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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).
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:
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.
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.
As capital growth within your pension pot is tax-exempt, you are not allowed to deduct your losses either.
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:
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.
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:
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.
Sections in FINANCIAL CONSIDERATIONS IN THE UNITED STATES OF AMERICA:
» Money Transfers for Expats in the United States Of America
» Foreign Exchange for Expats in the United States Of America
» Banking for Expats in the United States Of America
» Pensions for Expats in the United States Of America
» Investment for Expats in the United States Of America
» Wealth Management for Expats in the United States Of America
» Property Investment for Expats in the United States Of America
» Insurance for Expats in the United States Of America
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