Offshore retirement account


U.S. national with offshore retirement account

Case description

The client, a U.S. national, living and working in the Netherlands, came to us with the question if his Dutch employer could make contributions directly into his offshore retirement plan. The employer had initially answered negatively.

Our analyses

Offshore retirement plans are investment plans that are typically registered and maintained on the British Isles (Guernsey, Isle of Man). The plans have a contract term of 10 to 30 years and are meant to supplement retirement income, hence the label retirement account. These plans do generate a healthy return but the main benefit of these plans compared to a regular investment account is that they utilize the U.K.’s offshore tax rules which generally means that these plans generate tax free income. However, the tax free treatment only applies to residents of the U.K. because of the offshore tax rules. Unfortunately, these plans are often promoted to every English speaking expat in the Netherlands, including U.S. nationals.

U.S. nationals living in the Netherlands do not have any of the tax benefits that a U.K. resident would have: both the Netherlands and the US based on worldwide income and assets.

These offshore retirement accounts lack the characteristics for being considered as qualifying retirement accounts and are therefore considered investment assets for Dutch Box-3 taxation. The value of the plan is, therefore, subject to 1.2% tax annually.

With respect to the U.S. treatment, there is no tax treaty protection allowing these plans to be treated as qualifying retirement accounts.  These plans are therefore subject to U.S. taxation similar to any other investment account with taxation on dividend and capital gains. In addition, because these plans typically only offer investments in mutual funds, these plans are also subject to the PFIC taxation rules. The combined Dutch taxation and the U.S. PFIC taxation generally cancel any benefit that these plans offer and can sometimes even cancel any profit coming from the plans.

Advice to client

In response to the initial question, the conclusion was that because these plans are not considered qualifying retirement accounts, the employer is not allowed to directly contribute the employee’s pension contributions to the offshore plan. Should the client persist in contributing to the plan, then the client would need to waive his rights to an employer sponsored pension and receive the equivalent contributions as a taxable payment subject to tax withholding. The net can then be invested in the plan by the client.

However, our recommendation is to cancel the offshore plan as the combination of the expenses and commission to maintain the plan plus all the tax consequences will take away all benefits of the plan. Client would be better served to invest his money through a U.S. based investment account.

Services to client

Cancelling investment plan

The client had fulfilled 2 of the contracted 15-years of the investment plan.  Ending the contract now would result in the client losing 80% of the amount invested as a cancellation penalty.

We quantified the negative tax effects of maintaining the plan of the next 13 years and offset against an investment plan in the U.S. with the same yield. This was based on a simple extrapolated model and not accounting for factors such as currency fluctuations.  Based on our model, client concluded that canceling the plan and taking a loss now would be more beneficial than continuing the plan for the next 13 years.

Correcting previous tax filing

Unfortunately, the client failed to report the offshore investment plan in both his Dutch and U.S. income tax returns assuming that, labeled a retirement account, it would be tax free.

We assisted the client in disclosing the retirement account to the Dutch tax authorities and correcting the previous 2 years of incorrect Dutch tax returns. Because it was only two years, the client did not need to pay any penalties on the back taxes. Client did need to pay 2 years of interest on back taxes at 3% per year.

For U.S. purposes we reported the cancellation of the plan as a sale in Form 8621 in the current year without amending previous years. The amount invested was less than the return so there was no taxable PFIC income. 

We did, however, need to amend the client’s FBAR Forms for the previous two years. The client chose not to make use of any disclosure incentives and filed the amended FBAR forms with an accompanying explanation provided by us. To present, client did not receive any response from the U.S. Department of the Treasury or the IRS. This generally means that his amended forms were accepted.