US expats can invest in IRAs, 401(k)s, Roth IRAs, and other retirement plans like domestic residents. Every choice has different tax consequences, regulations, and restrictions, including contribution and withdrawal limits.

American expats can effectively utilize these retirement accounts to manage their investments despite the extra complexities. They must understand and navigate each investment choice's requirements and opportunities to optimize their financial planning while living overseas.

IRA Contributions for Americans Abroad

An American living abroad must understand IRA contributions. The 2019 and 2020 traditional and Roth IRA interest rates allow U.S. citizens to contribute up to $6,000 or $7,000 for those 50 and older. These rules apply to US and foreign residents. Foreign income and tax exemptions or deductions, such as the foreign earned income exclusion (FEIE) or foreign housing exclusion, determine your ability to contribute to a regular or Roth IRA.

After accounting for deductions and exclusions, your income should be sufficient to be eligible for IRA contributions abroad. If you entirely offset your income using the FEIE and lack other income sources, you cannot contribute to an IRA. Conversely, IRA contributions might still be feasible if you partially exclude income or opt for the foreign tax credit (FTC).

Consider a U.S. citizen in Australia with a $95,000 income who uses the FEIE to exclude it all on U.S. taxes. With no remaining income post-exclusion, she cannot invest in an IRA. However, if she had chosen the FTC over the FEIE, she would have had taxable income in the U.S. and could have contributed to her IRA.

Now, if her earnings were $150,000 and she used the FEIE to exclude $107,600 (the maximum for 2020), the remaining income would permit IRA contributions. Given the complexity and variation in tax laws and compliance rules across different countries, consulting a Tax Advisor is critical.

Comparing Roth and Traditional IRAs for U.S. Expatriates

Understanding the differences between traditional and Roth IRAs is vital for Americans residing overseas. Traditional IRAs allow contributions up to a certain limit, offering a tax deduction proportional to the contribution amount. The funds in these accounts are tax-deferred, meaning taxes are payable upon withdrawal.

Roth IRAs share similarities with traditional ones but have notable differences. Firstly, when opening a Roth IRA, it must be designated as such. The earnings in a Roth IRA interest rates are generally tax-free, not just deferred. You can withdraw your contributions anytime without tax or penalty, and contributions can continue even after reaching 70½ years of age. Unlike traditional IRAs, no mandatory withdrawals are starting at 70½.

Roth IRA qualification hinges on income restrictions; the current cap is $124,000. This means that if they have an annual income of between $124,000 and $139,000, they can pay some reduced contribution, while for those earning more than $149,000, no contribution could be made.

Your contribution capacity differs depending on the modified adjusted gross income (magi) and filing status for the fiscal year 2020. Couples who are married and file joint returns and qualified widowers with a modified adjusted gross income of $196,000 or less can contribute the maximum amount permitted. MAGI of $196,000 – $206,000 reduces their contribution level, whereas above $206,000 is not allowed.

A single individual, head of household, or married filing separately without living with a spouse can contribute up to the maximum amount if their adjusted gross income (AGI) is less than $124,000. Additionally, they would decrease contributions if their MAGI was between $124,000 and $139,000. In addition, other contributions are not allowed.

Advantages of Roth IRAs for Expatriates

The tax structure of Roth IRA for non U.S. citizens living abroad accounts is most appealing to expats. When withdrawn, these accounts' interest, dividends, and capital gains are tax-free. This feature exempts Roth IRA profits from immediate and total taxation if the distributions meet the criteria. This is a significant benefit for expats who face varying tax scenarios in different countries.

When deciding between a traditional retirement account and a Roth IRA, the central question is which tax benefit is more valuable: deferring taxes on the entire account or enjoying tax exemption on investment income.

This decision depends on tax rates and personal finances. If expatriates expect retirement tax rates to be higher than their current rates, they should consider a Roth IRA. In such cases, paying taxes now and enjoying tax-free investment income may be wise.

Expatriates can use Roth IRA calculators to evaluate their benefits. These Roth IRA calculators help understand how tax rates, present and future, affect Roth IRA benefits. State taxes are also important. State taxes may not be a major concern for many American expatriates, but they affect Roth IRA selection. Non-U.S. citizens abroad may prefer Roth IRA conversions due to the lack of state taxes.

Brokerage Account Investing While Residing Abroad

Expatriates often face unique challenges when managing investments, especially those who maintain connections with the United States. A significant aspect of Roth IRA interest rates for US citizens living abroad is understanding the constraints brokerage firms impose. Certain brokerages limit or prohibit services for clients residing overseas.

As an illustration, Fidelity outlines on its website that individuals outside the US can't buy new mutual funds. Moreover, establishing a new brokerage account is impossible if you didn't have one before moving abroad.

Better to Avoid Passive Foreign Investment Company

US citizens should be cautious about opening brokerage accounts in other countries, particularly for purchasing ETFs or mutual funds. This action subjects them to the complexities of Passive Foreign Investment Company (PFIC) regulations.

PFIC entails intricate tax reporting with severe penalties for errors. Managing a PFIC typically requires the expertise of a professional tax preparer, adding to the administrative burden.

FBAR Criteria

Another crucial financial obligation for US expatriates is adhering to the Foreign Bank Account Report (FBAR) requirements. This applies to those exceeding USD 10,000 in all foreign accounts at any point during the year.

Filing the FBAR with the U.S. Department of the Treasury is mandatory. It is a part of responsible financial management for those holding us dual citizenship or living in countries listed under the us dual citizenship countries list. This regulation ensures transparency and compliance with U.S. tax laws, an essential consideration for dual citizenship US holders.