One advantage of living overseas as an expatriate is that you get access to an extensive array of international saving and investment plans. You may consider securing your retirement by making contribution to your Individual Retirement Account after adding this investment to your portfolio.
As a US expat, there a few things you need to know about:
- Understanding the advantage of an IRA account
- Maximizing your IRA contribution and avoid double taxation in your country of residence and the US and
- The difference between IRA and a Roth
Understanding the different rules and taxation methods of each will help you make the best choice for your situation.
What is an IRA and why do I want to invest in it?
An IRA is an account set up at a financial institution that allows you to save for retirement with tax-free growth or on a tax-deferred basis.
So let´s imagine, for example, that you’re a single US expat who made $40,000 this year and that you are now considering making an contribution of $5,000 in the US for a retirement plan.
Here´s a tax comparative of a non-IRA to an IRA contribution:
| Non-IRA Contribution | IRA Contribution | Tax Savings | |||
| Gross Income | 50,000 | 50,000 | |||
| Retirement Contribution | 0 | 5,000 | |||
| Adjusted Gross Income | 50,000 | 45,000 | |||
| Tax Liability (Rate @ 15%) | 7,500 | 6,750 | 750 |
In this scenario, you would enjoy the following:
- a tax saving of $750 this year and
- a deferral income on the retirement contribution (depending on your type IRA) until you withdraw that amount.
In other words:
- You get to deduct your contribution up to a certain amount
- The income/return on that contribution is taxed only when distributed
So, in the case where you´ve invested $5,000 for the last 3 years, your total tax exempted income will amount to $3,155 and will be tax only when withdrawn
| Year 1 | Year 2 | Year 3 | Total | |||
| Contribution | 5,000 | 10,000 | 15,000 | |||
| Prior Year Income on your contribution | 500 | 1,050 | ||||
| Income on your contribution (Rate of return @ 10%) | 500 | 1,050 | 1,605 | 3,155 |
What type of IRA plan should I contribute to?
There are main types of IRAs:
- Traditional,
- Roth, and
- Rollover
Generally, Roth IRAs are the preferable option.
One of the chief differences between the two is the method in which they are taxed.
With a traditional IRA, you get a tax deduction for the contributions you make throughout the year but you will owe taxes in the future when money is withdrawn.
With a Roth IRA, on the other hand, you pay current tax rates on your contributions and (as long as all rules are followed) distributions are tax free.
|
Tax Effect |
|||
| Contribution | Deductible | Non-Deductible | |
| Distribution – Contribution | Non-Taxable | Non-Taxable | |
| Distribution – Income on Contribution | Taxable | Non-Taxable | |
Another variance is the required age to pull out funds. With a traditional IRA, you essentially start making withdrawals by age 70½; whereas with a Roth IRA, there is no compulsory distribution age. And another difference is in the income requirements. Traditional IRAs are opened to everyone at every level of income. A Roth IRA, on the other hand, is reserved for individuals who earn less than $110K per year.
How much can I contribute?
Normally, you cannot make more contributions to a Roth IRA in a taxable year than is allowed by the IRA Administration. Currently, the maximum annual contribution to a Roth IRA is $5,000 for ages 49 and lower (and $6K for ages 50 and above). If you make more contributions than are permitted in a fiscal year, you will be subject to a 6% penalty, but there are two possible techniques to avoid this penalty. You can withdraw the extra amount before your next US tax return´s due date. The second method is to contact the IRA administrator and request that they allocate the additional balance to the next tax year.
Since you´re a US Expat, you most likely qualify for the FEIE (Foreign Earned Income Exclusion) or the Foreign Tax Credit. Under both methods, many US Expats find they owe no US taxes at all after claiming these deductions.
There is a small potential difficultly with this rule, however: In order to contribute foreign earned income into your Roth IRA, you must have earned enough in a fiscal year than you were able to deduct (or chose to deduct) with the Foreign Earned Income Exclusion.
For example, you may deduct up to $100,800 for the Foreign Earned Income Exclusion.
| Full Foreign Earned Income Exclusion | |||
| Gross Income | 50,000 | ||
| Foreign Earned Income Exemption | 50,000 | ||
| Taxable Income | 0 | ||
| Retirement Contribution | 5,000 | ||
| Excess Contribution | 5,000 | ||
| Excess Contribution Penalty (Rate @ 6%) | 300 |
The further advantage of a Roth IRA with regards to tax savings is that you’re eliminating the possibility of being taxed at high tax rates in the future. Tax rates vary all the time and it’s tough to tell what changes will happen once you reach retirement age. For all you know, it may rise steeply in the future and return to the high rates. By paying minimal taxes on your contributions to a Roth IRA now as a US Expat, while you are still younger, you’re taking strides in assuring your protection from future fluctuating tax rate (at the very least in this retirement account).
When can I make contributions to my IRA account?
Make sure to open it and make your first contribution before April 15 of next year to get the most out of your Roth IRA.
Need More Information on US Expat Tax for IRA?
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