How 401k is taxed in Madrid under the tax agreement with USA

How Spain taxes 401(k) withdrawals for residents in Madrid

Once a person becomes tax-resident in Spain, including any autonomous region, withdrawals from a U.S. 401(k) are treated as general taxable income. Each distribution is added to the Spanish personal income tax base and subject to progressive IRPF rates. Large withdrawals can place the taxpayer in higher tax brackets, meaning timing and structuring of withdrawals become crucial for tax-efficient planning.

Even if the individual never paid U.S. tax on contributions because they were deferred in the U.S., Spain taxes the full amount of the withdrawal once it is received. Spain does not apply the U.S. concept of tax-deferred treatment for pension plans; instead, it views the 401(k) payout as ordinary income. For Spanish residents, understanding this difference is key to preventing unexpected tax liabilities.

Tax treaty coordination between Spain and the USA for 401(k) plans

The Spain–USA Double Tax Treaty provides essential clarity for private-sector pensions such as 401(k) distributions. Under the treaty, 401(k) benefits are generally taxable in the country of residence, meaning Spain has primary tax rights over distributions received by Spanish residents. For most non-U.S. citizens, the United States does not tax these distributions once Spain taxes them, as specified in our website, under the treaty.

U.S. citizens, however, remain subject to U.S. taxation under citizenship-based tax rules even while living in Spain. In those cases, individuals may offset the Spanish tax through a foreign tax credit on the U.S. return and vice-versa if applicable. For both citizens and non-citizens, the treaty remains the central instrument ensuring that pension withdrawals are not fully taxed twice.

Wealth tax considerations for 401(k) holders in Madrid

Spanish Wealth Tax may apply when a taxpayer’s net wealth exceeds the threshold established by law. The full value of a 401(k) is generally included in the wealth tax base once the taxpayer is legally allowed to access the funds. Depending on residency in a specific Madrid, thresholds and tax rates differ substantially, which can have a major financial impact on pension holders.

If a resident of Madrid has accumulated significant 401(k) assets, proactive wealth tax planning becomes important. Some individuals may rebalance or partially withdraw funds over time to reduce the total balance subject to the tax. Each Madrid uses its own scales and allowances, so the same 401(k) balance may be taxed differently depending on where the resident lives in Spain.

Regional income tax variations in Madrid

While Spain applies national income brackets, each Madrid sets its own additional marginal rates. This means that two residents with identical 401(k) withdrawals may face different tax outcomes if they reside in different regions. Some Madrid regions apply lower top marginal rates, whereas others apply higher rates, especially for high-income taxpayers.

Understanding the regional tax scale in Madrid is key to optimising withdrawals. In cases where retirees have flexibility to relocate within Spain, moving from a high-tax region to a lower-tax region may result in considerable tax savings on 401(k) distributions and wealth tax exposure. Planning should ideally be conducted before distributions begin.

Reporting and compliance obligations for 401(k) accounts

401(k) plans do not normally need to be declared on Modelo 720 as long as the plan remains a qualified U.S. employer pension. However, all distributions must be reported on the Spanish income tax return, and taxpayers should maintain evidence that the account is a qualified plan to avoid reclassification. Reporting obligations also apply on the U.S. side, including Form 8938 and FBAR when thresholds are met.

For U.S. citizens, claiming a foreign tax credit on IRS Form 1116 is often necessary to avoid double taxation. For non-U.S. citizens, filing requirements may be reduced once Spain taxes the distribution as the residence country. With the correct planning, Spain–USA treaty protections and foreign tax credits ensure tax efficiency for individuals retiring with a 401(k) while resident in Spain.

To receive personalised international tax advice, contact us via the following link: http://wa.me/34644121802