Planning for retirement is something everyone should be thinking about, regardless of age – and if you’re a US expat, there are additional factors involved that you’ll need to consider related to your expatriate taxes. Fortunately, when it comes to retirement funds, there are a number of methods for saving money so you won’t have to worry when the time comes to retire and enjoy a new season of your life. Here, we will break down qualified retirement plans – ones that are approved by the IRS and that give you a tax benefit from contributing toward them.
Determining the Best Retirement Fund for Your Situation
When it comes to picking the best retirement fund as a US expat, you’ll need to consider your employment status – are you an employee, self-employed, an employer of many – or unemployed? Next, you should determine what type of income you have – either earned or unearned:
- Earned: A salary, wages and other income earned through a job, work or services performed.
- Unearned: Money you receive without ‘working’ for it. This would be passive income (interest, dividends and capital gains), in addition to things like retirement account distributions, social security benefits, unemployment contributions, gambling winnings and more. You can find more information about unearned income on our blog.
Generally speaking, most US qualified retirement plans require that you have earned income in order to contribute to them. If your income is unearned or from passive sources, you aren’t able to contribute to a qualified retirement plan as a US expat.
Special Considerations a US Expat Will Need to Make
Contributing to any qualified retirement plan in which you’ll receive a tax benefit (now or in the future) will need to be done with income that hasn’t been excluded from your US expat taxes. Essentially, this means you cannot use income that you’ve excluded on your US Tax Return with the Foreign Earned Income Exclusion (FEIE), as this would be considered a ‘double dip’ of tax benefits with the same income by the IRS. This limitation includes contributions to a ROTH IRA (which we’ll discuss below), even though there is no deduction on your tax return for it. If your income is greater than the FEIE, you may be able to contribute to a qualified retirement plan.
If the country in which you reside has a tax rate that is close to or higher than the US, you should consider the option of filing your US expat tax return with only the Foreign Tax Credit (FTC) and not using the FEIE. This will likely allow you to still have a zero tax due return, while allowing you to contribute to a US qualified retirement plan. However, forgoing the FEIE does have some tax implications. If you’ve taken it in a prior year, you will be unable to take the exclusion for five years, and once that period has passed, you must apply and gain approval to take it again. Note that this shouldn’t be an issue for a US expat who lives in a country with a high tax rate and who has little or no US-sourced income.
If the country in which you live has little or no income taxes, forgoing the FEIE may not be a good idea for your situation – this could leave you with more taxes than contributions to a qualified retirement plan would compensate for. If your income exceeds the FEIE, you would be able to contribute to a retirement plan with the excess earned income, within plan contribution limits.
Also, it’s important to note that your country of residence may not recognize your contributions to a US qualified retirement plan as an income deduction and you may be required to pay taxes on that income in the country. As a US expat, you should do your research and understand the tax laws in your host country before you make contribution decisions.
Expat Retirement Planning: Type of Retirement Accounts
So, what type of retirement account should you contribute to? You’ll find you have several options from which to choose, each with its own benefits and drawbacks, depending on your employment status and what your present and future (expected) tax rates will be. Here are your options:
- IRAs: Traditional and ROTH
- 401(k): Traditional and Solo 401(k)
- SEP (Simplified Employee Pension)
- SIMPLE IRA
If you’re employed (not self-employed), you have the ability to contribute to a traditional or ROTH IRA, or an employer set-up 401(k) or SIMPLE IRA. In most cases, if you have a foreign employer, you may not have a 401(k) or SIMPLE IRA option, since these are set up within US boundaries. You can learn more about these retirement options on the IRS website.
Traditional or ROTH IRA?
You may be wondering what the difference between these two types of IRAs are – well, the primary discrepancy is at what point you’ll be taxed on your money. While a traditional IRA taxes you on your money in the future (when you withdraw funds), a ROTH IRA taxes you on your funds now. Determining the best option will require a bit of strategic thinking.
- If you’re a younger US expat at the beginning of your career, your tax rate might be lower than in the future (when you have strong investments and retirement income). In this case, a ROTH IRA would be a better option.
- If you’re an older individual, investing your money at the peak of your earning potential (therefore at the highest tax rate), contributing to a Traditional IRA would benefit you more greatly since you’ll receive a tax break now when your tax rates are the highest.
- If you’re self-employed or own a small business, there are several options for you. You could contribute to an individual IRA (Traditional or ROTH), or set up a retirement account for your company, like a SIMPLE IRA or Self-Employed Plan (SEP). By setting up a retirement plan for your small business, you would be able to contribute as an employee in addition to an additional ‘employer’ amount.
Each plan has its own specific rules and restrictions, so it’s a good idea to consult with an expat tax professional to discuss your individual tax situation and make the best investment decision for you. For more expat tax advice, download a US expat tax guide for your particular situation.
Not Sure What Type of Retirement Account Is Best for You as a US Expat?
Our team of expat-expert CPAs and IRS Enrolled Agents can help you understand how your investment options will affect your US expat taxes – contact us today and get the details you need to make an informed decision.