Ask an Expert: 5 Tips for Expats Investing in IRAs & Roth IRAs
By David Kuenzi, Thun Financial Advisors
The Wall Street Journal asked David Kuenzi of Thun Financial advisors for tips for U.S. expat investing in IRAs and Roth IRA accounts.
- Find out if you qualify: The U.S. Internal Revenue Service’s limit on annual IRA contributions — $5,500 ($6,500 for workers older than 50) or taxable earned income, whichever is less — applies equally to U.S. workers and Americans abroad with earned income. The catch for American wage earners abroad is that they are likely taking advantage of the Foreign Earned Income Exclusion and possibly the Foreign Housing Exclusion. If these income exclusions reduce the amount of taxable earned income to zero, no IRA contribution can be made. Americans abroad earning more than these exclusion amounts are eligible under U.S. tax rules to make IRA contributions.
- Make sure it makes financial sense to contribute: Even where an IRA contribution will result in lower U.S. taxable income, country-of-residence tax rules may negate the IRA tax benefit. For example, Americans living in a high-tax country such as Germany typically eliminate their entire U.S. tax liability through a combination of foreign tax exclusions and credits. If no U.S. tax is due, then making an IRA contribution only makes sense if it will reduce the taxpayer’s German tax bill. However, IRA contributions are not deductible in Germany. So no tax relief is achieved in either country. Furthermore, distributions from the IRA will still be taxable in the U.S. The net effect is double taxation – income contributed to the IRA is taxed when earned in Germany and will be taxed again by the U.S. when withdrawn.
- Check out local tax rules: In a country such as Switzerland, where local tax rules allow for the deductibility of U.S. IRA contributions, an IRA contribution often makes sense because it reduces the combined U.S. and Swiss tax bills. Similarly, in a low-tax jurisdiction such as Hong Kong, where higher-income Americans will be unable to eliminate their entire U.S. tax liability with foreign income exclusions and credits, an IRA contribution will reduce the amount of U.S. taxes due without creating any additional Hong Kong tax liability. As these examples demonstrate, the advisability of IRA contributions for Americans abroad must be considered country by country, case by case.
- Study the cross-border tax treatment of retirement accounts: Relevant rules are found in bilateral tax treaties between the U.S and more than 70 foreign countries. Tax treatment of IRAs and IRAs (as well as other types of pension plans) may or may not be specifically addressed in the applicable tax treaty. Even where the treaty does not explicitly permit the deductibility of U.S. IRA contributions, local tax rules in some countries may nevertheless permit this type of deduction.
- Consider Roth IRAs … carefully: Roth IRAs are also an option for Americans abroad. From a purely U.S. tax perspective, Roths are attractive because they permit invested amounts to grow completely free of U.S. tax (not just tax deferred as with a traditional IRA). Roth contributions are not permitted for single U.S. persons with Modified Adjusted Gross Income in excess of $114,000 ($181,000 for couples married filing jointly). However, U.S. taxpayers with incomes above threshold amounts are eligible for conversion of traditional IRAs to Roth IRAs. Roth conversion should be considered by expats who anticipate returning to the U.S. and retiring in a high-tax state; these individuals should consider converting traditional IRAs to Roth IRAs while still abroad when the converted amount may not be subject to state and local income tax. Pay attention to local tax treatment of Roths, however. Most countries do not grant tax-free status to Roth distributions. Therefore, post-tax contributions made to a U.S. Roth may be subject to double taxation – once when earned and again by a non-U.S. tax authority when withdrawn in retirement if the account holder is still abroad.
Mr. Kuenzi is the founding partner of Thun Financial Advisors, a U.S. investment firm based in Madison, WI, that provides investment management and financial planning services to Americans abroad.