Distributions and inheriting money from a US Pension, whether that is a 401k or a IRA, is difficult. For UK residents there are administrative challenges, getting advice how to use the inheritance, taxation of distribution (in the US and UK) and best method to use the funds wisely.
When a UK resident inherits a 401k or IRA (Individual Retirement Account) from a U.S. relative who is not married to them, they have several options for handling the funds. The choice depends on their financial goals, tax situation, and whether they prefer immediate access to the money or long-term investment growth.
What age did the US pension owner die?
One of the first considerations for the beneficiary is the age of the person who died, as that impacts the options available to them. The US has rules that require after age 72, a minimum annual amount is paid from their pension. So, this age impacts on the options that the non-spousal benefit accesses.
Key Rules for Non-Spousal Beneficiaries
The withdrawal rules depend on whether the original IRA owner had started taking Required Minimum Distributions (RMDs) before they passed away:
- If RMDs Had Already Started (Age 72+ at Death)
- The beneficiary must continue taking RMDs based on their own life expectancy or the original owner’s schedule, whichever is longer.
- The remaining balance must still be fully withdrawn within 10 years for most non-spousal beneficiaries.
- This rule ensures that the U.S. government collects taxes on the account over time.
- If RMDs Had Not Started (Under Age 72 at Death)
- The beneficiary is not required to take annual RMDs but must withdraw the entire balance within 10 years.
- There is flexibility in when to take distributions, allowing tax-efficient withdrawals.
Options for a UK Beneficiary of an Inherited U.S. IRA/401k
1. Take a Lump Sum Withdrawal
A UK beneficiary can choose to withdraw the entire IRA balance as a one-time lump sum. While this provides immediate access to the funds, it comes with significant tax implications. The full amount is subject to U.S. income tax at ordinary rates, with 30% withholding tax applied unless a tax treaty benefit is claimed. Additionally, the lump sum must be reported to HMRC in the UK, and UK tax may be due, though foreign tax credits can help reduce double taxation.
2. Open an Inherited IRA (Beneficiary IRA) in the U.S.
Instead of taking the money all at once, a UK beneficiary can transfer the funds into an Inherited IRA in their name. This allows them to keep the money invested and take distributions over time. Most non-spousal beneficiaries must withdraw the full balance within 10 years of the original owner’s death, but there are no required minimum withdrawals each year—meaning they can manage their tax liability by spreading withdrawals over time. The withdrawals remain taxable in the U.S. and must be reported in the UK, but proper tax planning can reduce the overall burden.
3. Take Distributions Over 10 Years
If the IRA is moved into an Inherited IRA, the beneficiary can withdraw gradually over a 10-year period. This strategy allows them to control how much tax they pay each year while keeping the remaining funds invested. By spreading withdrawals across multiple years, a UK beneficiary can potentially stay in a lower tax bracket, reducing their total tax liability in both the U.S. and UK.
4. Use a Trustee-to-Trustee Transfer
A trustee-to-trustee transfer can be arranged for beneficiaries who want to keep the IRA funds invested while deciding on a withdrawal strategy. The new IRA must be appropriately titled to indicate that it is an Inherited IRA (e.g., “John Doe IRA (deceased) for the benefit of Jane Doe, beneficiary”). This ensures that the account remains tax-deferred until withdrawals are taken.
5. Consider Tax Treaty Benefits
There is taxation on USA-inherited IRA/401k withdrawals in the USA and potentially in the UK. The U.S.-UK tax treaty, the U.S. has the primary right to tax IRA distributions, but the beneficiary must still report the income in the UK. In many cases, a foreign tax credit can be used to offset UK tax on the same income. However, proper tax reporting is crucial to ensure compliance with both U.S. and UK tax authorities. For inherited Roth Individual Retirement Accounts, payments to a UK resident are not taxable in the United States and not taxable in the United Kingdom.
Tax on USA-inherited 401k / IRA withdrawal / distribution
Inherited IRA distributions are taxed as ordinary income is the primary rule. There are some exceptions to this headline. Generally, the distribution from an inherited IRA is added to your taxable income for that year. This means it is taxed at your current income tax rate. Under the UK-US Dual Taxation Agreement, there are exceptions to the double taxation in the USA and United Kingdom. Roth IRAs withdrawals are not taxed in the US or UK, because of clause 1b. Lump sums are taxed in the USA but not in the UK but are declarable.
Choosing the Best Option for UK beneficiary of US pension inheritance
The best option for a UK beneficiary depends on their age, financial needs, and tax situation. A lump sum might be suitable for elderly beneficiaries who need immediate access to funds, while younger beneficiaries may benefit from keeping the IRA invested and spreading withdrawals over time.
Edale can provide guidance on inherited IRAs, tax planning, and managing distributions to optimise financial outcomes.
Examples of US 401k/ IRA inheritance for different beneficiaries
Practical illustrations can often make the rules around inheriting US pensions more relatable. Below are some cases we have received with some details changed to respect individual circumstances and personal situations.
Margaret, a 76-year-old retiree in the UK, inherits a $50,000 Traditional IRA from her late brother, John, who lived in the U.S. John was 80 years old and had been taking Required Minimum Distributions (RMDs). Given that Margaret was already retired has a comfortable pension, and does not want to deal with ongoing investment management. She prefers simplicity over long-term tax planning. A Lump Sum Withdrawal was the best method for her. The rationale for this approach are:
✅ She doesn’t need long-term investment growth at her age.
✅ The amount is manageable in one tax year, avoiding complex future withdrawals.
✅ She won’t face early withdrawal penalties, as inherited IRAs allow penalty-free distributions.
Sarah, a 55-year-old UK resident, and her 78-year-old mother, Margaret, inherit a $300,000 401(k) pension from Sarah’s late uncle, who was a U.S. resident. The 401(k) was left equally to both Sarah and Margaret, meaning each receives $150,000. At 78 years old, Margaret finds the paperwork and client due diligence process too complex for an Inherited IRA transfer. Given her age and financial needs, she opts for a direct lump sum withdrawal of her $150,000 share. It is simpler and provides her with immediate access to funds for her care needs. With guidance, she can apply for foreign tax credits in the UK to offset some of the U.S. taxes paid.Since Sarah is still working but planning for retirement, she decides to transfer her $150,000 into an Inherited IRA. This allows her to:
✅ Keep the funds invested while spreading withdrawals over time.
✅ Avoid a lump sum tax hit in the U.S. and UK.
✅ Withdraw over three years to help cover her mother’s increasing care costs while minimizing tax liabilities.
James, a 35-year-old UK resident, inherits a $200,000 401(k) pension from his late father, who was an American expat in the UK. As a non-spouse beneficiary, James must decide how to manage the inheritance while considering his career, tax implications, and long-term financial goals. Since James is in a higher earning phase of his career, he decides to transfer the funds into an Inherited IRA and spread withdrawals over 10 years to:
✅ Reduce tax liability by withdrawing smaller amounts while working.
✅ Keep money invested for potential growth.
✅ Time withdrawals strategically—opting for larger withdrawals if he takes a career break or earns less in future years.