IRA advice for a US expat
Hi – I am looking for advice on how to invest for retirement as an expat using IRA and Roth IRA accounts.
I am a UK and US citizen living and working in the UK (employed by a UK employer). I would like to put money into a Roth account but my Modified AGI exceeds the income thresholds, therefore I would like to look into the option of contributing into a Traditional IRA and then converting that into a Roth (for as long as that’s allowed).
I would be contributing After-UK-Tax income into the Traditional IRA and therefore would like to ensure it’s not taxed again by the IRS when I do the conversion into a Roth.
Is is possible to do what I’ve described and what is the right way to execute this?
Thanks,
Stefan
Permalink Submitted by Peter Lingane on Sat, 2012-03-03 17:04
I see no difficulty, in principle, in doing what you propose. I assume that you are resident in the UK, that you file a US tax return and that your UK wages exceed your foreign earned income and housing exclusions. See Pub 590 (2011), p.7.
Distributions from a traditional or Roth IRA are likely taxable income on your UK return if repatriated to the UK but you should confirm with a UK tax authority.
If IRA distributions are taxed by the UK, UK tax deferred and tax free investment schemes could be better retirement savings vehicles if you intend to retire in the UK.
These are complex issues. I urge you to seek advice from someone who is familiar with both your US and UK tax situation.
Permalink Submitted by Stefan Stefan on Sun, 2012-03-04 11:18
Peter – thanks for your response. Retirement is a long way away so at this point I don’t know where I’ll retire. However, I don’t think that a UK tax deferred vehicle offers any advantages, here is why I think that.
1) If using a UK ISA (the UK similar to a Roth) then the IRS would likely tax distributions even though the UK will not.
2) If using a UK-tax deferred (company pension like a 401k) then the IRS does not recognize foreign pension schemes, considers them as income and taxes them in current year
Interested to hear if you think my above assumptions are incorrect.
Yes, you are correct that I live in the UK. I do not take the foreign income exclusion because it’s much simpler to take the Foreign Tax Credit. Since the UK income tax rate is higher than the US, after taking the foreign tax credit I effectively owe nothing to the IRS.
Permalink Submitted by Peter Lingane on Sun, 2012-03-04 16:26
You pay US tax on your worldwide income, less any foreign tax paid on the same income, and UK tax on income earned in or repatriated to the UK when a UK resident and UK tax on income sourced to the UK when a US resident. Please confirm this statement with your tax adviser. There is also the tax treaty to consider.
If you retire in the US, you will probably pay no US or UK tax on Roth distributions and US tax on the ISA.
If you retire in the UK, you will probably pay UK tax but no US tax on Roth distributions and US tax but no UK tax on the ISA.
If the Roth/ISA distributions are the same and if the UK marginal tax rate is higher than the US marginal rate, you pay less tax with an ISA if you retire in the UK and you pay less tax with a Roth IRA if you retire in the US.
Reg §1.219-1 says that you cannot make an IRA contribution based on compensation “not includible in gross income.” You include your foreign compensation in gross income because this makes for a simpler tax return and no difference to your US tax liability. I don’t know whether the foreign income exclusion is optional. If I were auditing your US return, I’d deny any IRA contribution based on compensation that is not includible in gross income whether or not you included it. But then I don’t work for the IRS. Nor have I researched this issue.
Permalink Submitted by Peter Lingane on Sun, 2012-03-04 18:30
The US does not allow a credit for all foreign taxes paid. The credit only applies to the foreign tax on income that is also taxed by the US. Since the US allows you to exclude the first hundred thousand dollars or so of your foreign compensation, I don’t see that you can claim a credit for the UK tax paid on the first hundred thousand dollars of your foreign compensation.
Ask your tax adviser whether you should amend your US returns to reflect the foreign income exclusion and a smaller tax credit. There probably won’t be a change in your US tax liability.