Managing Your US Retirement Account Abroad and the US Income Tax Implications

Managing Retirement Accounts and US Income Tax Impact

If you have worked in the United States, it is likely that you have paid into a US retirement account such as an IRA (Individual Retirement Arrangement) or a 401k (a company-sponsored retirement plan). The question is: once you give up US residency, what should be done with your retirement account from a tax standpoint? Clearly, you want to choose an option that suits your needs without paying unnecessary US income tax or early-withdrawal penalties that can significantly reduce your hard-earned savings.

Typically, you have three options for managing your IRA or 401(k) retirement plan:

  1. Transfer your savings to another type of retirement account
  2. Withdraw and distribute the money
  3. Leave your funds in the current account

Let’s take a closer look at each of these options for Americans living overseas.

1. Transfer your savings to another retirement account

In an ideal world you would have complete cross-border portability for your US retirement account such that you could transfer the funds without tax consequences to an equivalent account in your new country of residency. Unfortunately, US income tax regulations typically do not allow such transfers.

While you can sometimes transfer from one type of US plan to another without tax consequences (such as from a 401k to an IRA), it is usually not possible to transfer from a US plan to a non-US plan; with the possible exception of some specially-structured corporate pension plans. Since these are not available to most Americans abroad, the majority will want to consider distributing their funds or leaving their funds in the current account.

2. Withdraw and distribute your retirement funds

With this option, you could withdraw the funds in your US plan and do what you like with the proceeds. US retirement plans are quite flexible in terms of allowing access to one’s funds. Unlike retirement and pension accounts in many other countries that may allow only limited lump-sum withdrawals and only once a certain age is reached, you can access any or all of the funds in a US IRA at any time. Other types of US plans, such as deferred compensation plans or defined benefit plans are less flexible.

401(k) Withdrawal Overseas

If you have a 401k account from a former employer, this can be transferred to an IRA (“rolled over”), at which point the funds can be accessed easily.

Disadvantages of Withdrawing Funds

The downsides of withdrawing the funds from your retirement plan are that you lose the tax-deferral benefits, which may be substantial over time and the distributed funds may be subject to taxes. There is also the possibility for a 10% penalty for early withdrawal if you are under age 59½.

Taxes are typically due on amounts that have been contributed pre-tax to 401k and Traditional IRA accounts and on the earnings in these accounts. Roth IRAs and Roth 401ks are funded with after-tax money and therefore there is no US income tax to be paid when funds are withdrawn.

US accounts also typically offer substantial investor protection in the form of insurance against the default of the financial institution holding the account. Such protection may be much more limited or even non-existent in other countries, especially many offshore jurisdictions.

3. Leave your retirement account alone

The third option is to leave the account as is, to be accessed as the need arises in retirement or otherwise once early withdrawal penalties no longer apply. This is the best option for many people, but the issue non-US residents often face is that their US retirement plan administrator may not be willing to deal with them now that they no longer live in the United States. Many brokerage firms will insist that you close your account once you are no longer a US resident. Or they may allow you to retain the account but will not allow management of the investments–in effect freezing the account. More American expatriates are turning to firms that specialize in investment management for non-US residents in order to deal with these issues.

Look out for currency risk

Apart from the administrative issues faced by leaving the account as is, another concern may be currency risk. Typically US retirement accounts are invested mostly in US Dollar denominated investments, but if you reside outside the USA you may eventually spend the funds in another currency. This can introduce significant currency risk in addition to the investment risk you may already be assuming. For example, someone with a US-based retirement account who moved abroad at the beginning of 2002 but left their investments in USD denominated assets may have suffered significant loss of purchasing power over the next ten years as the USD weakened by 33% vs. the Euro, by 11% vs. the British Pound, by 38% vs. the Canadian Dollar, and by 50% vs. the Australian Dollar.

Clearly it is important to consider currency risk if you may eventually be spending your retirement funds in a currency different from that in which they are invested. Many US brokerage firms and investment advisors do not consider this and maintain only a minimal allocation to non-US investments. Also, retirement accounts such as 401ks typically only offer very limited non-US investment options so it may be to your benefit to terminate such plans once you are no longer a US resident and move the money to an IRA where it can be more globally diversified.

Consider your tax status

One final consideration is the tax status of your US retirement account in your current country of residency. The United States has income tax treaties with many countries that allow for mutual deferral of taxation on certain types of retirement and pension accounts. However, there are also many countries that do not have a tax treaty with the USA, or where the tax treaty only applies to certain types of US tax-deferred accounts and not to others. In this case, your US tax-deferred account may not be tax-deferred in your country of residency.

Ultimately, the choice is yours as to how to handle your account based on your individual circumstances. The important thing to remember is that US retirement accounts such as IRAs and 401ks typically cannot be moved to an equivalent account in a different country without distributing the accounts for tax purposes and paying US income tax and possibly early withdrawal penalties. For this reason it is often best to keep the money in a US retirement account to be drawn on as needed. If you do plan to keep the US account, consider the currency risk and whether the account maintains its tax-deferred status in the country of residency. If you have any questions about the account’s status, it’s important to consult professional investment advisor to ensure you aren’t hit with unexpected taxes that devalue your retirement savings.

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Tom Zachystal, CFA, CFP is President of Individual Asset Management (IAM), a Registered Investment Advisor specializing in investment management and financial planning for expatriates.

This article is for informational purposes only; it is not intended to offer advice or guidance on legal, tax, or investment matters. Such advice can be given only with full understanding of a person’s specific situation.