Inherited IRA from America

gt568

This is prolly a very niche question....


My mum has inherited an IRA from my dad who passed away last month... It's worth $12000.


If she withdraws it as a lump sum what are the tax implications...


Does she have to pay federal US income tax?
UK income tax (though I thought inheritance under IHT limits would be tax free)?


Any advice?

EdSwippet

gt568 wrote: »

Does she have to pay federal US income tax? UK income tax (though I thought inheritance under IHT limits would be tax free)?

Assuming your mother is not herself a US citizen, takes a single lump sum, and this is a traditional pre-tax IRA (and not a Roth IRA, for example), I believe the answer is: US federal income tax, no UK income tax. This would be under Article 17 paragraph 2 of the US/UK tax treaty:

2. Notwithstanding the provisions of paragraph 1 of this Article, a lump-sum payment derived from a pension scheme established in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in the first-mentioned State.

Expect to pay between 10% to 12% federal tax on this $12,000 withdrawal; there is no additional early withdrawal penalty on withdrawals under age 59.5 from an inherited IRA. It is likely that the custodian will over-withhold US tax, perhaps as much as 30%; this will require your mother to file a form 1040-NR tax return with the IRS to recover the balance. Before she can do any of this though, she probably needs to roll this IRA over into an 'inherited IRA' at the custodian, and this may well mean she first has to file a (somewhat complex) form 706-NA US nonresident alien tax return with the IRS and then wait months (and months, and months) for the IRS to process that before the custodian will release the funds. Nothing is ever simple where the US is involved.

The answer will be different if your mother is a US citizen or green card holder, if she does not take this as a single lump sum, or if this is not a traditional pre-tax IRA.

gt568

She isn't a US citizen and no longer has a green card.


The investment firm have sent the paperwork to turn it into an inherited IRA. They have also asked if she wants to withdraw as a lump sum, keep it as her account or decline the offer.....


I'm no tax expert and not sure the best option.

Cook_County

gt568 wrote: »

She isn't a US citizen and no longer has a green card.


The investment firm have sent the paperwork to turn it into an inherited IRA. They have also asked if she wants to withdraw as a lump sum, keep it as her account or decline the offer.....


I'm no tax expert and not sure the best option.

What does these words mean: "and no longer has a green card"?


Did she formally abandon the green card by filing Form I-407 or -alternatively - has she simply lost the paperwork? The tax consequences are very, very different.


I don't think this is a niche question incidentally as it what I handle every day...

gt568

We all formally handed back our green cards when we left the US in about 1993.

Cook_County

On the basis your mum is a non-resident alien and takes a sjngle one-time lump-sum distribution the only tax due is in the US. [ HMRC may disagree incidentally.] If she receives the payment in 2020 she'll file a 2020 US tax return during 2021.

gt568

So to return to this, Schwab have opened mums inherited IRA.  I assume she can just ask this to be closed and the money repatriated back to the UK?

gt568

Schwab have stated they will withhold 30% for federal taxes.

She's paid (paying) UK tax on her social security benefits, so how do I skin the cat in getting back the 30%?
Do I need to employ a US tax expert?  I'm lost with this really.....

EdSwippet

gt568 said:

Schwab have stated they will withhold 30% for federal taxes.

She's paid (paying) UK tax on her social security benefits, so how do I skin the cat in getting back the 30%?

As outlined in my earlier post. The actual US tax due will likely be less than 30%, but it won't be zero. You compute the right tax rate and recover the overwithholding from the IRS by filing a form 1040-NR tax return. You might need a form 8833 added, if you need to claim US/UK tax treaty benefits from the US. There will be no UK tax impact, under the treaty, Article 17 paragraph 2.

I assume you are sure that your mother will not fall foul of the US's 10% early withdrawal penalty on any of this, since that's (probably) not covered by the treaty. Age 59.5 is usually the magic point, but there are some special rules for inherited IRAs that you'll want to be sure of as well.

gt568

EdSwippet said:

gt568 said:

Schwab have stated they will withhold 30% for federal taxes.

She's paid (paying) UK tax on her social security benefits, so how do I skin the cat in getting back the 30%?

As outlined in my earlier post. The actual US tax due will likely be less than 30%, but it won't be zero. You compute the right tax rate and recover the overwithholding from the IRS by filing a form 1040-NR tax return. You might need a form 8833 added, if you need to claim US/UK tax treaty benefits from the US. There will be no UK tax impact, under the treaty, Article 17 paragraph 2.

I assume you are sure that your mother will not fall foul of the US's 10% early withdrawal penalty on any of this, since that's (probably) not covered by the treaty. Age 59.5 is usually the magic point, but there are some special rules for inherited IRAs that you'll want to be sure of as well.

She is 73.  I have no idea what you mean by the bolded bit?

As to the earlier bit of the post, am I right in thinking then I fill out the 1040-NR declaring only the IRA money?  All the rest of her money was taxed in the UK.

I wish they had brought all this money back years ago before Dad died, this is a mess.

As an aside is there no tax efficient way to withdraw from an IRA?

EdSwippet

gt568 said:

She is 73.  I have no idea what you mean by the bolded bit?

You can ignore it, then. Early withdrawal penalties are not relevant if your mother is 73. (It's possible she should have been taking 'required minimum distributions' after age 70.5. That's another whole can of worms though, and for now I'd suggest pretending you'd not heard of these.)

gt568 said:

As to the earlier bit of the post, am I right in thinking then I fill out the 1040-NR declaring only the IRA money?  All the rest of her money was taxed in the UK.
...
As an aside is there no tax efficient way to withdraw from an IRA?

Only US source income goes on the 1040-NR, so yes, just the IRA lump-sum withdrawal (assuming your mother has no other US financial connections or US based accounts).

As for tax efficiency, if taken as a lump sum your mother would face around $1,246 in US tax on a $12,000 withdrawal. That's 10.4%.

What is her current top marginal UK tax rate? If she's a basic rate taxpayer, taking this as a single lump sum is already tax efficient, relative to taking it as normal withdrawals that would be taxable at 20% in the UK. If her income is below £12,500 annually, so that she currently pays no UK tax, then taking 'regular' withdrawals from this IRA, up to the £12,500 limit each year, would be more efficient. In the case of regular withdrawals, treaty Article 17 paragraph 1(a) says that these types of withdrawal are taxable only to the UK and not the US. In this case, you would need to file a 1040-NR and form 8833 to the US citing this article, so as to recover the entire US withholding applied by Schwab.

I'm not clear how much more tax efficiency you could look for. I assume your mother holds a pre-tax traditional IRA, and not a Roth IRA. In that case, it was funded from untaxed income, and so there's tax to consider on withdrawals one way or another. The US/UK treaty gives you some flexibility in which country you end up paying that tax to, by virtue of its separation of lump sum and normal withdrawal treatments, but playing that flexibility off against your mother's other general tax circumstances is going to be the best achievable. A tax rate of 0% might be doable, but if not then 10.4% is not a bad rate, considering that this is almost certainly lower than the US tax rate avoided on this money when the IRA contributions were made.