Hungary Pension System and US Tax Implications: IRS Overview

Hungary Pension System and US Tax Implications

Hungary Pension System and US Tax Implications 

Hungary Pension System and US Tax Implications: The United States and Hungary have entered into a bilateral international tax treaty. The tax treaty impacts the way various matters are handled when it comes to US Persons or Hungarian Persons who have income generated either sourced in the other country — or as a resident of the other country. The treaty provides information regarding how pension is taxed — but due to the saving clause there is some tax implications that may not be foreseen by taxpayers receiving pension from either country when evaluating the treaty — it depends on where their country of residence is, and the source of the income. Let’s go through the basics of the Hungarian Pension System and how US persons earning pension from Hungarian sources may be impacted.

How the Hungary Pension System Works

As summarized by the SSA:

• • • In 1997, reform laws created a two-pillar social security program, replacing the traditional pay-as-you-go (PAYG) defined benefit system then in place.  Starting in January 1998, the new program consists of two main social security systems:

      • a first pillar unfunded PAYG contributory system, and

      • a second pillar fully funded individual account Mandatory Pension Fund (MPF) system.

    • Under the new rules, all workers new to the workforce or age 42 or younger had to participate in both systems. 

    • Workers older than age 42 on June 30, 1998, and those having Hungarian coverage before that date, could choose whether to contribute only to the PAYG system or contribute to both. 

      •  However, on December 13, 2010, the Hungarian Parliament passed a law moving workers out of the MPF and transferring their entire account balances to the PAYG pension system.  Workers could choose through January 31, 2011 to remain in the MPF. 

Hungary follows a 2-pillar pension system.

As summarized by the SSA:

• • • Hungary pays social security benefits to workers who meet the applicable eligibility standards, including minimum length of coverage and other requirements. 

    • Under Article 8, Hungary will add a person’s U.S. coverage to his or her Hungarian coverage, if necessary, to meet eligibility rules.  If the person meets the requirements based on combined U.S. and Hungarian credits, Hungary will pay a partial benefit proportional to the amount of coverage credited under the Hungarian system.

Saving Clause in Hungary/US Tax Treaty

• • • Except to the extent provided in paragraph 5, this Convention shall not affect the taxation by a Contracting State of its residents (as determined under Article 4 (Resident)) and its citizens. Further, except to the extent provided in paragraph 5 and notwithstanding the other provisions of this Convention, a former citizen or former long-term resident of a Contracting State may, for the period of ten years following the loss of such status, be taxed in accordance with the laws of that Contracting State.

    • The provisions of paragraph 4 shall not affect:

      •  a) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), paragraphs 1 b), 2, and 3 of Article 17 (Pensions and Income from Social Security) and Articles 23 (Relief From Double Taxation), 24 (Non-Discrimination), and 25 (Mutual Agreement Procedure); and

      •  b) the benefits conferred by a Contracting State under Articles 18 (Government Service), 19 (Students and Trainees), 20 (Professors and Teachers), and 27 (Members of Diplomatic Missions and Consular Posts), upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State.

    • While the saving clause limits the application of the tax treaty, paragraphs 1b, 2 and 3 are exempted from the Saving Clause.

Article 17 Pensions and Income From Social Security

• • • 1.

      • a) Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State.

      • b) Notwithstanding subparagraph a), the amount of any such pension or remuneration arising in a Contracting State that, when received, would be exempt from taxation in that State if the beneficial owner were a resident thereof shall be exempt from taxation in the Contracting State of which the beneficial owner is a resident.

    •  2. Notwithstanding the provisions of paragraph 1:

      • a) payments made by the United States under provisions of the social security or similar legislation of the United States to a resident of Hungary shall be taxable only in the United States; and

      • b) payments made by Hungary under the mandatory pension scheme of Hungary to a resident or citizen of the United States shall be taxable only in Hungary.

    • 3. Where an individual who is a resident of one of the States is a member or beneficiary of, or participant in, a pension fund that is a resident of the other State, income earned by the pension fund may be taxed as income of that individual only when, and, subject to the provisions of paragraph 1, to the extent that, it is paid to, or for the benefit of, that individual from the pension fund (and not transferred to another pension fund in that other State). resident of one of the States is a member or beneficiary of, or participant in, a pension fund that is a resident of the other State, income earned by the pension fund may be taxed as income of that individual only when, and, subject to the provisions of paragraph 1, to the extent that, it is paid to, or for the benefit of, that individual from the pension fund (and not transferred to another pension fund in that other State).

What does Paragraph (1a) Mean?

It should be noted that the Hungarian pension system has undergone significant changes over the past ten years — with some taxpayers still having MPF and other having alternate versions of private pension dating back many years; paragraph 1(a) is not exempt the saving clause. Therefore, while the general proposition is that pensions are only taxable in this state of residence of the Taxpayer, since it is not exempt from the saving clause — either country would still have the right to tax the pension as they would ordinarily tax pension — but limited, based on the remainder of article 17 which is exempt from the saving clause.

What does Paragraph (1b) Mean?

Paragraph 1(b)provides that if the pension or other renumeration would have been exempt in one country had the taxpayer been a resident of that country when they were receiving, then it will still be exempt in the other country they are residing in.

What does Paragraph (2a/2b) Mean?

This stands for the proposition that when it involves US Social Security, even if it is being paid to a resident of Hungary, it is only taxable by the United States. Conversely, when payments are being made by hungry regarding the mandatory pension scheme to a person who is a resident of the United States — it is still only taxable in Hungary.

What does Paragraph (3) Mean?

This means that when a person is a resident of one country but participates in a pension fund that is a resident of the other country, that income earned by the pension fund in the other country can only be taxed as income (subject to paragraph one ) when it is paid out and not transferred to another fund in that same country.

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