Should I choose a contract-based or trust-based pension as a US citizen in the UK?
Published on June 13, 2024
by Deborshi Choudhury, EA
Deborshi Choudhury, an IRS Enrolled Agent with 17 years of expat tax experience, specializes in U.S. tax preparation, tax planning, and tax advice for U.S. citizens and Green Card holders living and working in the UAE and Canada.
Table of Contents
If you have the option, it’s usually advantageous to opt for a contract-based pension. This preference stems from the flexibility and fewer restrictions these pensions offer for US citizens and Green Card holders compared to trust-based pensions.
Why is a UK contract-based pension better for a US citizen?
A contract-based pension allows you to contribute more to your pension than your employer without triggering US tax issues. In the UK, taxpayers can add tens of thousands of pounds annually to their pensions tax-free, making it an excellent retirement savings strategy.
What are the tax implications for US citizens with trust-based pensions?
In contrast, trust-based pensions require US citizens to ensure their contributions do not surpass those of their employers. Exceeding this limit necessitates a foreign trust filing with the IRS, which can be costly and carries severe penalties for non-compliance. Contract-based pensions avoid this complication.
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It’s for American citizens that didn’t know they had to file U.S. tax returns each year, and have therefore fallen behind. Some more than 30 years! With the IRS Streamlined Procedure, say goodbye to overdue tax returns, late fees, and penalties.
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How do I know if my UK pension is contract-based or trust-based?
Contract-based pensions are individual agreements with a pension provider, typically an insurance company. Trust-based pensions, however, are established by employers and governed by a trust, managed by trustees who are legally required to act in the best interests of the members.
Here’s a comparison table to clarify the differences between contract-based and trust-based UK pensions:
|
Aspect |
Contract-based Pensions |
Trust-based Pensions |
|
Regulatory Body |
The Pension Regulator |
|
|
Management |
Managed by a pension provider’s investment team |
Managed by a board of trustees |
|
Responsibility |
The provider handles investment choices and member communications |
Trustees oversee all aspects, including investment and administration |
|
Governance |
Subject to specific investment rules set by the FCA |
Governed by trustees with a duty to act in the best interests of scheme members |
|
Type of Scheme |
Includes personal pensions like group personal pensions and SIPPs |
Includes occupational schemes, often part of larger master trusts |
The primary difference lies in the oversight of your pension. Contract-based pensions provide individual control but require you to manage your investment choices, often without direct assistance. Trust-based pensions are managed by trustees who share the responsibility for the scheme’s performance and adherence to regulations, potentially offering a layer of protection and guidance that contract-based schemes lack.
Can I choose where my pension money goes?
Yes, but the extent of your control depends on the type of pension plan you have. In a contract-based pension, you may have some say in how your money is invested. These plans typically offer various investment options, including stocks, bonds, and mutual funds. Many account holders either rely on their pension provider for investment decisions or convert their accounts into Self-Invested Personal Pensions (SIPPs) for full control.
On the other hand, trust-based pensions generally do not provide direct control over individual investments. Instead, trustees handle investment decisions for all members, although you might have some input into the overall investment strategy or the selection of trustees, who must act in your best interest.
What costs more, contract-based or trust-based pensions?
The cost varies based on the specific plans. Contract-based pensions usually have more transparent fee structures, including management, administration, and investment option fees. These costs can include annual management charges (AMCs) and additional fees for specific funds, giving you some control over your expenses.
Trust-based pensions may offer better value, especially for larger schemes that benefit from economies of scale. While the fees might be lower per individual due to shared costs among members, the fee structure can be less transparent, with administrative and investment costs often bundled together.
What should I consider when choosing a pension?
- Investment Options: Look at the variety and performance of investment choices. A diverse range of options can meet different risk preferences among your employees.
- Cost and Fees: Understand the fee structure of each pension type. Lower fees can significantly impact the growth of the pension fund over time.
- Tax Implications: Assess how each pension scheme affects both your and your employees’ tax situations. Choose structures that offer the most tax-efficient benefits.
- Employer Obligations: Evaluate your responsibilities, including contributions, administrative tasks, and legal obligations under each pension scheme.
- Employee Engagement: Opt for a pension scheme that is easy for employees to understand and engage with, enhancing their retirement planning experience.
- Professional Advice: Consulting a tax professional is highly recommended. They can provide valuable insights into how your pension choice aligns with your financial future, helping you maximize your retirement savings.
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