How does Australia tax your US retirement account?

Retirement highway sign

For those who have moved between the US and Australia, access to and tax treatment of retirement accounts is a common issue. We’ve covered the US taxation of superannuation in several posts, but the tax treatment by both countries of 401k and IRA accounts held in the US is also important. Today’s post will cover the Australian side of this equation. My next post will discuss what happens to your US retirement accounts when you renounce US citizenship (or for Australian expats returning from the US).

Is an IRA or 401k a “Foreign Superannuation fund”?

Australian tax law has special rules for taxing the transfer of “foreign super” into your Australian superannuation account. To qualify, you must be able to make non-concessional contributions into your Australian super account and you cannot exceed the contribution caps. For amounts transferred from a foreign superannuation fund, s305.70 and s305.80 of ITAA1997 give you the option in some circumstances of having the lump sum taxed inside your Australian superannuation account (at 15%) rather than being taxed at your personal tax rate. Additionally, the taxable amount under these provisions is essentially the increase in the value of the fund since the date you became an Australian tax resident. BUT these rules only apply if the transfer is from an account that is deemed to be “foreign superannuation” under Australian law. Unfortunately, several private rulings have held that IRA, 401k, and other US retirement accounts are NOT considered “foreign superannuation funds”, and therefore are NOT taxed under these rules.

Let’s examine the logic in one of the more recent rulings, which goes into great detail on what is required for a fund to be a foreign superannuation fund. What it boils down to is that the sole purpose of the fund must be the provision of retirement benefits; provisions for the payment of benefits for any reason other than retirement will mean that a foreign fund does not meet the definition of foreign superannuation fund, and the provisions for transfer of foreign super will not apply. In the case of US retirement accounts, Congress has legislated the ability of funds to distribute benefits in the case of hardship. It is these provisions that the ATO points to in determining that US plans are not solely for retirement – whether you have accessed such withdrawals or not. US funds are not required to offer hardship distributions, so classification of foreign superannuation funds requires a close reading of the trust deed.

If not foreign super, then what?

Private rulings covering 401k,  traditional IRA, and Roth IRA [1] distributions have all concluded that withdrawals from these accounts are taxed as trust distributions. The general rule for trust distributions is that the corpus of the trust (that is, the original contributions) and income previously taxed in Australia are distributed tax free, but any distribution of previously untaxed (by Australia) trust earnings is included in assessable income. Prior to 2010, Australia had provisions taxing foreign investment fund income that may have included US retirement accounts (only accounts exceeding a given threshold were taxed), so any income taxed under these provisions will not be taxed again.

What do these trust rules mean? Say you contributed $5000 to your IRA twenty years ago (while living in the US) and the account is now worth $20,000. The $5,000 is considered the trust corpus, so, when you withdraw $20,000, that $5,000 will not be taxed, but the remaining $15,000 will be included in your assessable income. Wait a minute – what if most of that $15,000 of appreciation occurred before you became an Australian resident? In Interpretative Decision 2011/93, the ATO has ruled that this is irrelevant.

So, what’s included in corpus? Generally, it is personal and employer contributions to the account, whether or not those contributions were made with pre-tax or after-tax money. If you rollover or consolidate accounts prior to becoming an Australian resident, this does not convert appreciation prior to the rollover into corpus. Thus, one of the consequences of the ruling that US retirement accounts are generally not foreign superannuation funds is that the fund earnings accrued prior to becoming an Australian resident are included in your Australian taxable income. Any withdrawal from a US retirement account by an Australian resident will result in currently assessable income in Australia.

Planning

This is one area where competent professional advice is essential. Any tax planning must consider both the US and Australian tax consequences. For those still in the workforce, Australian tax rates are generally higher than US tax rates, so including 401k/IRA withdrawals in current income can be expensive. For those with accounts containing a large amount of appreciation or those with Roth variants, it may actually be worthwhile to take the US tax hit from early withdrawal prior to becoming an Australian tax resident. And, record-keeping is essential to establish the amount of corpus – do you know how much the original contributions were? Can you find out?

What about the treaty?

As noted many times on this site, the current treaty does not adequately address retirement savings. Article 18(1) provides that pensions are taxed by the country of residence. For Australian residents who are not US citizens, this may provide relief from US tax – more on that in my next post – but it will not provide any relief from Australian tax.

The more I explore this area, the clearer it becomes that the treaty must be re-negotiated. Retirement savings is an important area of public policy in both countries. If our free trade agreement is to allow free movement of labour as well as capital, then there must be retirement account portability. The pension and retirement account articles in the current US model tax treaty are certainly a step forward from the current treaty, but they do not go far enough.


[1] Note that Roth variants of these accounts are taxed by Australia exactly the same as the traditional variants – so it might be worthwhile cashing out those Roth accounts prior to becoming an Australian resident.

14 thoughts on “How does Australia tax your US retirement account?”

  1. An excellent post – thank you for this. In the 21st Century people are more and more likely to experience tax residency in more than one country. Those who plan to acquire a new tax residency must always consider how their existing assets/pension plans will be treated under the laws of both countries. Here is a recent article explaining how damaging a lack of planning can be:

    https://business.financialpost.com/personal-finance/taxes/foreign-pension-income-is-generally-still-taxable-as-far-as-the-cra-is-concerned#comments-area

  2. John Richardson. I thought that the US was the only country with Taxation on World Wide Income?……Reading this article states that Canada does exactly this also. Am I wrong to assume Canada and US Taxation are ‘the same’ terms and conditions.

    1. Most countries tax their residents on worldwide income. The difference with the US is that it taxes citizens on worldwide income regardless of whether those citizens are actually resident in the US.

      1. Karen, thanks for your article. Very informative and apropos to my circumstances. I am indebted to you for opening my eyes to some of the financial legalities of my dual citizenship. Can you recommend any of the US/Australia tax services to give me good advice? I know this is not your business, but I don’t know where to go to get advice on my particular circumstances. Thank you.

    2. Quinn, I second Karen’s answer. Let’s look at it this way.

      There is a difference between “who” a country treats as its tax residents and “what” income the country imposes tax on.

      Who: The United States treats all US citizens as US tax residents regardless of where they live in the world. Canada treats only Canadian residents at tax residents. In other words, if an individual does not live in Canada he would not be a Canadian tax resident.

      What: Canada, the United States, Australia and the vast majority of countries in the world impose taxation on worldwide income – meaning that (assuming you are a tax resident) you are subject to tax on income regardless of where it has been earned.

  3. Excellent summary!
    If I am a US nonresident alien, and Australian tax resident, is the accumulation (growth) in my 401k or IRA taxable by the ATO?
    My reading of this suggests no, ATO will only tax that income upon withdrawal – is that correct?
    Thanks

    1. Under current Australian tax laws only withdrawals are taxed. Pre 2010 there were rules that could have resulted in Australian tax on accumulation.

  4. Does anyone know what happens to an IRA if and when you leave Australia? Suppose you opened an IRA while in the U.S.; the corpus is $5,000, the accumulation before arriving in Australia is $15,000; the accumulation while resident in Australia is $5,000. No withdrawals or contributions are made while resident in Australia. You leave Australia with an IRA worth $25,000. Australia taxes you on your assets when you leave; would that include the IRA? It seems odd that it wouldn’t but not sure it’d be captured by the rules.

    1. My understanding is that Australian departure taxes are only on property that generates capital gains, and therefore there should be no Australian tax on an IRA when you leave Australia. What matters is your tax residence when you withdraw from the IRA. You should consult an Australian tax agent to confirm this.

      1. Thanks. The definition of capital is quite broad, so I am not so sure. I’ll have to ask an expert. Thanks for coming back to me.

  5. Thanks Karen!
    So given that the Australian Government has now allowed withdrawals from superannuation due to Hardship in this post Covid world, can the ATO ruling about 401k/403bs now be challenged??

    1. The recent provision for hardship withdrawals from super (as well as the first time homebuyers super scheme) highlight the hypocrisy of the ATO position on 401k/403b accounts. However, the only way I can think of to find out whether the ATO has changed its position on this would be to apply for a private ruling based on your own specific circumstances.

  6. Waiting for comments on Maia’s question. Especially now some Australians have accessed their superannuation early during Covid. It will be interesting if there is a change in the ATO’s ruling.

  7. Great article, thank you! Any recommendations for tax experts that could advise on this issue? I reside in the USA but am an Australian citizen that hasn’t resided there for over 10 years – I am wondering if it’s better to seek out a tax expert in the US or in Australia? As you mention, they need to know both sides as we’re currently working out where to stock up our superannuation

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