Summary
In a recent decision, the Belgian Ruling Office concludes that the pension capital built up in the US in a 401(k) account is taxable in Belgium at the time of payout, at separate tax rates as referred to in Article 171 of the Belgian Tax Code (and not at the standard progressive rates of 25% up to 50%). This way, the US plan is taxed like the traditional Group Insurance Plan that most employees benefit from in Belgium.
Under certain conditions, the distribution from an IRA is not subject to personal income tax in Belgium. Although a proper analysis of the type of IRA by the tax office remains absent, the decisive element appears to be that no tax benefits may ever have been claimed (in Belgium) with respect to the personal contributions made to the IRA(Decision of 14 November 2023, Nr. 2023.0712).
This recent decision does require some nuance and further clarification.
401(k) Pension Plan
In the US, pension plans generally fall into two broad categories: Defined Benefit Plans and Defined Contribution Plans. The 401(k) account is a type of Defined Contribution Plan and is the most popular retirement plan offered in the US by private-sector employers.
An employee can choose to have a portion of their salary deposited into a 401(k) account each month. Both the amount contributed to the 401(k) account and the amount matched by the employer will not be taxed, resulting in a tax saving. Employees contribute pre-tax income, which defers taxes until the funds are withdrawn, typically at retirement.
There are different types of 401(k) plans available, like the traditional 401(k) Plan, Roth 401(k) Plan, Safe Harbor 401(k) Plan, SIMPLE 401(k) Plan, Solo 401(k) Plan (One-Participant 401(k)) and Tiered Profit Sharing 401(k) Plan. Each type of plan has specific rules regarding eligibility, contributions, withdrawals, and taxation.
IRA & Roth IRA Plan
On the other hand, an IRA, or Individual Retirement Account, is a personal savings plan that allows you to personally save for retirement with tax-free growth or on a tax-deferred basis. Types of IRAs include traditional IRAs, Roth IRAs, Simplified Employee Pension (SEP) IRAs, and Savings Incentive Match Plan for Employees (SIMPLE) IRAs. An IRA is a long-term savings account that is designed primarily for self-employed people who do not have access to workplace retirement accounts such as the 401(k), although it can also be used in conjunction with such plans. With a traditional IRA you pay no taxes on its earnings until retirement, when withdrawals are taxed as income.
On the other hand, contributions to a Roth IRA have typically already been taxed, which normally results in tax-free withdrawals at retirement. Therefore, the annual contributions come from post-tax income and they cannot be deducted from your annual income. Your earnings will grow tax-free, no matter what type of investment you hold in your Roth IRA, be it mutual funds, stocks, or real estate.
In their recent decision, the Ruling Office briefly refers to the distinction between a Roth IRA and a traditional IRA but does not analyse the type of IRA in the case at hand. It therefore sets the impression that all types of IRAs are tax-exempt in Belgium, which is not correct. On this point the recent ruling is not sufficiently clear in our opinion.
US-BE Tax Treaty
Article 17 (1) a) of the Tax Treaty with the US stipulates that pensions and similar remunerations obtained by a resident of Belgium are taxable only in Belgium (and vice versa). As a result, the right to tax the disbursed capital from the 401(k) and from the IRA is normally given to the country of residence, in this case Belgium. Pension capital built up in the US becomes normally taxable in Belgium at the time of payout.
This does not avoid the US potentially applying a taxation as well due to the Savings Clause. This clause preserves the right of the US to tax its own citizens and treaty residents as if no tax treaty with Belgium were in effect. However, in that case, the US usually gives a tax credit for the income tax paid in Belgium.
Tax exemption
If the taxpayer can demonstrate that the disbursed capitals in the US would benefit from a tax exemption if they were paid out to a US tax resident, Belgium must grant an exemption in accordance with Article 17 (1) b) of the Tax Treaty. In other words, Belgium needs to give an exemption if the US offers a tax exemption system for payouts to its residents, particularly for payments from Roth IRAs.
For a traditional IRA, the Ruling Office highlights that distributions are tax exempt to the extent that the payment is made in consideration for non-tax deductible contributions. This goes against the basic principle that traditional IRAs are typically tax-deferred plans.
Your contributions in a traditional IRA may be fully or partially tax-deductible in the US, depending on your filing status. Your deduction may also be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels. In some cases, you may even be required to withdraw the excess contributions from your IRA.
The number of cases whereby a distribution from a traditional IRA will be exempt for US tax purposes, will therefore be limited in our opinion.
Belgian Domestic Law
Pension capital from a 401(k) account is considered supplementary pension capital (second pillar) in Belgium (cf. Article 34, §1, 2° b) of the Belgian Tax Code), taxed at separate tax rates specified in Article 171 of the same Tax Code, if the taxpayer chooses to withdraw the entire amount.
IRA payouts are seen as pensions from individually concluded life insurance contracts (third pillar) and are also taxable as a pension (cf. Article 34, § 1, 2° d) of the Belgian Tax Code), unless the beneficiary never claimed a tax benefit for it. Whether the latter should only be looked at from a Belgian perspective seems odd, especially when the taxpayer lived all their career outside Belgium and decides to retire here. In that case, tax deductible contributions will have been made in the US (or inanother country), but never in Belgium.
Conclusion
This ruling, although poorly motivated, highlights the complexities of tax obligations concerning pension distributions for individuals living in one country but having pension benefits accruing from another, emphasizing the importance of both treaty provisions and domestic laws in determining your tax liabilities.