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One of the most common questions Americans face is how to invest for the future. When do you start saving? Where should you put your money?
For Americans living abroad, investing becomes even more complicated. Expat taxes are nothing if not complex, and how you structure your investment portfolio could have a major impact on your finances. Maintaining a tax-efficient portfolio requires careful planning.
Needless to say, many expats find the whole process daunting. The good news is that you don’t have to figure it out on your own. In this guide, we’ll help you cut through the confusion so you can make informed decisions on how you should be saving and investing for retirement.
Here’s what you need to know about the best investments for expats.
First things first: what do we mean when we talk about maintaining a “tax-efficient portfolio?”
Tax efficiency refers to how much of your return on investment (ROI) will be left over after you’ve paid your taxes on that return. To calculate this, simply follow these steps:
For example, let’s say you invest $1,000 in a bond that will give you a $100 return at maturity. That is ab ROI of 10%. However, because the tax rate for this bond is 25%, you will only get to keep $75. This means that your actual post-tax ROI is 7.5%.
Next, let’s say you bought 100 shares of XYZ Corporation for a total of $10,000. Eventually, you sell those shares for $11,000, yielding a gain of $1,000. Once again, this is an ROI of 10%. However, the capital gains tax on that return is 15%, leaving you with $850. This gives you a post-tax ROI of 8.5%.
In these examples, the XYZ Corporation stock is more tax efficient than the bond—8.5% compared with 7.5%.
Maintaining a tax-efficient portfolio means maximizing the post-tax return on all your investments. Americans living abroad must be especially careful when choosing their investments, as expat tax laws can be complicated with applied to foreign investments and financial accounts.
Expats also have to take the possibility of double taxation into account. In some cases, you may risk having to pay taxes twice on the same investment—once to the US government and again to your country of residence.
If you aren’t careful, expat taxes can add up fast, leaving you with an inefficient portfolio and disappointing returns.
Regardless of where you live in the world, there are normally three types of investment options to consider when investing. These are:
Let’s take a look at each.
Taxable investments are investments that do not offer any tax advantages. Common examples include US mutual funds and brokerage accounts.
While this may sound like a bad idea, there can be a number of advantages. These investments are often more liquid, meaning you can access your money faster. Taxable investments also tend to come with lower administrative costs and can be tailored to fit into your tax bracket with less tax accruing.
Tax-deferred investments are investments that allow you to save your return and pay any tax due later. Common examples include IRAs, 401(k)s, and other retirement accounts. This allows you to delay taxation for the investment income until you’re subject to a lower tax rate during retirement.
Currently, the US only allows tax deferment for US-based and US-established retirement plans. Foreign plans do not qualify for deferred-tax status, even if they are similar to US-style retirement plans (e.g., the Australian Superannuation plans).
Tax-free investments are investments where the return is free from US taxation. The most common example of this is a US municipal bond.
Americans who live in the US have a variety of great choices for efficient investments with low taxes and fees. For Americans living abroad, however, the options are a bit more limited. Most non-US retirement accounts are considered fully taxable investments, no matter how they are treated in your resident country.
So what are the best investments for expats? Unfortunately, the answer to that question will vary from person to person. There’s no one-size-fits-all solution. Your financial situation and tax requirements will determine what investments are best for you.
However, there are strategies that anyone can use to build a tax-efficient portfolio. Let’s look at some tips to help you make the right choices.
Before investing your money, you should have a clear goal in place. The most common reason for investing is to save for retirement. However, maybe you have other goals as well, such as adding to a college fund for your children.
Regardless of why you’re investing, you should decide how much you’re hoping to earn. (Be specific, too. “As much as I can” doesn’t count.)
Knowing how long you have to reach your goals will have a major impact on how your structure your investment portfolio. How many years do you have left to earn and save? This will be determined by what you’re saving for. For example, if you’re saving for retirement and you plan to retire in twenty years, that gives you a twenty-year timeline.
All investments come with some level of risk. However, not all are equally risky. Some are much safer than others. The amount you spend on a given investment will also determine how much of a gamble you’re making.
Deciding how comfortable you are with taking risks will make it easier to filter through your investment options.
One of the most important aspects of building a tax-efficient portfolio is understanding what taxes your investments will be subject to. Take the time to learn the specifics of each potential investment. This will help you rule out inefficient investments.
Once you know your goals, timeline, willingness to take risks, and any taxes involved, it’s time to decide which investments are best for you. After considering the above factors, you should be able to find investments that fit your priorities.
Of course, this is never a decision you want to make on your own. Consult a qualified financial advisor for reliable advice on how to invest your money wisely.
Knowing how your investment will be taxed by the IRS is an essential part of building a tax-efficient portfolio.
Most forms of investment are taxed as income or capital gains. They may also be taxed twice—in the US and your country of residence. Fortunately, the US has established tax treaties with many countries. These treaties are designed to ward off double taxation.
In addition to the numerous Us tax treaties, the IRS also provides several other potential tax credits and deductions for expats, such as:
Using these tax benefits, most expats are able to erase their US tax debt entirely.
Aside from income and capital gains taxes, there are several other types of taxes expat investors may be required to file. These additional filing requirements almost always require additional tax preparation costs to meet the obligations. While not a tax, the additional preparation fees increase your total expenses relating to foreign investments.
Here are a few of the most common.
As an expat, you have probably heard of the Foreign Account Tax Compliance Act (FATCA). This law requires US taxpayers to report certain foreign financial accounts, and offshore assets. It also requires foreign financial institutions to disclose certain information about financial accounts held or substantially owned by US taxpayers.
If you own non-US financial assets valued above certain thresholds, you must file a FATCA report. The specific threshold for your finances will depend on your filing status and whether you qualify as a bona fide resident of another country.
The Foreign Bank Account Report (FBAR) is a report most Americans living abroad are required to file—especially when making foreign investments. If you have at least $10,000 deposited in one or more non-US financial accounts, you will need to report it by filing an FBAR.
Depending on how you structure your investments, the IRS could classify your portfolio as a Passive Foreign Investment Company (PFIC). This happens most commonly when investing in non-US brokerage accounts, such as mutual funds.
In most cases, the income from these types of investments must be reported using IRS Form 8621. In fact, you would need to file a separate form for each account that is considered a PFIC.
Note: There are some special elections you can make to defer the tax. Consult an expat tax professional to learn more.
The Net Investment Income Tax (NIIT) is a tax that applies when your net investment income exceeds certain thresholds. The rate for this tax is 3.8%. If your investment income meets the standards of the NIIT, you must report it by filing IRS Form 8960.
We hope this guide has helped you understand how to determine the best investments for expats. However, creating a tax-efficient portfolio as an American abroad is a complicated process. It takes plenty of time, patience, and know-how. Choosing the right financial adviser to help you could make all the difference. You need someone who understands the intricacies of expat taxes and foreign investing.
We can help.
At Greenback Expat Tax Services, we specialize in helping expats manage their US tax obligations and optimize their financial strategies. Just contact us, and our team of CPAs and IRS Enrolled Agents will be happy to answer any questions you have.
We can even prepare your expat taxes on your behalf!
Learn more about our services and flat-fee pricing to file your expat taxes.