Living in a foreign country brings about unique challenges and opportunities when it comes to retirement planning. One such challenge faced by Americans planning on retiring abroad is navigating two different financial and tax systems.
In this article, we will explore the essential considerations and strategies that can help Americans living abroad overcome these challenges and make the most of their retirement.
We will cover:
- Where to save and invest
- The pillars of retirement income
- Currency considerations
- Understand tax implications
- Healthcare coverage
- Estate planning
Where to save and invest
Living abroad can offer different retirement savings options compared to those available in the United States. While traditional IRAs and 401(k)s offer tax advantages for US residents, contributions to 401ks may only be possible if working for the US branch of your company since these are US corporate retirement accounts, and IRA contributions are limited and only possible if you have US taxable income.
If you already have an existing IRA or 401k before moving abroad, then the taxation of distributions from it when the time comes will be subject to the tax treaty between the USA and your country of residency. Most tax treaties provide for taxation of such distributions in the country of residency, however in some cases there is different treatment if it is a lump sum distribution. Also, depending on your country of residency there may be a US withholding tax assessed by the institution that administers your retirement account, which can range from 0% to 30% depending on the circumstances.
Another consideration may be that Roth accounts are not mentioned in most tax treaties and therefore may be considered as regular taxable brokerage accounts in your country of residency.
Another possibility is to explore pension accounts in your new country of residence. Many countries offer tax-advantaged savings accounts and local pension plans with unique tax incentives that may align better with your current situation or future retirement plans. In many cases, where there is a tax treaty between the USA and your country of residence, pension plans may receive the same tax treatment under the treaty as your US retirement plan would if you were a US resident. However, other types of tax-advantaged savings accounts, such as UK ISAs for example, may not qualify as pension plans under the treaty and therefore may not be tax-advantaged for US tax purposes.
The pillars of retirement income
It’s important to plan to have multiple income streams when you retire, often referred to as the pillars of your retirement income. These typically include:
Social Security / State Pension: If you have made sufficient contributions to the US Social Security system, you are eligible to collect your Social Security payments while residing anywhere in the world. Additionally, depending on your host country’s rules, you may also be eligible for social security benefits from that country if you have contributed adequately to their social security system. If you do receive social security income from the USA as well as another country, then your US social security may be limited under the Windfall Elimination Provision.
Box: Totalization Agreements: If you have contributed to the social security systems of both the US and another country but haven’t accumulated enough credits to qualify for benefits in either country independently, a Totalization Agreement may come into effect. This agreement allows the pooling of contributions made in both countries, enabling retirees to receive social security payments in whichever of the two countries they choose to retire.
Company Workplace Pension Plans: Employer-sponsored pension plans are common in many countries, offering an additional source of retirement income for American expats working for foreign companies. Understanding the features of these plans, such as contribution amounts, vesting timelines, and payout options, is essential, as they can provide you with another pillar of your retirement income.
Private income: this may come from investments and assets you accumulate over the years, such as savings, dividends, royalties, or rental income from investment properties.
Currency considerations
Currency fluctuations can have a big impact on your retirement income, especially if you are receiving income from the United States in US dollars while living abroad, or in foreign currency while living in the US. As exchange rates fluctuate, there’s a risk that it affects the value of both your retirement income and your assets.
To minimize currency risk, you might consider diversifying your retirement investments to include a mix of assets denominated in both US dollars and your local currency. This approach can help stabilize your income and provide protection against currency volatility. Also, when you transfer currency between countries, using a specialist broker rather than your bank may get you much better exchange rates.
Understand tax implications
Retirement planning for Americans living abroad requires a clear understanding of the tax implications of saving in both the US and in their country of residence. This is because the United States taxes its citizens on their worldwide income, meaning that even if you reside overseas, you are still required to file a US tax return annually.
To avoid double taxation, your expat tax advisor will help you claim either the Foreign Tax Credit or the Foreign Earned Income Exclusion when filing your US tax return. Additionally, when retirement planning from abroad, it’s important to be aware that certain investments in foreign mutual funds or Exchange Traded Funds (ETFs) may trigger PFIC (Passive Foreign Investment Company) reporting, leading to more complex tax reporting and potential US tax liabilities.
You may also be able to take advantage of provisions in tax treaties between the US and your country of residency pertaining to withholding rates on certain types of income such as dividends, interest, or capital gains. Understanding and leveraging these tax treaties can help optimize your tax situation and ensure a smoother retirement planning process, so always consult with a specialist expat tax professional as well as with an expat financial advisor.
Estate planning
Estate planning becomes more complex for Americans living abroad due to cross-border considerations. Each country has its own rules and regulations concerning inheritance and estate taxes. In some instances a US trust may not be recognized in your country of residency, or may be taxed at unfavorable rates as compared to holding your assets in your name or jointly with a spouse. Some countries also have hereditary laws that govern how assets are to be divided upon death.
To address these complexities, consider consulting an estate planning attorney with cross-border experience to help you draft a plan that covers your assets in both the US and your country of residence. This plan should encompass wills in each country where you have assets, trusts, powers of attorney, and any other necessary documents to ensure a seamless transfer of assets to your heirs. Taking these steps will help protect your assets and give you peace of mind knowing your wishes are carried out effectively.
How you invest when planning for retirement can have substantial implications for your tax and reporting obligations and future lifestyle. Start saving as early as possible to benefit from the power of compounding, and consult an expat financial advisor to ensure you align your planning and investing with your future plans and goals.
You should also review and adjust your financial strategy on an ongoing basis as your plans and circumstances evolve. Being proactive and seeking professional advice will help you prepare for a prosperous, fulfilling retirement.
This article is for informational purposes only; it is not intended to offer advice or guidance on legal, tax, or investment matters. Such advice can be given only with full understanding of a person’s specific situation.