Traditional vs Roth IRAs: The Keys for Expats
- Can Americans Living Abroad Maintain an IRA?
- IRA Contribution Rules for Overseas Americans
- The Difference between Roth IRA and Traditional IRA
- Setting Up an IRA While Living Abroad
- Can You Move Your IRA Overseas?
- How to Calculate Modified Adjusted Gross Income (MAGI) for a Roth IRA for Expats
- What If the FEIE Disqualifies Me from Contributing to My IRA?
- How to Calculate How Much You Can Contribute to an IRA
- Still Have Questions Regarding IRAs? Get Help from an Expat Tax Expert
Most Americans have some trouble understanding the details of their individual retirement accounts (IRAs). If you move to a foreign country, IRA accounts become even more complicated. To help make sense of this complex topic, here’s what you need to know about traditional and Roth IRAs for expats when making retirement contributions.
Key Takeaways
- Traditional IRAs and Roth IRAs have plenty of overlap, but they also have notable differences.
- The key difference is that you can deduct contributions to a Traditional IRA, but not a Roth IRA. When withdrawing money from them upon retirement, Traditional IRA withdrawals are taxable and Roth IRA withdrawals are not taxable.
Can Americans Living Abroad Maintain an IRA?
Yes. US citizens living overseas can maintain both traditional and Roth IRAs. However, there are restrictions on who can make contributions. This means that while you won’t have to dissolve or transfer your IRA assets while living abroad, you may not be able to add to them either.
IRA Contribution Rules for Overseas Americans
Whether or not you can contribute to an IRA while living overseas depends on your income level and any deductions or exclusions you claim. As a quick overview:
- You can contribute to a traditional IRA if you are under the age of 70½ and receive taxable compensation, which is defined as salary, wages, or self-employment income. This does not include investment income or any other type of income.
- You can contribute to a Roth IRA if you receive taxable compensation and your modified adjusted gross income (MAGI) is below certain thresholds.
For expats, the key factor is taxable income. All US citizens are required to file a US federal tax return and report their worldwide income, regardless of where they live. However, the IRS offers a variety of tax deductions and exclusions for Americans living abroad. As a result, many expats don’t end up owing any taxes.
If you have no taxable income after applying the dedications and exclusions available, you will not have any taxable income and thus be ineligible to contribute to a traditional or Roth IRA.
Let’s look at a couple of examples.
- Patricia, a US citizen, moves to Norway. She works as an occupational therapist and earns the equivalent of $80,000 per year. Using the Foreign Earned Income Exclusion (FEIE), she excludes her entire income from US taxation. With no leftover taxable income, Patricia is unable to contribute to a traditional or Roth IRA.
- Lucas moves to South Korea, where he works as an optometrist. His salary is the equivalent of $150,000 per year. Using the 2023 tax year FEIE exclusion amount, he excludes $120,000 of his income from US taxation, and his standard deduction is $12,950. Lucas will have $17,050 ($30,000 – $12,950) in taxable income; he is able to contribute to an IRA (as long as he also meets the other standards).
This is a simplified version of the IRA contribution rules for expats. The rules can vary widely depending on your financial details or the foreign country you live in. We recommend consulting an expat tax professional when determining your IRA eligibility.
The Difference between Roth IRA and Traditional IRA
Traditional IRAs and Roth IRAs have plenty of overlap, but they also have notable differences.
Traditional IRAs
- Before 2020, contributions to a traditional IRA were limited to individuals under 70½ years of age. However, with the Secure Act in January 2020, this age restriction for Traditional IRA contributions was abolished by the IRS.
- These contributions are tax-deferred, meaning that you won’t have to pay any taxes on them until you withdraw the funds from your account.
- You can deduct your traditional IRA contributions on your tax return for the year you contributed them.
- You can begin withdrawing your IRA funds at age 59½ without any penalties (aside from the taxes you deferred when making your contributions)
- If you withdraw from your IRA before age 59½, you will typically have to pay an early withdrawal penalty (some exceptions apply, such as when buying a first home or having a child)
Roth IRAs
- Roth IRA contributions are not tax-deferred, and the funds you deposit into your account are generally after-tax.
- You cannot deduct Roth IRA contributions on your tax return
- Because Roth IRA contributions are usually made using after-tax money, your withdrawals won’t be taxed, as that would count as double taxation
- You can begin withdrawing your Roth funds at age 59½ without any penalties (aside from the taxes you deferred when making your contributions)
- If you withdraw from your Roth before age 59½, you will typically have to pay an early withdrawal penalty (some exceptions apply, such as when buying a first home or having a child)
Setting Up an IRA While Living Abroad
Can expats set up an IRA while living abroad? Yes! In fact, you can create either a traditional or Roth IRA. (Though the rules discussed above will dictate whether you can make contributions to either.)
If you already live overseas, we strongly recommend choosing a US-based IRA rather than a foreign IRA. Foreign investments are taxed differently from US investments and come with heavier reporting requirements.
However, there are exceptions to the rule. An expat tax professional will be able to advise you on the best choice for your individual situation.
Can You Move Your IRA Overseas?
Rolling an existing US IRA into a foreign pension is possible in some cases, but it’s seldom easy. It’s often simpler to withdraw the funds from your IRA and open a new account in a foreign country. (However, this can lead to steep penalties and tax if you withdraw the funds before reaching the age of 59½.)
How to Calculate Modified Adjusted Gross Income (MAGI) for a Roth IRA for Expats
As mentioned above, your Modified Adjusted Gross Income (MAGI) must be below a certain threshold to make Roth IRA contributions. Thus, when determining whether you are eligible to contribute to a Roth IRA, you will need to calculate your MAGI.
Your MAGI is your gross adjusted income (AGI) plus any untaxed:
- Foreign earned income
- Social Security income
- Interest
This means that even if you use expat tax exemptions or exclusions, your foreign income is still part of your MAGI. For example, if you use the FEIE to exclude a portion or all of your foreign income, that income will still count toward your MAGI.
What If the FEIE Disqualifies Me from Contributing to My IRA?
If claiming the FEIE excludes all of your foreign-earned income from taxation, you won’t be eligible to make any IRA contributions. So, what are your options? Let’s take a look.
1. Refusing the FEIE
Firstly, you could choose not to claim the FEIE at all. You are not required to use the FEIE even if you qualify for it. However, if you have used the FEIE in the past, you will have to revoke your election to use it explicitly, and you will not be able to claim it again for five years.
2. Claiming Only Part of the FEIE
Depending on your situation, you may be able to claim only a part of the FEIE. This depends on whether you qualify for the FEIE under the bona fide residence test or the physical presence test.
You are required to claim the entire FEIE amount available to you. It’s all or nothing. Since the bona fide residence test qualifies you for the FEIE for a full tax year, you must claim the full FEIE amount available for that year.
However, the physical presence test isn’t tied to any particular tax year. It applies to any 12-month period. If you time your trips to and from the US right, you could reduce the amount of FEIE you are eligible for in a given tax year. This would allow you to claim a smaller portion of the FEIE while still having taxable income left over to contribute to an expat IRA.
Use our simple excel calculator to get an estimate of how the foreign earned income exclusion will save you money. It will make your day!
3. Tax-Free Roth IRA Conversions
In some instances, even if you use the FEIE to exclude your foreign income, you may be able to convert some of your pre-tax funds into a Roth IRA without paying a dime. Consult an expat tax expert to see if this is an option for you.
How to Calculate How Much You Can Contribute to an IRA
If you are eligible to make contributions to a traditional or Roth IRA, there will be a maximum amount you are allowed to contribute each year. This amount is based on your income, filing status, and age. The IRS provides a table explaining how much you can contribute during the current tax year.
Still Have Questions Regarding IRAs? Get Help from an Expat Tax Expert
Have questions about traditional and Roth IRAs for expats? No problem! We have the answers you need. In fact, we can even help you meet your US tax obligations.
Contact us, and one of our customer champions will gladly help. If you need very specific advice on your specific tax situation, you can also click below to get a consultation with one of our expat tax experts.
