For all Americans financial and retirement planning can be stressful with the various circumstances and factors that need to be accounted for and planned around. For expatriates it can be especially difficult to carefully plan for retirement when they are constantly traveling or are fully relocated. It can take a lot of time to find and keep track of the various plans that they can apply for, and to monitor said plans to ensure that they are being responsibly managed.

When expatriates begin their retirement planning one of the first choices they need to make is whether they wish to retire back in the U.S or retire abroad in their current or another country. 

If they wish to retire abroad there are many steps to take to reduce their tax liabilities. Starting with researching their country of choices tax system and treaties with the U.S, and how U.S federal taxes will still impact them while living abroad. Additionally, when living fully abroad in retirement it is important to make a clean break from their state of residency in the U.S. Especially if that state has a high-income tax, if they leave any traces of their life behind the state can claim that they plan to return one day and continue taxing them. If the expatriate is planning to remain abroad for the rest of their life, they may consider selling any property, and surrendering their drivers license and voters registration card to prove their intent and protect them from further state taxation. 

However, if they wish to return to the U.S to retire, then they might find it difficult or even impossible to transfer their benefits back without a professional’s help. Especially if their plan is in a country without a tax treaty that specifically defines pension plans. Some of the most common plans American expatriates use while living abroad are:

  • Swiss Pillar Pension Plan

  • Canadian Registered Retirement Savings Plan (RRSP)

  • Hong Kong Mandatory Provident Fund (MPF) and Occupational Retirement Schemes

  • Ordinance (ORSO)

  • Australian Superannuation

  • French Caisses de Petraites

  • UK employer sponsored Pension Plan (PIPPS)

While these are the most commonly used plans, they may not work for everyone. Since when expatriates select a plan, it will depend on their native country and its respective treaties with various countries. 

For U.S citizens there are very few countries whose treaties specifically define pensions and how they will be treated, for example the UK, Canada, Malta, and Belgium. These treaties account for double taxation, pension treatment, and expatriates financial reporting requirements. However, each of these treaties define pensions differently, and utilize different terms for pensions. So, at the moment there isn’t a standardized definition for the U.S treaties which has led to some unforeseen issues.

In the treaty with Malta “pension fund” was defined in a way that left much open to interpretation and led to the abuse of the U.S- Malta tax treaty. The treaty with Malta made it so that any pension created within Malta would be only subjected to U.S taxation at distribution, and that U.S citizens would receive the same tax-exempt benefits as a Malta citizen when funds were distributed. Late 2021 the treaty was shut down as the IRS found that Malta had become a haven for pension scams, and tax shelters. Due to the loose definition of pension fund, some U.S citizens found that they could contribute and then sell appreciated assets like property that would not be taxed as they were a part of a tax-exempt pension fund. In January of 2022, the U.S and Malta have entered into a Competent Authority Agreement (CAA) which has restricted the previous definition of pension fund so that only cash contributions to the pension will be permitted. So, to prevent pension scams, and trouble with the IRS it is essential that individuals carefully research their country of choices tax treaties, and history with pension treatments in regard to the U.S.

For expatriates operating in countries without these amendments in the tax treaties, some have resorted to combining their residing country’s social security benefit scheme with international savings accounts and/or offshore pension plans. Americans need to be careful with internationals savings as they are viewed with intense scrutiny by the IRS and can trigger audits and result in higher fees with their bank. Many international saving plans also contain higher premium fees, and complex regulations.However, offshore pension plans can have some serious disadvantages.

Offshore pension plans are a combination of life insurance, and investment funds. Your contribution is split between the life insurance premium and investments into equities in a fund pool with other plan holders. However, before starting an offshore pension plan you should seriously investigate the company supplying the plan and avoid this option unless you are confident in their integrity. As many investigations have found that in some companies up to 80% of contributions could go towards fees. Even if the expatriate finds a reliable and cost-effective offshore pension plan the IRS does not view offshore pension funds as qualified under the US tax rules. This means that the IRS does not permit foreign pensions to qualify for special tax treatments. This can lead to double taxation on pension accounts because, offshore pension plans are considered income in the U.S. Meaning any contributions made will not reduce taxable income, and if their employer contributes to the fund, it will further increase their taxable income. In the end your income including contributions and the withdrawals will be taxed by the U.S and depending on the country you are residing in your income could be taxed there as well.

Some of the double taxation can be avoided by claiming the Foreign Tax Credit. This credit allows U.S citizens to offset some of the taxes imposed on income, dividends, interest, and royalties. To qualify for this credit, you must meet four requirements:

  1. Either a foreign country or a U.S territory must have levied the tax. Currently the U.S territories include Puerto Rico, American Samoa, U.S Virgin Islands, Guam, and the Northern Mariana Islands.

  2. There must be a payment or accrual of taxes to the foreign country, or U.S. territories. 6

  3. The tax must be the actual and legal tax liability incurred during that year.

  4. The tax must be either an income tax or a tax incurred instead of income tax.

This credit can be claimed one of two ways, either as an itemized deduction, or as a credit on the taxes to be paid. If the deduction is chosen, then it will be included in the Schedule A portion of the 1040 or 1040-SR, and the deduction will reduce your taxable income. Alternatively, if the credit is chosen then it will be submitted on the Form 1116 and attached to the end of the tax return. When applied the credit will be directly credited to your total tax liability. With either option it is important to remember to calculate the total taxes paid in U.S dollars, and to use the exchange rate that was in effect when either the tax was paid or was withheld. Additionally, there is a limit how much credit you are allowed to receive in a year, to calculate the limit you would divide your foreign taxable income by your total taxable income (domestic and foreign incomes) and then multiply it by your U.S tax liability. However, if your available credit is greater than your limit, you are able to carry it back one year, and forward up to ten years to ensure you get the full tax benefit of said credit.

Additionally, if qualified expatriates can apply for the foreign earned income exclusion. The foreign earned income exclusion allows you to exclude up to $122,000 per person if married. Both of the spouses must work abroad and either meet the Bona fide residence test or presence test to qualify. If they qualify for only a part of the year the $122,000 will be prorated to the qualified days of that year. To qualify for the foreign earned income exclusion, they must pass either the Bona Fide Residence Test, or the Presence Test. To pass the Bona Fide Residence Test they need to have resided for a full tax year (January 1 st - December 31 st ) in a foreign country or countries. The Presence Test will consider them a U.S citizen for tax purposes if within a calendar year they are physically present in the U.S at least:

  • 31 days in the current year

  • 183 days during the last three years, this includes the current year and the two years immediately preceding it.

    • All of the days present in the current year

    • One third of the days in the last year

    • One sixth of the days in the year prior to that.

  • There are some exceptions to the presence test, you will not be counted as physically present if:

    • You regularly commute from a residence in Canada or Mexico

    • You are in the country less than 24 hours

    • You are a crew member of a foreign vessel currently in port at a U.S city

    • You are unable to leave the U.S due to a medical condition that developed when you are in the U.S

    • You count as an exempted individual, this includes, foreign government-related individuals, teachers or trainees, students, or professional athletes.

When taking these credits into consideration expatriates also have stricter reporting requirements when it comes to their pensions and foreign assets, and they can be quite complicated at times. This due to the fact that there are several different forms that could apply depending on the expatriates’ circumstances. Just to begin with expatriates are required to report the plan or foreign bank accounts on a Foreign Bank Account Report (FBAR) which is located on the FinCEN Form 114. Additionally, they must report any contributions or distributions (Form 3520), annual income in the plan (form 1040), and they must report the plan as an asset (Form 8938). These are just the beginning of the forms that apply to expatriates, so it is key to keep meticulous records. In addition to keeping records of the agreement and its regular statements maintaining records on the location of the trust and its custodian, what contributions and distributions are made, what the future required minimum distributions are, and whether there is any ability to make investment decisions will also help when reporting to the federal government.