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Pensions for Expats in the United States Of America

Submitted: July 2013

Pension contributions are generally not mandatory in the US. However, voluntary contributions towards private pension plans may attract tax relief.

US pension schemes

There are many different types of pension schemes in the US.  The most common schemes are Individual Retirement Accounts (IRAs), 401(k) plans, and their variants (e.g. Roth IRAs).

Tax-relieved schemes

Put simply, these products allow you to achieve tax deferral until you withdraw your pension benefits.

Full tax deductibility is available when pension contributions must not exceed an amount specified by law. This maximum limit may vary depending on the plan. For example, the limit is $17,500 for contributions to traditional 401(k) plans in 2013. Excess contributions may attract an excise tax at a rate of between 6 and 10%.

Deductibility on pension contributions is normally available for tax purposes, but not for social security purposes. Hence, pension contributions are still subject to Federal Insurance Contributions Act (FICA) taxes, Medicare taxes, and Federal Unemployment Insurance Act (FUTA) taxes.

Once your funds are within the pension pot, the capital is allowed to grow tax-free. Of course, the pension pot is regulated by law and it needs to comply with strict rules. This is not only about withdrawal restrictions, but it’s also a matter of investment restrictions. The law bars you from investing in collectibles from your pension pot. However, your trustee may impose additional restrictions (e.g. no access to real estate, or leveraged investments, etc.).

You can draw on your US pension only in the event of:

  • Death
  • Permanent disability
  • Reaching the age of 59½
  • Payment of higher education costs, or
  • Purchase of first home (up to a $10,000 lifetime allowance)

Failure to comply with withdrawal restrictions may attract a 10% penalty. This penalty is also applicable if you fail to start drawing on your pension after 70½.

“Roth” products

You may choose to build up a pension pot with your after-tax dollars. Typically, this can be achieved through Roth IRAs or Roth 401(k) plans.

The good thing with Roth products is that capital may grow tax-free and pension payouts are also tax-exempt. On the flip side of the coin, contributions to Roth products are not tax-deductible.

You should not use Roth products unless you genuinely intend to save for retirement. This is because US tax rules are designed to bar you from using Roth products to evade investment income taxation. Therefore, you have to pay a 10% penalty on “non-qualifying distributions” from Roth products.

Investment losses

As capital growth within your pension pot is tax-exempt, you are not allowed to deduct your losses either.

Example

Gary has $100,000 in his IRA, and he also has a share dealing account on which he has invested $200,000.

In 2014, Gary has a capital loss of $5,000 inside his IRA, and a capital gain of $20,000 within his regular share dealing account.

Gary’s taxable capital gain is $20,000.

Superannuation practical tips

First and foremost, you should view superannuation as a complex financial product on which you are charged fees to get the superannuation industry running. These fees may vary greatly from one superannuation product to another.

From a practical point of view, you should:

  • compare retirement products
  • check if DIY investing is available on your retirement plan, if you wish to manage your investments for yourself
  • feel free to consider switching, if you can
  • consolidate your superannuation arrangements
  • not panic if a fund manager underperforms for a particular year – you need it to deliver adequate returns over the long term

Financial planning issues

The US tax system gives you some freedom as to when and how you build your pension pot. Most importantly, it lets you have some discretion as to when you would be taxed.

From a financial perspective, you are better off claiming tax benefits when you think you need it most. One may argue that you should claim tax benefits at the time of your life where your tax rate is highest. However, financial planning may involve many other dimensions, such as liquidity or personal considerations. Therefore, it is on a case-by-case basis and you might wish to seek professional advice.

International matters

Social security agreements

The US may have entered into a social security agreement with your home country. These agreements are primarily designed to avoid discrimination and double social security coverage. They may cover employees as well as self-employed individuals.

In addition, social security agreements may “totalise” your periods of contributions in the US and in your home country. This is particularly helpful if your home country expects you to contribute for a long time (e.g. you must have contributed for 40 years to avoid a pension rebate).

A list of social security agreements concluded by the US is available here.

International superannuation planning

Superannuation schemes are tax-efficient products in the US. Thus, they are heavily regulated in order to avoid undue tax base erosion. The same fundamental principle is likely to apply to foreign equivalents. Thus, you should check:

  • how your foreign pension arrangements are taxed whilst you are in the US
  • how your overseas investments within your US pension pot are taxed by foreign countries, and
  • how your US pension pot may be taxed in your home country. Generally, this only affects payouts, but there is no guarantee that capital growth will be untaxed in your home country (e.g. under foreign investment fund rules, which may be overridden by US model tax treaties)

Your home country may have a tax treaty with the US to avoid double taxation on your foreign pensions. As a general rule, pension payouts are only taxable in your country of residence, and payouts from “Roth” pension products may be treaty-exempt in the foreign country. That said, US model tax treaties have very complex rules with regard to pension taxation. Therefore, you should check if you don’t fall under an exception.

Retaining your foreign pension arrangements may be the most practical option if you don’t intend to stay in the US. Nevertheless, cross-border superannuation planning is always on a case-by-case basis. It is strongly recommended to seek professional advice regarding this matter.

 

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