How U.S. expats can plan their retirement
Retirement planning is crucial for every citizen, even for US Expats living and working overseas. If you are one of them, you need not worry on how you can secure your retirement living in a different country. You have access to a huge variety of international savings and investment plans. Amongst a number of different options, Roth IRA would be the best one to consider for a number of reasons. Let us see why, but before that let’s understand the difference between traditional IRA and Roth IRA.
Difference between Traditional IRA and Roth IRA
– How they are Taxed: In traditional IRA, you get a tax deduction for the contributions you make throughout the year. However, you will have to pay taxes in the future whenever the money is withdrawn. With Roth IRA, you just have to pay current tax rates on all your contributions and the distributions will be tax free.
– Mandatory Age to Withdraw the Funds: For traditional IRA, you must start making withdrawals by the age of 70½, whereas there is no such mandatory distribution age with a Roth IRA.
– Income Requirements: You can open and maintain a traditional IRA, regardless of the level of your income. On the other hand, a Roth IRA is reserved for individuals who earn less than $110K per year.
Why is Roth IRA Preferred over Traditional IRA by Expats
– More Financial Flexibility
One of the main reasons for creating a retirement account is to ensure that there is an income for your future, especially for situations where you need access to an emergency fund, like a sudden medical, educational or home-related emergencies. You can do that with traditional IRA but you will have to pay heavy penalties. In the case of Roth IRA, once it has been open for 5 years, you can avoid paying heavy penalties when you need to make an early withdrawal for any emergency.
– Short Term and Long Term Savings
If you are a US Expat, you will be qualified for the Foreign Earned Income Exclusion or FEIE and/or the Foreign Tax Credit. Both of these allow you to claim foreign income or foreign paid taxes to deduct from your US tax liability. In most cases, you would find that you would owe no US taxes once you claim these deductions, which means that you can escape tax liability completely. However, there is a catch to this rule — you have to earn more in a fiscal year than you were able to deduct with the FEIE in order to deposit your foreign earned income into your Roth IRA. Although, other deductions will be available to you as a US Expat that will help in minimizing your tax liability allowing you to pay fewer taxes than what you would have to pay with a traditional IRA.
Another benefit of Roth IRA is that you are eliminating the possibility of being taxed at high tax rates when you need to make contributions. With fluctuating tax rates, you can never be sure of how much you would have to pay in case of emergency contributions in the future.
Explore Tax-Advantaged Retirement Accounts
As a taxpayer, you can manage the tax impact of your investment strategies. If done properly, tax management can add up to 3% of total annual return to your stock portfolio. This would allow you to add an additional 100% of total return to your investment account in 24 years, simply by making good strategic tax choices. There are numerous tax exempt or tax deferred investment accounts that you can choose for long-term investment success. As an expat, you must take advantage of these opportunities but make sure you completely understand how they work.
Consult with a well-qualified international advisor if necessary. Avoid non-U.S. retirement accounts (unless recognized as US qualified by a bilateral tax treaty) as they don’t have special tax status offered by IRS and there will be PFIC taxation on the same. Finally, understand how the country of residence tax law treats US retirement accounts.
By Rick Pendykoski
About the author: Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last 10 years has turned his focus to self-directed accounts and alternative investments.
Rick regularly posts helpful tips and articles on his blog at SD Retirement as well as MoneyForLunch, Biggerpocket, SocialMediaToday, WealthManagement, SeekingAplha, and NuWireInvestor.