• Part II: US Expatriates
    No Social Security In Sight. What Should You Do?

    By Virginia La Torre Jeker J.D.


    Following on Part I of this tax blog post, here are some tips from Vince Truong, CFP®. Vince is the only United States Certified Financial Planner™ in the United Arab Emirates. In today’s post Vince will provide information for US expatriates who are struggling with retirement planning simply because they are working for foreign employers and thus not eligible for contributions being made into the US Social Security program.

    Thank you Vince, for being the guest blogger today.

    Non-US Investment Vehicles / Malta Pension

    There are many non-US investment vehicles being marketed aggressively to US expats as alternatives for retirement savings. One that comes to mind is a pension based on the US/Malta Double Tax Treaty. The tax consequences of this pension aside, US persons should carefully examine the charges of the pension and the underlying investment vehicle (often an offshore regular savings plan or portfolio bond). Oftentimes, for smaller investors, the annual charges of the pension and the investment vehicle can range from 3% – 6% per annum are higher depending on the amount invested. That means when you’re saving on a regular basis, your returns will be likely be very poor when accounting for the charges as well as the impact of dollar cost averaging (portfolio returns in a rising market for a regular saver will always be lower than that of the market, all else being equal). Moreover, many “advisers” take commission on these products which then locks your money in for many years due to the “Establishment Charge.” So if you try to surrender before the term is over, you will lose proportionate amounts of your account value depending on how many years are left.

    For larger lump sum investments, these plans make more sense as the charges are lower as a percentage of the account value. The key issue with using the Malta pension is an actual savings net of charges and taxes upon distribution (where a 30% lump sum distribution is tax free as per the treaty and any income is partially taxed as to the gain compared to the amount invested). In other words, would you have better returns in a inexpensive US platform (which generally has only small trading charges), but where you pay your investment taxes? Much depends on your tax bracket and the amount invested but you should seek professional assistance to do an apples-to-apples comparison.

    Offshore Regular Savings Plans

    Another oft-promoted way to save for retirement are offshore regular savings plans (Generali Vision, Zurich Vista, Friends Provident Premier, to name a few). Offshore savings plans are a great way to discipline oneself to save and invest on a regular basis. You invest a fixed amount for a set number of years into a portfolio of mutual funds covering different asset classes with various geographic exposure. They are especially appropriate for those saving more modest amounts, who might otherwise spend the money, and/or who need professional investment advice. In fact, without savings plans, individuals saving modest amounts might not be able to find any adviser willing to help them because there wouldn’t be enough assets under management for the adviser to charge a fee on and be fairly compensated. So for those who need investment assistance, a savings plan is a viable option for growing their wealth through financial markets.

    Be Aware

    However, here are some things you should be aware of:

    • These plans are technically foreign life insurance policies with an investment component and should be reported accordingly. This will involve taxes of course and the expertise of someone familiar with how these policies work. Note, most US-based tax advisers have never seen such policies and most non-US financial advisers have no understanding of the tax consequences.
    • Don’t be enticed by “bonus allocations.” This is where the plan provider gives you a bonus of say 5% on any monies you put in. Put in $1000, the company puts in $50. Sounds good, right? Bonus allocations are nice but no matter what plan you’re looking at, they do not cover all the charges. Why would any company give you money for free? Ask for the “Reduction in Yield” (RIY) of the product as illustrated–essentially, its annualized charges. Even with bonus allocations and loyalty bonuses, the typical RIY is 2% – 2.5%pa; this is perhaps a fair trade off for a disciplined savings mechanism along with the assistance of a knowledgeable, professional adviser, if that’s indeed what you’re getting (more on that later).
    • If you’re being told that you only have to put money in for 18 months or so and then you can do whatever you want (for instance, stop paying in or reduce your payments), you should tell the adviser to do the same with his own money and see if he’d be willing to. He’s telling you a half truth. Putting money in for say, 18 months, means you will have funded the investment through its initial period. Once that initial period is over, the adviser’s commission is fully paid–no chance of clawbacks on his commissions. This means that if the adviser is not very professional, chances are he’s essentially done with you unless you have more business or referrals for him. Don’t count on him to be interested in looking after your investments for the next 20 or 25 years or however long he signed you up for.

    It’s convenient for the adviser to stress that you at least get through 18 months of premium payments. The problem with this half-truthful advice is that the bulk of the charges are taken out of the funds you put in during the initial period. After the initial period, you have the accumulation period. Funds put in during the accumulation period are not charged as much and most of your return will thus be coming from the accumulation “units.” What this means is that you will never see a meaningful return because you might be paying 6% pa on the policy comprised entirely of initial units. The number one rule for a savings plan is to make sure you’re putting in a conservative amount for a conservative term that you are highly confident you can fulfill. If for some reason you can’t fulfill those terms, you will still be charged on the monies you contractually agreed to put in, regardless of whether you’re able to or not.

    • Ask the adviser about his job history, education, professional qualifications and investment philosophy. Sometimes we’re afraid to insult someone because we’re nice, polite and good people. We assume the person sitting across from us is also a good and honest person. That’s a dangerous assumption. Ask the adviser tough questions. It’s your hard-earned money after all.

    Tried and True – Usually the Best Bet – Think IRAs and US Brokerage Accounts

    For most US taxpayers, the best solution is the tried and true. That means using what is available and unquestionably legitimate – Individual Retirement Accounts (IRAs). If you have earned income (income above the Foreign Earned Income Exclusion for those using the FEIE), you may be able to contribute $5500 per annum to an IRA (Traditional or Roth) for those under age 50. Those age 50 and over can make an additional catch up contributions of $1,000. These are the 2016 limits and are not scheduled to increase in 2017. Contributions for a given tax year are due by April 15 of the following tax year.

    Couples who are Married Filing Jointly (MFJ) can generally make contributions for each spouse even if one is not working; this is a Spousal IRA contribution. For instance, let’s assume a family of four where one spouse is earning $150,000 and the other spouse is not working at all. Their marginal MFJ tax bracket is 25%. They apply the Foreign Earned Income Exclusion of $101,300 in 2016. With two children, they have four personal exemptions at $4,050 each or $16,200. Then let’s assume they take the standard deduction of $12,600. In total, then, they have $130,100 of tax free income (ignore housing allowances and any other deductions/credits for the moment). So the taxable income is $150,000 less $130,100 or $19,900 taxable at the marginal rate of 25%, resulting in taxes due of $4,975. However, because they have earned income, they can contribute $5,500 for the working spouse to a deductible Traditional IRA along with a spousal contribution of $5,500 for the non-working spouse. This takes the taxable income down to $8,900 which, taxed at 25% results in taxes of $2,225. Hence, there is a savings of $2,750 compared to not having made IRA contributions ($4,975 less $2,225).

    Note that contributions to Roth IRAs would be appropriate where there would be no meaningful tax due. For instance, in the above example, if the couple earned only $130,100, they wouldn’t need a tax deduction net of the FEIE, personal exemptions and standard deduction. However, they still have earned income above the FEIE and are eligible for IRA contributions. So in this example, a Roth IRA contribution (which is not tax deductible, grows tax deferred and is withdrawn tax free at retirement) would make more sense than a Traditional IRAs that is fully taxed when withdrawn.

    FYI, Roth IRA contributions are phased out starting at Modified Adjusted Gross Incomes (MAGI) of $117,000 for Individuals and $184,000 for Marrieds Filing Jointly. Note that MAGI is your Adjusted Gross Income but you need to add back deductions such as the FEIE, Trad IRA deductions, foreign housing deductions, etc. So if an MFJ filer has an MAGI of less than $184,000, they can make the usual $5,500 contribution to a Roth. If their MAGI is $194,000 or higher, they are ineligible for any contribution. If their MAGI is between $184,000 and $194,000, they can make a reduced contribution (hence the “phase out”). For instance, the reduction for a MFJ filer under age 50 with an MAGI of $190,000 can make a reduced contribution of $2,200.

    US Brokerage Account

    Most US expats will want to open a plain vanilla, non-retirement US-based brokerage account that is taxable. These accounts are taxed on capital gains (short and long), dividends and interest, but given the limited options available, this is appropriate for nearly all. The challenge, however, is that depending on where you live, you may not be able to find an US investment provider willing to work with you. For instance, living in the UAE, I know of only two investment providers that would be willing to work with US taxpayers, offer US domiciled investments (no Passive Foreign Investment Companies) and offer proper 1099 reporting on your investments to the IRS — which offshore providers generally do not do. If you’re having trouble finding options, contact us over Linked In and we’ll see what we can do for you.

    Consider a 401(k) Plan

    Here’s a more esoteric option. Let’s say you work full time overseas but you own a US company (employing only you, partners and spouses) or have 1099 self-employment income (because, for instance, you do some consulting on the side). You may want to consider opening a 401(k) or solo 401(k) due to the higher potentially tax deductible contribution limits when compared to an IRA. Any kind of 401(k) has two contribution elements: 1) Salary Deferral for the employee of up to $18,000 in 2016 for those under age 50 and a catch-up provision of $6,000 for those age 50 and over; 2) Profit Sharing from the business depending on the type of business (sole proprietor or corporation) and the percentage of net business income or W-2 compensation.

    By way of example, let’s say you are 45 years old and have consulting income as a sole proprietor which, after deductible expenses, nets out at $50,000. You would be allowed an “Employee” Salary Deferral Contribution of $18,000 plus an “Employer” contribution of $9,293. That’s a total deductible contribution of $27,293 compared to $5,500 in an IRA. Note the maximum contribution allowed is $53,000 total which would be possible with net income of around $185,000.

    Navigating the options can be confusing; the correct solution will depend on your tax specifics, but we are here to help as needed.

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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

Virginia La Torre Jeker J.D.

Virginia La Torre Jeker J.D., is based in Dubai. Virginia has been a member of the New York Bar since 1984 and is also admitted to practice before the United States Tax Court. She has over 30 years of experience specializing in the international aspects of US tax, including FATCA. She has been quoted in the New York Times and Newsweek, and is regularly quoted in many local news articles and publications."

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