How to begin contributing to an IRA with foreign earned income?
July 14, 2016 5:50 AM   Subscribe

I am a US citizen living abroad the last few years and plan on returning home eventually. I have taken advantage of the Foreign Earned Income Exclusion each year I filed my taxes. Since I haven't been able to contribute excluded income to my IRA, I was wondering if there's a way for me to do so upon my return.
posted by AngryTypingGuy to Work & Money (4 answers total) 1 user marked this as a favorite
Is there an advantage to doing so? You're already not paying taxes on that money, seems like it would be better to just put it in a regular brokerage account and let it accumulate dividends and long term capital gains, which will most likely be taxed at a much lower rate than IRA withdrawals. Plus it's easier to get at the money before traditional retirement age.
posted by mskyle at 5:53 AM on July 14, 2016

There are two kinds of IRAs, Roth and Traditional.

If you're talking about Traditional, than mskyle has it sort of right-- you've *already* paid taxes on your excluded income (in whatever country you're living in), and the point of a Traditional is to defer paying taxes until retirement (when your rate might be better). You can't really benefit in this case because your excluded income is already after-tax (and the traditional IRA is a contribute-before-taxes instrument).

As for a Roth, that actually could benefit you (Roths are post-tax contribution; the benefit is that anything you put in to a Roth grows tax-free, and you don't pay taxes when you take it out at retirement). However, what you can contribute to a Roth is limited in two ways: if your income is too high, you can't contribute (or you can contribute less). And you must have paid US taxes on whatever you contribute (so if your US taxable income, after the exclusion, is $0, you can't contribute to a Roth that year).

You can however contribute to a Roth once you start earning back in the US again, and since the money is post-tax it doesn't matter if it was previously excluded income or not. (I have no idea if you can contribute to a Roth and also have a job-based retirement contribution when you get back; but you can look into that, it will be the same rules as for someone who never left the country in the first place).

Your last option is to advocate for change :-) There basically isn't a way for non-huge-income expats to contribute to retirement funds in a tax advantaged way; As such an expat myself, I'd like that to change. There are various organizations that advocate specifically for Americans abroad; pick one and support them.
posted by nat at 9:36 AM on July 14, 2016

You can contribute to both an IRA (traditional or Roth) and an employer-based plan in the same year.

You can only contribute $5500 per year to the IRA, though ($6500 if you're over 50). The amount you can contribute to an employer-sponsored account varies depending on the type(s) of account available (for most people it's $18,000 per year).

You can use any money you saved while abroad to max out any available retirement accounts when you come back. Depending on your income, though, you may be able to do that anyway. I make less than the foreign income exclusion and I max mine out.

You can't get those IRA contribution years that you missed back, though. But really, if you invest the money you're doing great! Say I put $5500 in a Roth IRA this year. But that $5500 cost me $7300 pre-tax because my marginal tax rate is 25%. You invest $7300 in a taxable brokerage account.

Then we wait 20 years. Both accounts return around 4% annually. Your brokerage account is now worth around $16,000. My Roth IRA is worth around $12,500. I don't owe any more tax on my money, which is nice! But you'll most likely only owe 10-15% on your $8700 gain (maybe 0% if you're in a lower income bracket!). So you still come out a couple thousand dollars ahead.
posted by mskyle at 12:36 PM on July 14, 2016

As I mentioned before, you've likely already paid tax, just not US tax, on your excluded income. So mskyle's example of you somehow having $7300 isn't really right; you would be using after tax dollars too, just not after US tax. (Your effective marginal tax rate may even be significantly higher, depending on where you live).

It's a bit confusing because most places only tax residents or property owners; the US is one of two countries that tax citizens living abroad at all.
posted by nat at 4:04 AM on July 15, 2016

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