Overview

One of the emerging planning strategies that is generally unknown and under-appreciated is the Malta Pension Plan (MPP). From the perspective of a U.S. taxpayer, the MPP should be viewed as an alternative that in many respects mirrors a Roth IRA. However, in most respects, it is far superior than a Roth IRA. This article looks at the MPP with respect to the Roth IRA with the view that if U.S. high net worth taxpayers and their advisors are not considering the MPP, they are “leaving money on the table”, i.e. paying unnecessary taxes.

Roth IRA Overview

According to the Investment Company Institute (ICI), Americans held $7.9 trillion in individual retirement accounts (IRAs) at year-end 2016, with Roth IRAs accounting for $660 billion of that total. Forty-seven percent of IRA assets, or $3.7 trillion, were invested in mutual funds. The second most common type is the Roth IRA, created by the Taxpayer Relief Act of 1997. Forty percent of Roth IRA–owning households in 2016 indicated their Roth IRA was the first type of IRA they opened. Households often invest in both traditional and Roth IRAs—64 percent of Roth IRA–owning households in 2016 also owned traditional IRAs. Sixty-nine percent of IRA investors in 2015 owned traditional IRAs and 34 percent owned Roth IRAs.

According to the ICI, Roth IRA investors tend to be younger than traditional IRA investors. At year-end 2015, 31 percent of Roth IRA investors were younger than 40, compared with only 16 percent of traditional IRA investors. Twenty-five percent of Roth IRA investors were 60 or older, compared with 40 percent of traditional IRA investors. This age pattern reflects the different key role of Roth IRAs, which tend to be opened by contributions, versus traditional IRAs, which tend to be opened with rollovers—an activity that tends to occur later in one’s career or at retirement

Few Roth IRA investors take withdrawals from their Roth IRAs in any given year. In contrast to traditional IRAs, which require investors aged 70½ or older to take required minimum distributions (RMDs), Roth IRAs do not have RMDs (unless they are inherited). As a result, withdrawal activity is much lower among Roth IRA investors. In 2015, while only 4.0 percent of Roth IRA investors aged 25 or older had withdrawals, 23.5 percent of traditional IRA investors had withdrawals.

A few trust companies such as Pensco and Entrust specialize in self-directed IRA (traditional or Roth) with non-traditional assets. Nevertheless, the IRA rules limit do not permit investment in life insurance, collectibles or foreign investments with the exception of American Depository Receipts (ADRs)

Another significant limitation is the imposition is the limitation on permissible investments. Roth IRAs are unable to make foreign investments or purchase life insurance. Roth IRAs cannot own collectibles. Traditional and Roth IRAs face the imposition of unrelated business taxable income (UBTI) for real estate investments subject to debt financing. UBTI will subject a pro rata portion of the real estate income to taxation  within the Roth IRA. Business income owned within the Roth IRA will also be subject to UBTI treatment. As a result, Roth investments will tend to be limited to passive investment assets.

One of the major limitations regarding the Roth IRA is eligibility for the Roth IRA. A taxpayer that files jointly is able to contribute to a Roth IRA if the taxpayer’s modified adjusted gross income (AGI) does not exceed $173,000. The contribution phases out between $189,000-198,999. The contribution limit is only $5,500. Individuals age 50 and over can contribute up to $1,000 extra per year to “catch up” for a total of $6,500. A non-working spouse can open a Roth IRA based on the working spouse’s earnings. 

Contributions to the Roth IRA must be made in cash. The prohibited transaction guidelines applicable to the traditional IRA. The  unrelated business taxable income (UBTI) (UBTI) rules also apply to Roth IRAs. The combination of the prohibited transaction and UBTI rules limit the ability of the taxpayer to own the taxpayer’s business interests within the Roth IRA.

The MPP

The primary difference between the Roth IRA and IRA or qualified plan is that the Roth IRA does not have required minimum distributions. Distributions from the Roth IRA are not subject to income taxation. However, the distribution from the Roth IRA must be a “qualified” distribution. Qualified distributions require five years of “seasoning” within the plan unless the taxpayer is at least age 59 ½.

Distributions before age 59 ½ are subject to a 10 percent early withdrawal penalty as well as normal tax treatment on the distribution (as if it were a traditional IRA). Like the IRA, exceptions to these rules exist for a distribution for a first-time home buyer; distribution to a disabled taxpayer, or a distribution to a beneficiary on account of the taxpayer’s death.

The account balance is included in the taxpayer’s taxable estate. At death, the remaining distribution of the account is subject to the same rules as the traditional IRA. A surviving spouse as the beneficiary of the Roth IRA can treat the Roth IRA as her own.

Overview of Malta Pension Schemes (MPP)

The Malta Pension Scheme in many respects is a surrogate to the Roth IRA. A taxpayer can make an unlimited contribution to the Malta Pension Scheme. Unlike the Roth IRA, the taxpayer may make in kind contributions to the MPP through the contribution of the asset or an interest in an entity holding the asset.

The MPP is treated as a grantor trust from a federal perspective. As a result, the contribution of an appreciated asset will not trigger any tax consequences on the transfer of an asset.  The contribution to the MPP is not deductible. FIRPTA (IRC Sec 897) and effectively connected income to a U.S. trade or business (IRC Sec 1445) is not applicable because the trust is treated as a foreign grantor trust for tax purposes. As a result, of the foreign grantor status treatment, the MPP will avoid UBTI treatment of debt financed real estate and business income within the MPP. This is significant advantage in favor of the MPP.

Malta law permits distributions to be made from such plans as early as age 50.The rules allow an initial lump sum payment of up to 30% of the value of the member’s pension fund to be made free of Maltese tax. Based on treaty provisions, distributions that are non-taxable for Malta tax purposes are also non-taxable in the United States. Under Malta law, three years must pass after the initial lump sum distribution before additional lump sum distributions could be made to a resident of Malta tax-free. In Year 4, the MPP may distribute additional funds to the participant without triggering a tax liability. Lump sum distributions may be made every year after the second lump sum distribution each year. Fifty percent of the distribution is tax-exempt, and fifty percent is taxable.

Annual distributions may be taken beginning at age 50 and are taxed under IRC Sec 72 for U.S. purposes. Part of each distribution is treated as a return of principal and part of each payment is treated as ordinary income or capital gains depending upon the underlying asset.

U.S. Tax Compliance Requirements

Participation in the MPP requires compliance with the FinCEN reporting requirements for foreign bank and financial accounts. FinCEN Form 114 (Report of Foreign Bank and Financial Accounts) must be filed annually with the Financial Crimes Enforcement Network (FinCEN), a bureau of the Department of the Treasury.

Code Section 6038D, also enacted as part of FATCA, requires that any individual who holds any interest in a “specified foreign financial asset” must disclose such asset if the aggregate value of all such assets exceeds $50,000 (or such higher dollar amounts as may be prescribed).IRS Form 8938 is used to report specified foreign financial assets if the total value of all the specified foreign financial assets in which you have an interest is more than the appropriate reporting threshold. The filing threshold for a married taxpayer filing a joint tax return if the specified financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year. As a foreign grantor trust, the taxpayer will most likely be required to file Form 3520.

Summary

The Malta Pension Plan is a powerful vehicle to provide for substantial tax deferral in a manner similar to the Roth IRA. However, it has planning benefits that far exceed the Roth IRA. Namely, the plan is not handcuffed by the contribution limits of the Roth IRA or prohibited transaction rules that would otherwise limit the ability to own an interest in the taxpayer’s business. Additionally, the UBTI tax rules do not apply. Roth owners may contribute real estate with debt financing or business interests that produce active business income that would otherwise be treated as UBTI within a Roth IRA. FIRTPA for real estate holdings does not apply. The taxpayer may also contribute assets or business interests in kind. At distribution a substantial portion of the deferred income may be distributed without taxation in Malta or the United States. Taxpayers looking for a long-term tax deferral without contribution limitations and complicated tax hurdles such as UBTI, should consider the MPP as a planning structure for long term investments.