Saving for retirement while living overseas
I received a question from a reader about how to save for retirement in his Roth IRA, while living outside the United States. Specifically, he wanted to know whether he could just pay taxes on the amount he wanted to contribute to an IRA and exclude the rest.
If you earned less than $87,600 in 2008 and take the foreign earned income exclusion (FEIE), you have to take it on all your income. You can’t separate out a portion in order to contribute to an IRA.
However, if you earn more than $87,600, anything over this amount but below $5000 can be contributed to an IRA. So for example, say you earned $91,000 in 2008. The difference – $3400 – can be contributed to an IRA because you will also be paying US taxes on the $3400.
If you don’t earn over the FEIE amount of $87,600, one other possible way to contribute to an IRA is to take the foreign tax credit instead of the FEIE. This can be done by filing IRS Form 1116. Depending on the tax rates of your current country, if they are a similar level to the US, you may still end up owing none or very little US taxes on your income after subtracting the foreign taxes you’ve already paid. But if your foreign tax rates are low, you may owe a lot of US taxes not covered by the credit.
By taking the foreign tax credit though, you can contribute the full $5000 (assuming you earn > $5000) to an IRA since all your earnings are potentially subject to US taxes. This is still true even if the tax credit for the foregin taxes completely wipes out your US tax liability.
It’s definitely worth doing both Form 1116 (foreign tax credit) and Form 2555 (FEIE) to see which works out better for you.
Here are two articles that might help:
http://www.irs.gov/pub/irs-pdf/p54.pdf
http://www.aca.ch/joomla/index.php?option=com_content&task=view&id=156&Itemid=46
Link to form 1116 and the instructions:
http://www.irs.gov/pub/irs-pdf/f1116.pdf
http://www.irs.gov/pub/irs-pdf/i1116.pdf
Basics of Saving for Retirement in the U.S.
Since I have around 30 years until retirement, I can’t say with any certainty whether I’ll be retiring in the the US or UK. Therefore, I want to make sure that I keep up my retirement savings on both sides of the pond. Currently, I contribute to my 401(k) at work, which since I’m a federal employee is called the Thrift Savings Plan, and I also contribute to a Roth IRA. Once I move to London next year, I will only be eligible to participate in particular retirement saving options. I’m going to talk about how to continue saving from abroad in a later post. In the meantime, the list below summarizes the main options in the US.
All of the following accounts or plans represent a “wrapper” meaning that the account is the outer wrapping or shell, which sets the rules for the account, but the inside is composed of the actual investments such as stocks, bonds, and cash. Once you’ve set up you’re account, you will still need to select what investments you would like inside the account. I’ll be covering investments in a later post.
Saving for Retirement Options in the US:
- 401(k) or 403(b) Plan
The unusual name comes from the section of the tax code that covers these plans. Offered through your employer, you can save up to $15,500 pre-tax in 2008 and if you’re over 50 you can save an additional $5,000 this year. 401(k)s and 403(b)s often come with a company match typically around 3-5%, which means that if you contribute 5% of your salary, your company may match you dollar for dollar up to a specific percentage. If eligible, these are great retirement vehicles due to the company match and the fact that it is automatically deducted from your paycheck, which makes saving fairly painless. Since money is deducted pre-tax from your paycheck, it also lowers your current tax bill. Taxes are paid when the money is withdrawn at retirement. - Roth 401(k)
This is a new option since 2006. It is also offered by your employer and deducted directly from your paycheck. There may also be a company match similar to a traditional 401(k) or 403(b) and it has the same contribution limits. The plan however is funded with after-tax money. Since you’ve already paid taxes on your contributions, no taxes are owed when you withdraw the money in retirement including your earnings! A drawback for these plans is that they are not currently offered very many places. - Traditional IRA (Individual Retirement Account)
This account can be opened through a brokerage, bank or mutual fund company. Contribution limits are $5,000 in 2008. In retirement, taxes are paid on your withdrawals for both contributions and earnings. There are no income limitations on contributing to a traditional IRA and you can contribute even if you are covered by a 401(k) at work. However, if you qualify, you may be able to deduct your contributions from your taxes but these benefits phase out at a variety of levels depending on your filing status, income level and whether or not you or your spouse are covered by a retirement plan at work. - Roth IRA
This type of account is also opened through a brokerage, bank or mutual fund company and contribution limits are $5,000 for 2008. There are no up-front tax breaks for the Roth as the account is funded with after-tax dollars, but withdrawals in retirement are tax-free for both contributions and earnings. You can contribute to a Roth IRA even if you are covered by a 401(k) at your job. In addition, you can withdraw contributions (but not earnings) before retirement without penalty, if necessary, though this is not recommended as this money is for retirement! Eligibility for a Roth IRA is determined by your income. The following information is from Wikipedia:
The Roth IRA MAGI phase out ranges for 2008 are:
* Single filers: Up to $101,000 (to qualify for a full contribution); $101,000-$116,000 (to be eligible for a partial contribution)
* Joint filers: Up to $159,000 (to qualify for a full contribution); $159,000-$169,000 (to be eligible for a partial contribution)
* Married filing separately (if the couple lived together for any part of the year): $0 (to qualify for a full contribution); $0-$10,000 (to be eligible for a partial contribution). - For those that are self-employed there are SEP IRA (Simplified Employee Pension Individual Retirement Account) and SIMPLE (Savings Incentive Match Plan For Employees Of Small Employers) IRAs. For SEP IRAS, you can save up to 25% of your income which for 2008 caps out at $46,000. SIMPLE IRAs have contribution limits of $10,500 in 2008 and the employer makes a contribution on your behalf. Please note that these accounts can become complicated depending on the number of employees in the business and specific IRA rules, so I recommend consulting a professional or brokerage company for guidance in setting one of these up.
Lastly, if you are over 50, you can make catch-up contributions over the limits described above. This amount differs for each account.
So those are the main types of retirement accounts in the US. For all of them you must have earned income of at least the amount you contribute in any given year. So you can’t open one for your two year old until they get their first job! But I’ll be talking about college savings plans in another post.