American Expat Financial Problem: Should Americans abroad keep their cash and investments in the U.S., country of residence or off-shore?

2017 Guide to Investment Management and Financial Planning for Americans Abroad

Americans abroad often end up investing through financial institutions in their place of residence or in popular financial centers such as London, Switzerland or Hong Kong. This is especially true when living abroad becomes a permanent or semi-permanent situation. However, when a full accounting is made of all factors that need to be considered, investing through non-U.S. financial institutions is almost always a costly mistake for Americans. Why?

1) Fees:  Whether one chooses to go with a large reputable investment bank headquartered in Switzerland or venture into the world of “off-shore” banking, a large part of an investor’s potential gain will be consumed by the very high fees charged by non-U.S. financial institutions. These fees are high everywhere in the world, but they are still much lower in the U.S. than anywhere else. A recent study in the Review of Financial Studies  of mutual fund fees by country found that among 18 developed European, American and Asian markets, fees in the U.S. were by far the lowest. For example, average expenses for mutual funds sold in Switzerland, the UK and Canada were 43%, 50% and 279% higher, respectively, than in the U.S. The numbers are especially striking for money market funds, where returns are very low to begin with: Swiss money market fund expenses average 1.14% while in the U.S. the average was 45% less.1 If an investor goes further afield into the world of “offshore” investing (in places such as Lichtenstein, Cyprus and the Cayman Islands) fees, commissions and transaction cost will be even higher than already costly European investments.

2) Investment access and liquidity: U.S. financial markets provide greater global investment access and liquidity than any other market in the world. There is virtually no investment anywhere in the world that cannot be bought easily and inexpensively on U.S. markets. For example, almost every publically traded company in the world lists its shares for trade on U.S. exchanges as well as in their home country. The vast and competitive U.S. fund industry makes virtually every global asset class open to investment through U.S. accounts, efficiently and at relatively low cost. Liquidity for investments such as ETFs (Exchange Traded Funds), global stocks, bonds and commodities is higher in the U.S. than other global financial centers. High liquidity reduces transaction costs and raises long-term rates of return on investments.

3) Taxes: Taxes are the next big reason that Americans should stay away from non-U.S. registered investments. Long-term investors in U.S. securities benefit from a low capital gains tax rate (15-20%). Additionally, taxes are paid on a deferred basis (only when the investment is sold). For U.S. taxable investors, neither of these significant tax advantages apply to investments in mutual funds, hedge funds or other kinds of pooled investments not incorporated in the U.S. Rather, such non- U.S. securities are classified by the IRS as Passive Foreign Investment Companies (PFIC) and are subject to a special, highly punitive tax regime (see box, p. 6). PFIC rules can easily push tax rates on investment income to as high as 60-70%. Furthermore, the new FATCA legislation (see box, p. 9) dramatically increases the ability of the IRS to enforce compliance with these rules and ratchets up penalties for non-compliance.

4) Reporting: The complexity of the U.S. tax code makes year-end accounting statements provided by U.S. brokerages invaluable. U.S. brokerage firms like Schwab and Fidelity supply their clients with detailed banking activity reports in the required IRS format segregating dividends, qualified dividends, taxable and non-taxable interest income, and short and long-term capital gains, to name only the most important categories, each of which requires distinct tax treatment. Non-U.S. institutions generally do not provide this kind of detailed reporting.

5) Compliance: If cumulative assets held by an American citizen at financial institutions outside the U.S. at any time exceed $10,000 they must be reported to the U.S. Treasury for that year. In addition, financial assets held at non-U.S. financial institutions exceeding $50,000 ($300,000 for U.S. taxpayers not resident in the U.S.) must now be on annual U.S. tax returns as a result of FATCA. Both the taxpayer and the non-U.S. financial institution must report on assets held by U.S. citizens. Filing the required documentation may increase the likelihood of an IRS audit. Penalties for not filing are severe and IRS resources being directed at enforcement have increased significantly in recent years. (See the corresponding boxes on PFIC (p.6) and FATCA (p.9)).

6) Safety: Regulatory standards in global banking centers range from very high (Switzerland) to almost non-existent in some of the more exotic off-shore banking locales. FDIC deposit and SIPC investment insurance automatically cover all U.S. accounts, but are unavailable for non-U.S. accounts.

Recommendation: Keep investment accounts in the U.S. and bank accounts in country of residence

For the reasons discussed above, we advise American citizens to maintain investment accounts in the U.S. In addition, Americans abroad should open local bank accounts in their country of residence. Local income and living expenses should be managed through this local account to avoid the expense of constantly converting between currencies. Money allotted for savings and investment, however, should be moved to the U.S. account and invested.

Download the complete 2017 Guide to Investment Management and Financial Planning for Americans Abroad