An Individual Retirement Account (IRA) is a popular and smart way that many Americans (including expats) save for retirement. One can contribute up to $5,500 per year ($6,500 if age 50 or more). There are four things to keep in mind when it comes to US expats and IRAs.

1. IRAs have tax advantages;
2. To contribute, one must adhere to certain rules; and
3. For US expats that exclude foreign earned income, there is additional complexity
4. There are multiple choices when a person inherits an IRA

US Expats and IRAs – What You Need to Know

IRA for Expats: Tax Advantages

There are two basic types of IRAs: traditional and Roth. With a traditional IRA, one receives a tax deduction in the year of the contribution. As a result, it is possible to lower the amount of taxes owed to the US government by contributing to a traditional IRA. The second tax advantage is that the assets in the IRA are allowed to grow year-after-year without being taxed (referred to as tax deferral). However, taxes are owed at the back end when one takes distributions, or cashes out of the IRA.

With a Roth IRA, the tax advantage works in the opposite direction. There is no upfront tax deduction in the year of the contribution. However, the assets in the IRA grow year-after-year without being taxed, and distributions are also tax-free.

The general theory is that a traditional IRA is better than a Roth if your tax rate at retirement is lower than during one’s working years. On the flip side, a Roth is preferable to a traditional IRA if your tax rate at retirement is higher than during one’s working years. The issue with this theory is that it’s often difficult to estimate one’s future tax rates. Therefore, we advise clients to take advantage of both vehicles. That way, one can manage distributions (traditional vs. Roth) in a tax-efficient manner.

To contribute to an IRA, one must adhere to certain rules

Rule # 1: One must have taxable compensation or business income in order to contribute to a traditional or Roth IRA

Rule # 2: With a traditional IRA, one cannot contribute after reaching 70 ½ in age

Rule # 3: With a Roth IRA, there are income limitations. With the exception of married filing separately status, the income limitations are reasonably high, so most people do qualify.

For US expats that exclude foreign earned income, there is some complexity

Many US expats utilize the foreign earned income exclusion (FEIE) to avoid paying taxes. One can exclude over $100K in foreign earned income. However, if 100% of compensation were to be excluded on the tax return, that person would be ineligible to contribute to an IRA (referencing rule #1 above).

There are several work-arounds or solutions to the “zero taxable compensation” problem, including:

• If one earns slightly more than the FEIE amount, then potentially not exercise the foreign housing exclusion;
• If exercising the FEIE via the physical presence test, then utilize a 365-period that allows for some taxable compensation;
• If one is married filing jointly, potentially exercise the FEIE for one spouse and not for the other

There are multiple choices when a person inherits an IRA

The rules regarding inherited IRA are complex, and we cover only the basics (the two most common options).

1. Spouses can treat the inherited IRA as his or her own; or
2. Lump sum distribution – one can take the money all at once, but will owe income taxes on a traditional IRA (but not on a Roth)

The rules for a foreign spouse and other foreign beneficiaries are very similar to when the beneficiary is a US person.

IRA for Expats (Concluding Remarks)

Many US expats should consider contributing to an IRA. Saving for retirement as an expat is arguably more important than when one lives in the United States. An IRA has clear tax advantages. Although the qualifications may be more complicated for expats, they are surmountable with adequate planning.

For general information on US expat taxation, please read: US Taxes for Americans Living Abroad – Ultimate Guide.