this is the key change! instead of reducing Pat’s foreign taxable income by the standard deduction, it stays the same, because the standard deduction isn’t allowed by the AMT)
  • Line 7 – Taxable income from sources outside the US for this category – $147,000 (just Pat’s taxable income, no deductions)
  • Line 8 – Total foreign taxes paid/accrued for this category – $38,360 (no change from the regular calculation
Form 1116 – Part III – Figuring the AMT FTC (non-simplified limitation)

Let’s do this calculation for the third time – now we’re using the data from the AMT Part I & II, following the instructions for form 6251 that tell us how to do the calculations for AMT.

  • Line 9 -Total foreign taxes paid/accrued for this category – $38,360 (copy from line 8)
  • Line 10 – Carryback or Carryover – $0 (still assuming zero, still doesn’t make a difference)
  • Line 14 – Foreign taxes available for credit – $38,360 (total of lines 9, 10, 12, and 13; we skipped lines 12 and 13 again)
  • Line 15 – Taxable income from sources outside the US for this category – $147,000 (here’s where the non-simplified method makes a difference – this value was $122,200 for the simplified method. Just copy from line 7, then we copy this down to line 17, because line 16 doesn’t apply to Polly)
  • Line 18 – Taxable income – $147,000 (this is the same number as using the simplified method, but now lines 17 and 18 are the same number)
  • Line 19 – Divide line 17 by line 18 – 1.000 (because of the non-simplified method, we’re now able to take a credit against 100% of the AMT, not just the 83% we could with the simplified method)
  • Line 20 – Alternative Minimum Tax before the AMT FTC – $8,736 (copy from form 6251 line 7, same as the simplified method. ).
  • Line 21 – Maximum AMT FTC for this category – $8,736 (line 19 times line 20 – copy this down to line 23, because line 22 doesn’t apply to Polly)
  • Line 24 – AMT Foreign tax credit for this category – $8,736 (the lesser of the maximum AMT FTC or the actual foreign taxes paid. For the UK, this will almost always be the maximum AMT FTC).

Now we’ve got an AMT FTC that is equal to the preliminary AMT amount – you can see where this is going now.

Form 6251 – Part II – Alternative Minimum Tax (non-simplified AMT FTC)
  • Line 8 – Alternative minimum tax foreign tax credit – $8,736 (from line 24 on form 1116)
  • Line 9 – Tentative minimum tax – $0 (line 7, the AMT before the FTC, minus line 8)
  • Line 10 – Regular Tax minus regular foreign tax credit – $0 – (this makes sense – under the regular tax system, Polly’s foreign tax credit completely offsets her regular taxes)
  • Line 11 – Alternative minimum tax – $0 (line 9 minus line 10)

Now we carry this back to form 1040 line 17, via schedule 2 lines 1 and 3. But since the value is zero, it’s easy to see that there’s no AMT payable. And since the “regular” FTC is equal to the “regular” tax, the tax owed is reduced to zero. If there are any refundable tax credits, like part of the child tax credit, Polly & Pat get paid to file their taxes. Even without the refundable part, they owe nothing! Much better result than the simplified limitation.

So What?

That was a really, really long winded way of saying that you should definitely do some calculations before you decide whether or not to use the “simplified limitation election” – if your situation is similar to Polly & Pat, it could cost you!

For me, understanding this much better now, I need to switch to the non-simplified method moving forward. I’m lucky to have only filed two years with the simplified method, and in both of those I had enough child tax credit that the AMT didn’t make any difference at all (the non-refundable part of the child tax credit was more than my AMT, so I still got the full amount of the refundable portion).

So I’ll write the IRS a letter, requesting consent to switch to the non-simplified method for 2021 onwards and explaining the situation (in a LOT less detail). Given how backed up they are these days, I may not even hear back before I file my 2021 taxes, but I’ll plan on using the non-simplified method – even if it takes them a year+ to respond, it won’t change the bottom line on my taxes until the kids grow out of the child tax credit.

If I hear back anything other than “that’s fine, go ahead”, I’ll provide an update so we can all learn together.

Further Reading:

IRS Training on calculating AMT FTC – this was helpful in understanding the calculations more conceptually than just using the form instructions

US and UK Taxes – Which are higher?

The UK, right? Lots of people make the assumption that the UK is a high tax country, with a generous social safety net funded from those high taxes (some people I know would disagree with how generous – more than the US in a lot of cases, at least, but no Norway!).

I wanted to see if that’s actually a good assumption, because I’ve looked at my own situation and while my UK taxes are a bit higher than my US federal taxes, when you look at other taxes plus health care, it seemed pretty close.

Spoiler: US federal taxes are lower than UK income taxes, but when you put in typical state taxes and health insurance, it gets pretty close. Read on for more!

Background – Tax Brackets

The US and the UK both work on a marginal and progressive tax system: the percentage tax you pay on your highest dollar/pound of income is not the same as on your lowest, and the rate is higher on higher incomes. I know that’s income tax 101, but it’s really important – the first pound that you make over the 40% threshold gets taxed at 40%, but all the others are at 0% or 20%.

I started to type out the US and UK tax brackets here, and then I remembered you guys can read:

  • UK Tax Brackets (there’s a hidden bracket between £100,000 and £125,000 where the personal allowance is reduced by £1 for every £2 extra earned – this results in a small but painful 60% tax bracket).
  • US Federal Tax Brackets

Both countries also have some other taxes that get added on to the income taxes – National Insurance in the UK and FICA (Social Security & Medicare) in the US.

Both systems offer a variety of ways of reducing your taxable income – deductions, credits, pension contributions, etc. For most of us planning for retirement, the biggest one will be those pension contributions, although others can be significant in your particular situation (child tax credit is a big one in the US, and part of it is refundable – can be free money for Americans in the UK!).

Instead of going through a bunch of theoretical math, I thought it might be easier to illustrate in two examples. I picked two examples that aren’t in the extremes of high or low income: Average Andy, who is pretty average, and Prosperous Polly & Pat, who are at the high end of the income scale but before you start getting to really crazy money – probably roughly typical of somebody planning for FIRE. These are just illustrative, and they avoid the complications that creep in at very high and very low levels of income.

Example 1 – Average Andy

Meet Andy – he’s pretty average. He’s 30 years old and makes £40,000 or $56,000 a year, pretty close to the median salary for a full-time employee in the US or UK. He’s single, doesn’t have any income outside his job, and contributes 5% to an employer pension (without salary sacrifice) or 401(k), reducing his taxable income to £38,000 or $53,200. We’ll ignore any employer matches, since those vary tremendously by job in both countries and don’t really impact the tax calculations.

Andy’s UK Taxes

Andy’s £40,000 breaks down like this:

  • Income Tax: £5,098
  • National Insurance: £3,660
  • Pension: £2,000 from Andy, £500 from HMRC as a tax benefit
  • Take Home Pay: £29,242

In total, Andy pays the government £8,758 and gets to keep £31,742 of his total £40,500 effective pay (since HMRC tops up his pension with £500). That’s a 21.6% overall tax rate. That’s also pretty much the end of the story – there’s no state tax and he gets the NHS thrown in for “free”. There are VAT and council tax, but those are based on consumption more than income, so we’ll ignore them.

Andy’s US Taxes

Andy’s $56,000 breaks down like this:

  • Federal Income Tax: $4,766
  • FICA (Medicare & Social Security): $4,284
  • 401(k): $2,800 from Andy – nothing directly from the IRS, but this income is deducted from his taxable income
  • Preliminary Take Home Pay: $46,950

Right now, we’re at Andy having an overall 16% tax rate. But wait! Andy might still need to pay state tax. This varies all over the place, from 0% to over 10%. Let’s split the difference and call it 5% – that just happens to be the actual income tax rate in Massachusetts, after the standard deduction (actually on the lower end if you rank them all out – not so bad for Taxachusetts!)

  • State Income Tax: $2,440

Now we’re at $44,510 (£31,792) – still doing better than UK Andy. But US Andy needs to pay for health insurance! This could be all over the place, depending on what (if anything) his employer offers. I found all kinds of numbers researching this post, but went with the Kaiser Family Foundation’s average employee contribution of $1,489 in 2019 for the employee part of individual health insurance.

  • Health Insurance: $1,489

That doesn’t account for any deductibles or other health spending not covered by his insurance – let’s assume Andy is perfectly healthy and fortunately doesn’t have to use it. That’s good, because average annual deductibles are typically in the thousands!

That leaves US Andy a $43,021 ($30,729) take home, and overall he gets to keep $45,821 (£32,729) of his $56,000 salary, for an overall 18.2% tax + health insurance rate.

Who wins, US or UK Andy?

To me, this is a tossup. US Andy gets to keep an extra £1,063 of his hard earned cash, but if he has any health issues, that’s coming right out of his pocket, at least until he hits his deductible.

However, he’s also contributing to the rather more generous US Social Security scheme, compared to the UK State Pension (I’ll do a post on this in the future, but simple version is that the max Social Security benefit at age 66 is about $3,148 a month, State Pension at age 68 is about £759.20 a month – both of those can increase by delaying, but State Pension isn’t going to catch up).

Either way, this isn’t a clear case of “UK taxes are way higher than the US” – they’re pretty close, especially once you put state taxes and health insurance into the equation.

Example 2 – Prosperous Polly & Pat

Polly is doing well – in the top few percent of the US or UK, earning £100,000 a year ($140,000), all from her job. Her spouse, Pat, mostly stays at home with their two kids, but has a small self-employed business earning £5,000 ($7,000). Polly contributes 5% a year to her pension/401(k).

Polly & Pat’s UK Taxes

Polly & Pat file their UK taxes separately, since there’s no such thing as a joint return:

CategoryPollyPatTotal
Income Tax£25,496£0£25,496
National Insurance£5,860£0£5,860
Pension£5,000 from Polly,
£3,333 from HMRC
£0£8,333
Take Home Pay£63,644£5,000£68,644

Pat & Polly pay the government £31,356 and gets to keep £76,977 of their total £108,333 effective pay (since HMRC tops up Polly’s pension with £3,333). That’s a 28.9% overall tax rate – a chunk more than Andy’s 21.6%. As with Andy, that’s about it – no state taxes, NHS included.

Polly & Pat’s US Taxes

Polly & Pat’s US taxes get lumped together, since they’re filing jointly:

  • Federal Income Tax: $12,053 (including 2 child tax credits at $2,000 each – this would change for 2021 with the recent increases to the child tax credit to $3,000 or $3,600 each, but for now it looks like that’s a COVID one-off for 2021)
  • Polly’s FICA: $10,596
  • Pat’s Self Employment Tax: $706 (half of this is deductible from the federal income tax, already included in the number above)
  • 401(k): $7,000 from Polly
  • Preliminary Take Home Pay: $116,645

So far, US Polly & Pat get to keep $123,645 of their $147,000 income, only a 15.9% tax rate compared to UK Polly & Pat at 28.9% – a big difference! But, let’s add in state tax – again assuming 5% Massachusetts flat tax:

  • State Income Tax: $6,460

And, let’s not forget health insurance – because it’s for a family, the rates go up:

  • Health Insurance: $5,726

And again, we’re assuming no deductibles actually get used – no emergency room visits from accidents with the kids, no health scares, etc.

Take off the state income tax and health insurance, and now we’ve got a take home of $104,459 – with the 401(k), US Polly and Pat get to keep $111,459, for an overall tax + health insurance rate of 24.2%.

Who wins, US or UK Polly & Pat?

This one is a bit further apart – in the UK, Polly & Pat are paying an effective tax rate of 28.9%, while in the US it’s only 24.2% – in the US, they get to keep more than £2,600 ($3,640) more of their hard earned money, about an extra £220 in their pocket every month.

Throw in a few medical expenses and you get pretty close, though – while the US probably comes out slightly cheaper here, I’d say that again it’s not a runaway winner.

Also, Polly’s pension/401(k) contributions are pretty low – she might be able to afford more. She probably won’t get out of the 40% band in the UK or the 22% bracket in the US, but every extra contribution makes a solid difference at those rates.

Implications for Americans in the UK

One thing these examples do reinforce is the common assumption that UK income taxes on any given bit of income are higher than US. That’s a useful simplifying assumption when thinking about your taxes, because it means, for most kinds of income, you’ll get a Foreign Tax Credit that is larger than what you owe the US, so you don’t actually owe anything.

That gets a little dicer for capital gains, dividends, and interest, since the UK has somewhat generous exemptions for these (up to £12,300, £2,000, and £1,000, respectively), where you won’t get FTCs for income that the US taxes.

On the whole, though, if you’re paying attention to how you earn and invest and making sure it’s friendly to both systems, you aren’t likely to owe Uncle Sam much, if anything. Various exceptions apply for specific situations, but it’s typically not far off!

Sources:

US Tax Calculator

UK Tax Calculator

UK & US Savings Accounts (Account Options)

I’m lumping these together because there’s no practical difference, aside from the currency. These aren’t really investment accounts, but just to cover the rest of the universe of accounts that Americans in the UK might have.

Synopsis

Short term savings or emergency fund only – low interest rates, often below inflation. There might be some deals that beat inflation, although they’re often only for smaller amounts.

Priority

Once you’ve built an emergency fund and put it somewhere safe, there’s no reason to keep building up value in a savings account. The exception would be short term goals – a house purchase or renovations, new car, special vacation, etc.

Eligibility

Pretty much everybody – special kids savings accounts for people under 16 or 18.

Risk & Return

Very safe, but with typically low interest rates.

UK accounts are insured by FSCS up to £85,000 per financial institution (with a caveat that several different “brands” of banks may be the same actual financial institution. For example, Halifax and RBS are part of the same financial institution, so two accounts, one with each, would only be covered to a total of £85k). There are also provisions for temporarily higher balances, like when you’re moving money around between a house sale and another purchase. More details on MoneySavingExpert

US accounts are insured by FDIC up to $250,000 per depositor per bank.

Withdrawal Options

Withdraw any time with no penalties, unless it’s a “fix” or “limited access” account in the UK, or the similar “Certificate of Deposit” in the US.

Contribution Limit

Typically none, although some accounts may have specific limits – “regular savers” are popular in the UK, where you can only put in a maximum amount per month, but they typically pay higher interest.

Fees

Typically none, unless you need to access a limited account early.

Tax Treatment – Contributions

Post-tax money for both the US and UK, no benefits.

Tax Treatment – Withdrawals

Interest is taxable as income in both the US and UK. The UK has a Personal Savings Allowance that means that most UK taxpayers don’t pay tax on interest. Only interest above the following amounts is taxable:

  • 20% tax bracket: above £1,000
  • 40% tax bracket: above £500
  • 45% tax bracket: all interest is taxable

The US doesn’t have a similar system, so if you make £100 interest in a UK bank account, you could pay US tax on it (depending on what the rest of your return looks like with deductions, foreign tax credits, etc.).

Further Reading

MoneySavingExpert on UK savings accounts

I haven’t found a similar site for US accounts (lots of kind of scammy sites out there, or ones looking just to drive affiliate revenue), but if you know of one I’ll happily add it.