Retirement Accounts Abroad

What to know about taxes on foreign pensions and retirement income

Reviewed by Margaret JamesFact checked by Michael RosenstonReviewed by Margaret JamesFact checked by Michael Rosenston

If you’ve worked abroad at some point, you may be wondering if foreign pension income is taxable in the U.S. You could potentially face a tax hit from both the U.S. and the other county (or countries), so it’s essential to understand how the taxation works before you start to draw your pension, annuity, or another source. Here’s what you need to know about how taxes and fees apply to foreign retirement accounts.

Key Takeaways

• Foreign sources of retirement income, which is often in the form of a pension or annuity, include foreign employers, foreign insurance companies, trusts and entities, and foreign governments.
• Some employers allow workers to set up trusts when IRAs are not an option when working abroad.
• IRAs are only available for those with earned income in the U.S.
• Renouncing U.S. citizenship is one option when the tax situation becomes too complex.
• Consulting with a tax specialist can help maximize retirement income while minimizing taxes.

If you have worked abroad, you may find the tax implications for retirement income can be even more complex than those in the U.S. as a result of regulations and treaty agreements.

If you receive foreign pension or annuity payments, take time to understand U.S. tax law, international tax law treaties, and tax regulations in the country from which you receive the pension or annuity.

Consider consulting with a specialist in international tax law and retirement holdings who can provide guidance on your specific situation to minimize your tax hit and maximize the amount of money you will receive from your retirement savings.

Foreign Retirement Pensions or Annuities

Retirement income from foreign sources can come from different kinds of accounts:

• A pension plan or annuity directly from a foreign employer
• A trust established for you by a foreign employer
• A payment from a foreign government or one of its agencies (this could include a foreign social security pension)
• Payments from a foreign insurance company
• A foreign trust or other entity designated to pay the annuity

Even if you worked for an American company abroad, you might be getting an annuity payment from a foreign trust because of the complications of funding a pension with foreign income.

To qualify to contribute to an IRA, you must have earned income in the U.S. or income on which U.S. taxes are paid. As a substitute, some U.S. companies set up a foreign trust for their employees working abroad to enable them to save for retirement. 

Important

You may not be able to fund individual retirement account (IRA) if all or most of your income can be excluded from U.S. taxes through the foreign earned income exclusion and the foreign housing exclusion.

Foreign housing and foreign income exclusions allow Americans working abroad to reduce their earned income to avoid taxation by the U.S. Still, those exclusions often make it difficult to invest using IRAs. 

How International Tax Treaties Work

When it comes time to collect foreign pensions or annuities, how they will be taxed depends on which countries hold the retirement funds and what type of tax treaty it has with the U.S. 

Each country has negotiated a different treaty with the U.S. These treaties often include tax exemptions and reductions that enable you to minimize the amount of taxes you owe.

Tax on Foreign Pensions

In many countries, a foreign pension enjoys favorable tax treatment within the country, but does not generally qualify as a qualified retirement plan under the IRS tax code. This means that for corporations and their employees, the contributions are not tax-deductible. Because this tends to be the rule, the payments you receive from your foreign retirement plan are not treated the same as a U.S.-based pension.

In fact, even your contributions to the non-qualified retirement plans are fully taxed as part of your gross income. This means that your foreign pension could actually be taxed twice—once when you contributed the money and again when you collect it during retirement.

Tax treaties with many countries sort out this issue so U.S. federal tax liability can be offset. However, you and your advisor must be aware of the treaties and how to fill out the forms for both the U.S. and the foreign country involved. 

If you have pensions from foreign countries where you worked, you can research tax treaties between the U.S. and those countries at the U.S. Internal Revenue Service (IRS) website. For some countries, the IRS has publications on specific treaties.

U.S. Reporting Requirements for Investments

In addition to complying with tax rules when receiving foreign pensions or annuities, you must also properly report any holdings in foreign banks or investment companies. The U.S. Foreign Account Tax Compliance Act (FATCA) requires any institution holding more than $10,000 for a U.S. citizen to report account information to the U.S. Treasury Department.

U.S. citizens who reside in the U.S. must include any financial assets that exceed $50,000 held at non-U.S. financial institutions on their U.S. tax returns. If you reside outside the U.S., you must report if the total value of your foreign assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year.

If your retirement assets are in a fund that the IRS classifies as a Passive Foreign Investment (PFIC), penalties can be significant if you do not file. Capital gains from PFIC accounts are taxed as ordinary income, up to 37%, not at the lower long-term capital gains rate.

Investing abroad can also require paying much higher fees for investments than U.S. institutions charge. Morningstar’s annual Global Investor Experience Study rates how the countries compare in terms of fees and expenses. Here are how they compared in 2022:

Top	Above Average	Average	Below Average	Bottom
Australia	Korea	Belgium	Canada	Italy
Netherlands	Norway	Denmark	China	Taiwan
U.S.	South Africa	Finland	France
	Sweden	Germany	Hong Kong
	U.K.	India	Mexico
		Japan	Singapore
		New Zealand
		Spain
		Switzerland
		Thailand

U.S. vs. Foreign Retirement Accounts

Whether it is better to hold your retirement investments in the U.S. or in foreign accounts depends in part on where you expect to be during retirement.

If you plan to live outside the U.S. in a country with a stable currency, you may be better off holding the bulk of your money in that country to avoid another major international investing risk—issues around the value of the currency you use for your daily living expenses.

The best way to avoid a currency exchange problem is to hold your investments in the currency that you will use the most often in retirement.

Renouncing U.S. Citizenship

Some U.S. citizens are dealing with U.S. tax complications by renouncing their U.S. citizenship. However, that can have consequences, such as affecting whether you will be able to collect Social Security. When you renounce citizenship, you become a nonresident alien (NRA).

Typically, when you renounce your citizenship you can still receive social security benefits as long as you have paid enough taxes for them while a citizen. Additionally, those who remain citizens, but have simply moved abroad can receive benefits. However, there are some countries where the payments cannot be sent such as Cuba and North Korea.

As a noncitizen in another country, and depending on where you live, you may need return to the U.S. for one full month every six months to continue receiving your Social Security benefits.

What Happens to My 401(k) When I Leave the U.S.?

If you have a traditional 401(k) plan, you will face an early withdrawal penalty if you withdraw funds before age 59½, even if you live outside the U.S. If you are leaving the U.S., you could keep your 401(k) plan under the custodianship of your employer, or roll it over to an IRA in which you would manage the investments.

Can You Transfer Retirement Funds to Another Country?

You cannot transfer retirement funds from your tax-advantaged account to an account in another country. You would have to cash out your 401(k), which will have tax and penalty consequences if you are under age 59½. You can then try to deposit your cash into an account in another country.

What Happens to My IRA if I Leave the U.S.?

If you leave the U.S. to live abroad, you can keep your U.S.-based IRA, no matter if it is a traditional or a Roth IRA. However, you may not be able to continue contributing to your tax-advantaged retirement account if you live abroad.

The Bottom Line

Tax on foreign pensions and collecting Social Security abroad can be complicated. If you’ve worked abroad and built your retirement portfolio outside the U.S., seek professional advice before you start to draw your pension or annuity. This will enable you to maximize your retirement income and minimize your tax bill from both the U.S. and the country (or countries) where your retirement funds are held.

Read the original article on Investopedia.