As a US expat it can be difficult to understand your retirement savings options and the tradeoffs available to you. There are a number of different scenarios which may apply to a US expat trying to save for retirement. We’ll look at the most common.
No earned income = no IRA contribution allowed.
Confusing? Yes it is confusing. Contributions to IRA accounts (2018 limit of $5,500) can only be made from “earned income”. You can’t contribute from unearned income (such as interest or dividends). Additionally, you can’t contribute if you have excluded all of your income from taxation by using the popular Foreign Earned Income Exclusion (FEIE).
This is probably the most common issue for younger expats. They exclude all their income using the FEIE and have no earned income left to contribute to an IRA. The 2018 FEIE amount is fairly generous at $103,900. The US expat can use the FEIE to exclude the smaller of 100% of their earned income or the FEIE amount. There is no option to partially exclude all but the $5,500 which could be contributed to an IRA.
One fix for this could be to not exclude (don’t use the FEIE at all!) and instead to claim the Foreign Tax Credit (FTC) for the foreign tax paid on the earned income. In many cases, this will offset the US income tax payable. This also means that there will be plenty of earned income available to contribute to an IRA back in the US. However, this assumes that you pay foreign income tax. Some countries have no income tax, therefore there Is no foreign tax to credit and you pay US tax on all of your earnings. Probably not a better plan!
Deducting retirement savings from earned income before applying the exclusion.
Another quirk of the tax code (as you know there are many) is that if you are an American who is self-employed (freelancer or business owner) and resident outside the US, you can create a SEP (Simplified Employee Pension) for yourself as your employee (note: If you have employees working in your foreign business who are non-resident aliens you can simply exclude them from the plan). Then you can contribute up to 25% of the employee’s income (there is another limit known as “eligible compensation” for 20178 the eligible compensation limit is $275,000. 25% of $275,000 is %55,000). Of course, as a self-employed person, the calculation is a little tricky as you can’t pay yourself all your income and then add more into the SEP. You make contributions for yourself out of your earnings, there are no other funds from which you could make a contribution.
Examples: Here are a couple of examples that may help to clarify the issues for both the self-employed US expat and the employee US expat.
Jen is a self-employed architect in Dubai (no foreign income tax). She earned $400,000 this year. Jen establishes a SEP and wants to contribute the maximum amount possible to it. Jen is both employer and employee.
Earned Income (and available cash)
Max contribution $55,000 (2018 limit)
Again, contributions to a SEP are deducted before calculating Earned Income. Jen can contribute $55,000 to her SEP which is the limit for 2018.
Earnings of ‘employer’
SEP contribution for employee (25% of eligible compensation)
Employee earned income
Foreign Earned Income Exclusion (2018 Amount)*
Taxable Income (simplified other deductions and credits exist)
Now the employee’s earned income is $345,000 for US income tax purposes. The usual considerations around using the FEIE or FTC apply. But assuming the FEIE is chosen US income tax is payable on $241,100 ($345,000 – $103,900). There are no foreign income taxes payable on this income, so the FTC will not help Jen.
* the full exclusion amount may not be available to a self-employed person.
Eric is single and is employed as an accountant in London (foreign income tax payable). He earned $105,000 (£81,890) this year. Eric’s employer does not provide a retirement plan. Eric cannot establish a SEP as he is not self-employed. Eric can contribute to an IRA and wants to contribute the maximum amount possible. For 2018 the maximum contribution allowable is $5,500. As a calendar year taxpayer, Eric has until April 15, 2019 to make this contribution.
Eric’s earned income is $105,000. If Eric chooses to use the FEIE of $103,900 he will only have $1,100 of non-excluded earned income with which to fund his IRA (any kind of IRA) but will have $0 (zero) tax liability. He has paid UK income tax on the non-excluded $1,100 in the amount of $445. This amount can be claimed and carried forward for possible future use as a credit against US tax on foreign income.
If he does not choose the FEIE, he will have $105,000 of earned income from which he can make a pre-tax contribution to his IRA of $5,500 leaving him with $99,500 of earned income. For 2018 he will receive a ‘standard deduction” of $12,000 which will reduce his taxable income to $87,500. Using 2018 tax tables this will result in a gross US income tax liability of $15,296. However, Eric is living in a country (UK) which levies personal income tax rate so there are Foreign Tax Credits to use to reduce (in this case completely) his US income tax.
Comparing options (2018 rates):
Using the FEIE
Using the FTC
Foreign Earned Income Exclusion
Gross Taxable Income
Taxable Income (simplified other deductions and credits exist)
Federal Income Tax (rough estimate)
Foreign Tax Credit (see note below)
US tax payable 2018
Foreign Tax Credit Carried Forward
Note: Eric pays £21,116 ($27,075) in UK income tax. Tax paid on the excluded income cannot be claimed. The foreign income tax paid on the non-excluded amount of $1,100 is $445. This amount can be carried forward 10 years. If the FEIE is not taken but the taxpayer chooses to use the Foreign Tax Credit, this will result in full credit being given for the tax paid and no US income tax being payable. The balance of the FTC of $11,113 ($27,075-$15,962) can be carried forward to be used against future US tax on foreign earned income.
In this example, we’ve said that Eric makes the maximum contribution allowed from his non-excluded earned income to an IRA. What isn’t discussed is what sort of IRA he should use. That’s for another blog, or you can contact us, and we’d be happy to discuss your situation with you.
As you can see, in these simplified examples, saving for retirement as a US expat involves more considerations than merely whether you have the funds to spare. Additional complications arise based on the jurisdiction you are living in, options available to you as an employee (employer-provided retirement plans), the tax treaty that the US has in place with the country in which you live (if any), and any plans you may have to move to yet another country or back to the US.