Certain lump sum distributions from a Malta pension plan are also not taxed, either in the United States or in Malta. But the distributions cannot be made until beneficiaries turn 50 (unless they can show hardship). Because of the tax treaty between the two countries, the distributions from the plan that aren’t subject to taxation by Malta are likewise not taxed by the United States.
The business owner can receive a lump sum distribution of up to 30% of his or her assets in the plan free of Maltese tax. This payment is required to be made within one year of the owner’s chosen retirement date (which must be set between age 50 and age 75). At that point, annual annuity payments must be taken, and these are taxable as ordinary income in the U.S. In addition, each year (starting in the third year after the annuity begins), the participant can take additional lump sum distributions of as much as 50% of “overfunding” in the pension account. The overfunding is the excess of the balance in the plan minus what is enough capital to support a lifetime annuity for what is referred to as “sufficient retirement income” (in Malta, this is roughly 60,000 euros per year, indexed for inflation). This additional lump sum distribution can be made without triggering Malta or United States taxes.
This result seems tremendously favorable to U.S. taxpayers. Maybe even too good to be true. So be warned: There is a substantial risk that if too many lump sum distributions are taken, or if the annual annuity payments are too small, then the IRS will argue that the plan is not operated to provide pension benefits, and all the tax advantages in the U.S. would be lost.
Case Study
A 49-year-only entrepreneur owns shares in a company valued at $60 million. The cost basis of the business is $5 million. The entrepreneur resigns as a company director and puts these assets in a Malta pension plan while there is no contract or term sheet in place for the sale of the business. Over the first year in the plan, the assets are marketed and sold. The entrepreneur is now 50 years old and is able to take out 30%—$20 million—and there are no United States or Maltese taxes on this disbursement of funds.
The entrepreneur must now wait three years to take out additional lump sum payments that will not be taxed. How much the entrepreneur can withdraw is a function of the amount the plan holds. There must be “sufficient retirement income” in the plan. This number is based on the “annual national minimum wage” in the jurisdiction where the entrepreneur lives. If the plan has more money than the “sufficient retirement income,” 50% of the excess can be withdrawn tax-free each year.
If the remaining $40 million in the Malta pension plan grew to $55 million in year four and it was determined that $1 million was required to meet the sufficient requirement income criteria, then the entrepreneur can take out $27 million tax free. Under Malta law, each successive year the same math calculation is done and monies are distributed to the plan participant. Arguably these are tax-free, but contributors should check with their tax advisor each year to confirm that the benefits remain available.
The participant cannot receive all of the monies from the Malta plan tax-free. The annual annuity distributions will be taxed as ordinary income. And any amounts remaining in the plan are subject to the U.S. estate tax upon the participant's death. Still, a sizable percentage of the funds, including growth within the plan, can be distributed without any income taxes either here or in Malta.
Conclusion
Again, the Malta plan has great tax advantages over Roth IRAs. There are no contribution limits, and a wide variety of assets can be used to fund the Malta pension. This is especially appropriate for successful business owners with appreciated company equity.
While many tax professionals find Malta plans to be very effective in addressing taxes, there are still reasons to tread lightly. For example, it’s possible the U.S. Treasury may not have intended for these plans to be used to eliminate capital gains taxes on appreciated assets.
Also, some tax professionals are uncomfortable with using the Malta plans, noting that in certain situations they could be considered an abuse of the tax treaty and that they vary significantly from pension plans in the United States. In time, this might lead to modifications in the treaty that would eliminate its advantages for business owners.
So it’s essential for those clients considering these plans to consult with a tax professional. All the advantages and possible complications need to be clearly specified in any particular scenario. Only then will it be possible to make informed and intelligent decisions. Moreover, if there are any lingering concerns, it might be wise to get a second opinion.
Russ Alan Prince is president of R.A. Prince & Associates.