NetActuary managing director Brian Bendzulla explained that US retirement funds are usually not accepted by the ATO as meeting the foreign superannuation fund requirements and are therefore treated as a foreign trust.
“This means that in the year of receipt, the whole distribution is assessable other than the amount of capital contributed. The person may have been an Australian tax resident for only a year or two but taxed on total gains over many years,” Mr Bendzulla warned.
“It gets worse. The US fund will impose a withholding tax on the whole distribution, but the ATO will only grant a partial tax credit. Having a benefit accumulated over many years assessed against a single tax year pushes the applicable marginal tax rate up massively.”
It is not unusual, he said, for a person to lose as much of the transfer on larger amounts they keep.
“That is not fair, [but] two strategies can be used to try and ameliorate this unfairness. The first is, if the US fund will allow it, to make several payments in different tax years to limit the top marginal tax rate applicable,” Mr Bendzulla said.
A second strategy, he explained, is to consider paying the entitlement as a pension.
“The pension can be a term pension of more than 10 years in roughly equal amounts besides lifetime annuities,” he said.
US DTA Article 18(1) states that, subject to the provisions of Article 19, “pensions and other similar remuneration paid to an individual who is a resident of one of the contracting states in consideration of past employment shall be taxable only in that state”.
“There are similar clauses for social security pensions and life office annuities. There is a deductible amount,” the managing director explained.
“This strategy may reduce the overall tax impost as lower marginal tax rates apply and the withholding tax problem is avoided.”