The prospect of moving abroad to teach can be very tempting to a lot of US teachers. Learning about a new culture, living in a different country, and earning more than you might while in the US are all good reasons to pack your bags and hop on the next international flight. While your new exotic life may be at the top of your mind, retirement planning may not be when you are getting accustomed to a new job or culture. But decisions you make now could affect your pension and retirement options down the road. So, read on to find out everything you need to know about retirement plans for international teachers.
1. Teaching Internationally? A Foreign Retirement Plan May Not “Pay Off”
For international teachers and other expats, the IRS does not consider most foreign pension or retirement plans to be “qualified” plans. This means that any money you put into the plan will not be tax-deferred, and any earnings in the account are not tax-exempt.
Depending upon the type of account, the reporting requirements to the IRS can be quite cumbersome. Foreign mutual funds, or a similar type of pooled investment, can be considered a Passive Foreign Investment Company (or PFIC). PFICs have a considerable filing requirement (take a peek at Form 8621) that will cost you both time and additional fees when you file your tax return. You will need to report the income from the account on your return (even if you don’t withdraw it from the account), and this income can be taxed as high as 37% on your return. Pretty steep!
Additionally, many of these retirement plans—depending on your level of control, contribution level, and/or income amount—can also trigger reporting on Forms 3520 and 3520A, which are information returns for a foreign grantor trust, which is what the IRS considers many of these arrangements. Like the PFICs, these forms can greatly increase the cost and complexity of your tax return.
2. Just Because You’re Abroad Doesn’t Mean Your Money Has to Be!
The good news is that if you are an overseas teacher, you can still save for retirement even if you don’t invest in a foreign plan. You have several different options for American teachers abroad that will help you pad your nest egg. First, you need to know whether or not you are working for a US company. If you are working for a US company, and they offer a 401(k) or similar type of plan, then you don’t have to worry about foreign considerations. All contributions you make to the US-based plan will be made before you are taxed on your income, and should be reflected on your W-2 at the end of the year.
If you have a foreign employer, you have a few different options listed below.
3. Contribute to an IRA
An Individual Retirement Arrangement (IRA) comes in two forms. A traditional IRA gives you a tax benefit in the year you contribute to the plan. A ROTH IRA gives you a tax benefit in the year you take distributions from the account. For 2020, you can contribute up to $6,000 ($7,000 if you are age 50 or older) into your IRA accounts (this is a total amount for all your IRA accounts).
There is a limit to the amount of IRA deduction you take if you are covered by a qualified retirement account at work. Qualified retirement accounts do not include foreign retirement or pension accounts. For international teachers without a qualified retirement account, there’s no limit on what you can deduct from your tax return.
4. Set Up an Individual 401(k)
International teachers can set up a 401(k) plan to save for retirement through many different types of brokerage houses. You can contribute up to $19,500 ($26,000 if you are age 50 or older) for 2020. This type of account allows you to be the employee and employer. Funds contributed to this account would be tax-exempt. When you begin to take distributions from the account, the principal and interest would be taxable income to you.
Please note that contributions to retirement accounts in #1 & #2 require the funds to be post-FEIE (Foreign Earned Income Exclusion). So, if you are using the FEIE and all your income has been excluded, you cannot contribute to these accounts.
5. Contribute to a US Mutual Fund with Tax-Exempt Investments
Contributions to US mutual funds that invest in tax-exempt municipal bonds or other tax-exempt investments may not give you an immediate tax advantage, but when the bonds mature, you will have income that is tax-exempt.
6. International Teachers May Have to Contribute to a Foreign Retirement Plan
You may have to start thinking about retirement funds now if a contribution to a foreign retirement account is required by the country you are working in because it has a tax treaty with the US. There are several countries where contribution to the country’s retirement plan or pension fund is mandatory for international teachers.
The good news is that these countries are generally covered under a tax treaty with the IRS. Here are some of the more common countries for international teachers, along with key facts about their retirement plans:
United Kingdom – Pension contributions made through your employer are covered by the tax treaty with the US and are not included in your taxable income. When you withdraw the funds, you will need to pay US tax on the distributions.
Australia – The mandatory employee retirement fund is called superannuation, or as the locals fondly call it, “supa.” Superannuation contributions need to be included in your income, and your employer’s portion also needs to be included in your income. The employer’s portion is not eligible to be excluded using the FEIE, but it is eligible for the foreign tax credit. Since Australia’s tax rate is generally higher than that of the USA, the credit generally covers any excess taxes on the added income.
Switzerland – Switzerland’s retirement planning is called the pillar system. There are three tiers. The first tier is the mandatory social security type contribution, and not reportable to the IRS or FinCen. The second tier is the voluntary employee-employer pension plan. The third tier is the private pension fund, one that is funded entirely by the employee. The second and third tiers are the retirement plans where international teachers may be making contributions. These accounts are not qualified, and not only the funds but also the earnings on the account are reportable on your US return.
7. Your Retirement Plan Affects Your Expat Taxes
When you are dealing with a foreign pension/retirement account, there are some reporting considerations you will need to make. If the account is a PFIC, Form 8621 will need to be included with your tax return. You will also need to make sure to include the accounts on your FBAR (FinCen 114) and FATCA Form 8938 reporting forms. Fortunately, the amounts that overseas teachers contribute and report on their US tax return will form a basis for you in the accounts. This basis will be considered “already taxed income” and will be subtracted from any distributions you take from the account in the future.
8. Additional Opportunities for International Teachers to Save!
Perhaps the biggest advantage you have when you work overseas is the FEIE. This exclusion allows overseas teachers to exclude up to $105,900 (for 2019) and housing expenses from your foreign earnings. The savings you have on your US taxes teaching abroad can help you to build a savings account. Many overseas teachers are in countries where there is little to no local tax, and many also have a low cost of living. If your income is below the exclusion amount for the year, you essentially have tax free income. This type of income is as good as or better than a retirement plan as you have an immediate tax advantage. So while it is easy to wait to put money away or spend it on a fun weekend trip, putting some away now will always pay off.
In this digital age, where more and more US citizens are branching out internationally with their employment, there are many more things to consider, particularly from a financial perspective. In addition to choosing a good place to set your hat, you should also look to protect your future financial well-being by choosing a retirement plan that’s right for you!
Sound Complicated? We Can Give You the Best Tax and Retirement Advice for International School Teachers.
Editor’s note: Originally published October 21, 2015; updated on February 7, 2020.