For many Americans who once worked in the United Kingdom or who have since returned to the United States, UK pensions can feel confusing. One of the most common questions is whether the UK pension lump sum is taxable in the US. The answer matters because the way you take your pension can make a significant difference to how much of your retirement savings you keep.
When retirement savings are held in a foreign country, such as the UK, and distributed to US residents, the tax treatment can become complicated due to cross-border rules and treaties.
This guide explains how UK pension lump sums are treated under US tax rules, how the US and UK tax treaty affects you, and what you should consider before withdrawing anything from your pot. Whether you hold a UK workplace pension, a personal pension or a SIPP, understanding your tax exposure is essential.
Understanding the UK Pension Lump Sum
In the United Kingdom, most pensions allow you to take 25 percent of your pension as a tax free lump sum, often referred to as the 25 tax free portion. This is known as the Pension Commencement Lump Sum. The amount is withdrawn from your pension pot, the total fund accumulated in your UK pension plan, typically built up through employer contributions and pension contributions over time. The gross distribution is the total amount withdrawn before any taxes are applied. Many people use this lump sum withdrawal to pay off debt, reinvest, or simply improve cash flow in early retirement.
The UK personal allowance may also reduce the tax liability on pension withdrawals, depending on your total income.
However, under UK taxation and UK tax law, the general rule is that the 25 percent lump sum can be taken tax free, but this tax exemption does not apply under US tax law. US citizens and US residents are taxed based on their worldwide income. This includes foreign pensions and foreign pension withdrawals.
Is the UK Pension Lump Sum Taxable in the US?
The Short Answer
Yes. In most cases, the UK tax free lump sum is taxable in the US. Although the UK pension system allows you to take 25 percent without paying UK tax, the United States does not recognize this exemption.
In practice, the IRS usually treats almost the entire distribution from a UK pension, including the lump sum, as taxable income in the US, because most or all of the contributions were made with pre tax money. Under US domestic law, specifically the Internal Revenue Code, foreign pension distributions are generally taxable unless a treaty provides a tax exemption. The treaty does not make the 25 percent lump sum tax free in the United States. Article 17(2) mainly decides which country has taxing rights, and the saving clause allows the US to continue taxing its citizens on their UK pension lump sums.
This means that when you take your 25 percent lump sum, it will normally be subject to US federal income tax. While the treaty aims to avoid double taxation, US taxpayers may need to claim a foreign tax credit if UK tax is paid on the pension, but this is not usually the case for the 25 percent lump sum. Depending on where you live, there may also be state tax. The lack of treaty benefits for lump sum withdrawals means US tax applies.
How the US UK Tax Treaty Treats Pension Lump Sums
The US UK income tax treaty is designed to prevent double taxation and to clarify which country has taxing rights by applying specific treaty rules. For pension income, Article 17 of the treaty applies, and these treaty rules determine how pension and lump sum payments are taxed.
Under the income tax treaty, pension distributions are only taxable in the country of residence. So if you live in the United States, the United States has the right to tax your UK pension withdrawals. If you reside in a third country (Country B), different treaty provisions may apply, and you should review the relevant treaty benefits and obligations.
However, the treaty does not provide a tax exemption for lump sum withdrawals, nor does it offer:
• A tax free allowance similar to the UK’s 25 percent
• A carve out for lump sum withdrawals
• Preferential treatment for UK specific retirement products
The UK government and US authorities negotiated the treaty to clarify taxing rights and treaty benefits for cross-border pension income, but the treaty rules do not grant a tax exemption for lump sum payments.
This is why, under the general rule, the IRS considers the lump sum fully taxable when you are a US resident, unless a specific treaty exemption applies. Under UK tax law, a portion of a pension lump sum may be tax free, but US tax law does not follow the same approach, leading to differences in UK taxation and US taxation of pension withdrawals.
Saving Clause and Tax Implications
The Saving Clause is a key provision in the US-UK tax treaty that every US expat with a UK pension should understand. Found in Article 1 of the tax treaty, the Saving Clause allows the United States to continue taxing its citizens and residents on their worldwide income, even if the treaty would otherwise provide an exemption or reduced rate. This means that, for most types of UK pension income, including lump sum distributions, the US can apply its own tax treatment, regardless of how the UK taxes that income. Because of the saving clause, US citizens and most US tax residents should assume their UK pension income, including lump sums, will still be taxed under normal US rules.
For US citizens and tax residents, the Saving Clause effectively overrides many of the treaty’s benefits when it comes to pension income. Even if the UK tax rules allow for a tax free lump sum or other favorable tax treatment, the US tax law takes precedence due to the Saving Clause. As a result, your UK pension income, including any lump sum withdrawals, is generally included in your taxable income on your US tax return.
Understanding the Saving Clause is crucial for avoiding unexpected tax liability. While the tax treaty aims to prevent double taxation and clarify taxing rights, the Saving Clause ensures that the US retains the right to tax your UK pension as part of your worldwide income. This can have significant tax implications for your retirement planning, making it essential to factor in both UK and US tax rules when deciding how and when to access your UK pension funds.
If you’re a US expat or dual resident with a UK pension, it’s important to seek advice on how the Saving Clause may affect your specific situation. Proper planning can help you navigate the complex tax treatment of foreign pensions and avoid costly surprises when reporting your UK pension income in the US.
What Happens If You Are a Dual UK US Citizen
If you hold both UK and US citizenship, the same rules apply. US citizens are taxed on worldwide income regardless of where they live. Only in rare situations involving the Foreign Earned Income Exclusion would foreign income be excluded, and pensions are not eligible for that exclusion.
Therefore, the lump sum is generally taxable in the United States even if you still live in the UK, or if you reside in a third country (Country B); the US still taxes the lump sum. Most US cross border tax specialists take the conservative view that the PCLS is taxable in the US, although there is ongoing debate in the profession about how the treaty applies in some edge cases.
How Your Type of UK Pension Affects US Taxation
Workplace pensions
Workplace pensions, including defined contribution schemes, auto enrollment schemes, and employer sponsored pensions, are typically funded by both employer contributions and employee pension contributions. These pension contributions often grow tax deferred until withdrawal. Lump sum withdrawals from these plans are considered ordinary taxable income in the US.
Personal pensions and SIPPs
Personal pensions and SIPPs are funded by individual and sometimes employer UK pension contributions. These pensions typically grow tax deferred until withdrawal. These are also treated as foreign pensions. Withdrawals are taxed as income by the IRS. Even if the UK allows the 25 percent tax free portion, the United States does not follow that treatment.
Defined benefit pensions
Many defined benefit plans do not offer a lump sum option. If they do, the same US tax rules apply. A lump sum distribution is treated as other pension income for US tax purposes.
Timing Your Lump Sum Matters
Because the IRS taxes your UK lump sum withdrawal as income, taking it all at once can unintentionally push you into a higher tax bracket.
For example
A forty thousand dollar lump sum withdrawal added to your regular income could create a significantly higher tax bill. Spreading withdrawals over several years or combining them with low income years can reduce overall tax liability.
Professional advice is essential here. A qualified cross border adviser can help you model different scenarios to determine the most tax efficient timing.
Can You Roll Your UK Pension Into a US Retirement Account
Many US residents ask whether they can transfer their UK pension into a US IRA or 401(k), including Roth IRAs, to avoid tax issues. However, under US law, transfers from UK pensions to US IRAs or other US retirement accounts, such as Roth IRAs, are generally not permitted. The United States does not allow tax-favored transfers from foreign pension plans into US qualified accounts.
While there are some limited exceptions for very specific employer schemes, 99 percent of the time a transfer is not possible.
This is one reason why many Americans choose to keep their UK pension invested until retirement and then take distributions strategically.
Reporting Requirements for UK Pensions in the US
US taxpayers with UK pensions may also have reporting obligations beyond income tax. These can include:
• FBAR reporting if your pension has reportable cash value
• FATCA Form 8938 if thresholds are met
• Form 3520 or 3520 A if the IRS considers the pension to resemble a foreign trust
• Reporting the UK state pension and state pension payments as income on your US tax return
Incorrect reporting can lead to penalties, so it is vital to work with someone experienced in US UK cross border pension compliance.
Practical Example
How US Tax Might Apply
Imagine you have a two hundred thousand pound pension in the UK. You decide to take the 25 percent lump sum, which is the gross distribution from your UK pension and amounts to fifty thousand pounds. The UK does not tax it. However, you live in the US.
Your fifty thousand pound gross distribution converts to roughly sixty two thousand dollars. The IRS considers this taxable income. It is added to your regular income for the tax year and taxed at your marginal bracket. If UK tax had been paid on this amount, you could claim a foreign tax credit to avoid double taxation, but this does not apply to the 25 percent lump sum.
This often surprises taxpayers who were expecting the UK tax free treatment to carry over.
Should You Still Take the UK Tax Free Lump Sum
In many cases, yes. Even though the lump sum is taxable in the US, you may still benefit because you avoid UK tax. However, the UK tax exemption for the 25 percent lump sum does not apply under US tax law, so the amount is still subject to US taxation. Paying tax only once is still better than paying tax twice. The key is to plan the timing carefully.
Some people choose to spread withdrawals over multiple years. Others take the lump sum while temporarily living in a low tax state. Some wait until retirement when income naturally decreases.
FAQs – Is the UK pension lump sum taxable in the US?
Is the 25 percent UK tax free lump sum also tax free in the US?
No. The United States taxes it as ordinary income.
Can the US UK Tax Treaty protect my lump sum?
No. The treaty does not provide an exemption for lump sums.
What if I take the lump sum while living outside both the US and the UK?
If you are a US citizen, it remains taxable in the US regardless of where you live.
Can I avoid US tax by transferring to an IRA?
No. Direct transfers from UK pensions to IRAs are not permitted.
Speak With a Cross Border Financial Adviser
Managing a UK pension from the United States is not simple. Incorrect planning can lead to unexpected taxes and missed opportunities. Harrison Brook helps Americans and returning US expats understand their UK pensions, optimise withdrawals, and integrate them into a global retirement strategy.
Contact us today for a free initial consultation and find out the most efficient way to manage your UK pension lump sum.
