American Expats and IRAs: A How-To Guide

This article is for general information purposes only and is not intended as specific tax advice. Please consult your tax advisor for advice relevant to your situation.

As the annual U.S. tax filing deadline for 2017 approaches (April 17, 2018), so does the deadline for making 2017 contributions to U.S. Individual Retirement Accounts (IRAs). But this is an area where U.S. expatriates need to be careful. If the rules surrounding IRA contributions weren’t complicated enough, being an expat adds another layer of complexity to the mix.

In general, expats have the same opportunities to contribute to various IRA structures as resident Americans. However, the complications introduced by resident country taxes and international marriages, as well as the use of the Foreign Earned Income Exclusion (FEIE), the Foreign Housing Exclusion (FHE) and the Foreign Tax Credits (FTC), warrant special consideration. Here we try to lay out some of the issues. A major caveat, however―there are no general rules that apply to every situation. Each case will need to be considered based on your own unique set of circumstances.

Traditional IRA

Benefits: The traditional IRA provides a way for U.S. taxpayers to save for retirement on a tax-deferred basis. Contributions are tax-deductible [subject to certain income limits if you participate in employer-sponsored retirement plans such as 401(k)s or SEP IRAs] and earnings on contributions grow tax-deferred until distribution. Distributions can be made without penalty at age 59½ and must begin by age 70½. Distributions are taxed at the taxpayer's marginal tax rate at the time of distribution. Eligibility: Taxpayers must have earned income greater than their contribution and be younger than 70½.

Contribution Limits: Up to USD 5,500 of earned income (USD 6,500 if age 50 and over) for 2017.
Tax Deductibility: Contributions by a taxpayer (and spouse) are tax deductible if neither spouse was covered by an employer-sponsored retirement plan during any part of the year. For situations where one or both spouses are covered by an employer-sponsored employment plan, the amount that can be deducted from current year income depends on the tax filing status and the amount of income earned. See IRS Publication 590-A for a complete discussion of these phase-out limits.

Special Considerations for Expats: Contributions can only be made on unexcluded earned income (such as wages or self-employment income). So, if all earned income is excluded from U.S. tax by the Foreign Earned Income Exclusion and the Foreign Housing Exclusion, you cannot make a contribution, and there are penalties for doing so.

In general, if all earned income is foreign earned and below the total of the FEIE and FHE, then you will not be able to contribute. High-income earners with foreign earned income above the total excluded amount can still contribute, but with an important caveat. If they are working in a high-tax country, where the combination of FEIE, FHE, and FTC has eliminated most or all U.S. tax liability, then it may not make sense to make a deductible contribution, even if eligible.

Taxes paid in the higher tax country will have eliminated or greatly reduced all U.S. tax liability due to the foreign tax credit, so even though contributions are deductible in theory, there is nothing left to deduct against. The net result of making a contribution, in this case, would end up in double taxation―once by the foreign country when the contribution was earned and again by the U.S. when it is distributed. In this case, it is better to contribute to a Roth if eligible or invest in a taxable account where the contribution is only taxed once (by the foreign country).

Tip: If married and filing a joint tax return, a non-working spouse can also contribute to an IRA as long as the combined contribution from both spouses does not exceed the working spouse’s unexcluded earned income.

Roth IRA

Benefits: The Roth IRA is a bit different from the traditional IRA. Contributions are not tax-deductible, but earnings grow tax-free. And when distributions are made, both the principal and earnings are tax-free. A benefit to the Roth over the IRA is that, in addition to tax-free withdrawals, there is no requirement to make distributions. This provides greater flexibility for the taxpayer to manage both income and taxes in retirement.

Eligibility: Individual taxpayers filing as single, head of household, or married filing separately and who didn’t live with their spouse with a modified adjusted gross income (MAGI) below USD 118,000 can contribute the full amount as long as they have unexcluded earned income in excess of their contribution. This amount is reduced for MAGIs between USD 118,000 and USD 132,999, and above USD 133,000 no contributions are allowed.

Individual taxpayers filing as married filing separately who did live with their spouse cannot contribute to a Roth IRA if their modified AGI is more than USD 10,000.

Married couples filing jointly can contribute the full amount as long as they have unexcluded earned income and their MAGI is less than USD 186,000. The contribution levels phase out between USD 186,000 and USD 195,999 and above USD 196,000 no contributions are allowed.

Contribution Limits: Up to USD 5,500 of earned income (USD 6,500 if age 50 and over) for 2017.

Tax Deductibility: Contributions are not tax deductible.

Special Considerations for Expats: Previously, U.S. expats married to non-U.S. citizens who filed U.S. tax as married, filing separately were prohibited from converting traditional IRAs to Roth IRAs. This restriction was lifted in 2010.

As mentioned above, contributions to a Roth will generally make sense for U.S. expats who have unexcluded income but for whom making a contribution to a traditional IRA would not make sense. For example, making contributions to a Roth IRA may make sense in a situation where the U.S. tax liability has been effectively reduced to zero, and any contribution to a traditional IRA would effectively be subject to double taxation.

Tip: For expats who exceed the income limits for deductible IRA contributions and Roth contributions, there may still be an option. Potentially, they can make non-deductible contributions to a traditional IRA and then immediately convert the IRA to a Roth. Depending on the situation, this may be effectively the same as making a Roth contribution in the first place but gets around the income limits on making a direct contribution to a Roth. Before employing this strategy, there are a number of considerations and it won’t work in all cases. For example, if you already have pretax funds in a traditional IRA, you cannot just designate your non-deductible contributions for conversion to a Roth even if it is in a separate account. Only the pro-rata proportion of your non-deductible contributions to your aggregate IRA balances would be converted tax-free to a Roth. The rest would be taxed as a rollover of your existing pre-tax IRA contributions. See Non-Deductible IRA: A Backdoor Roth for U.S. Expat High-Income Earners for more details.

Change coming for 2018 Tax Year

The Tax Cuts and Jobs Act of 2017 has made a number of changes to U.S. tax law, some of which may impact U.S. expatriate tax filers. One change effective in 2018 is that recharacterizations of Roth IRA conversions will no longer be allowed. This means that a conversion of a traditional IRA to a Roth IRA and a rollover from any other eligible retirement plan to a Roth IRA made after December 31, 2017, cannot be re-characterized as having been made to a traditional IRA.

There are a number of other changes in the Tax Cuts and Jobs Act of 2017, some which may impact US expatriate tax filers. For information specific to your situation, consult with a qualified tax advisor to see how you may be affected.
 

This article is a revised and updated version of one that appeared previously on www.crevelingandcreveling.com.

This article is for general informational purposes only and is not intended as specific tax advice. Please consult your tax advisor for advice relevant to your situation.
 

Additional Resources

WSJ Ask An Expert: Six Mistakes Expats Make With IRAs—And How to Avoid Them
Non-Deductible IRA: A Backdoor Roth for U.S. Expat High-Income Earners
Expat Financial Planning: Why Americans Should Consider a Solo 401(k)
IRS Publication 590-A Contributions to Individual Retirement Arrangements (IRAs)