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Author: Bauernaught One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121185  
Subject: Re: Expatriate investing Date: 6/25/2001 8:36 AM
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I'm a US expat living and working in London for a 2 year period (no plans to stay and naturalise even though I've enjoyed this time - I'm about halfway through my commitment right now). I am afraid I have bad news regarding Roth IRA participation (keep reading; info is attached below). I suggest joining expatexchange.com as soon as possible, and keeping up with their message boards (including the info from the finance board, some of which I've included here).

Also, I have found our the IRS's website to be very helpful regarding overseas tax questions: www.irs.gov
On the "Forms and Publications" link you'll find a host of information. There is also a good Q&A section. I used this website along with Turbo Tax to file my 2000 taxes (my first year overseas), and had no major problems figuring out the tax code as it applies to overseas Americans (and I'm not even an accountant or FS type!)

I did have to ask the IRS specific questions about my 1999 tax return because I had made a mistake on my 1998 taxes (not related to working overseas) - long story that I won't go into here. Anyway, I was working abroad at the time of filing and I chose email to communicate with them; I found them to be responsive and helpful over email if you ever need to do that.

I do not suggest participating in a UK-specific pension scheme unless you plan to naturalise or are staying longer term or are older than I am (31) and therefore closer to drawing the money back out. Even though I used to max out my 401(k) contributions when I lived in the states, I do not participate in the generous UK pension plan offered to me (yes, I forego free money - blasphemy according to my innate values!) because given the tradeoffs involved, it is not worth it for me. My understanding is that one cannot cash it out even upon leaving the country and can't draw on it until one is aged 60 or 65 (60 for women, 65 for men, although that is supposedly changing to be 65 for both sexes). That is too far away for me to be tied up with the UK tax system for 30 or so more years.

Good luck to you and your wife. If you need any other info, please let me know. I may not know the answer but may be able to refer you to someone who can help.

From the expatexchange.com website (the question regards working in Germany but the answer applies to you for the UK as it also applies to me, unfortunately).

IRA contributions while working abroad

"My question concerns contributing to my Roth IRA, which I have established with a major US-based fund management company. I will be working under German contract in Germany for an unspecified amount of time (i.e. I am NOT an expat transferred from the US; rather will be a "regular" local German employee). While I am not sure of all the German pension plans, I would like to continue to contribute to my Roth here in the States, as I will likely retire in the US. I talked to my adviser and he said that I will not be able to contribute to the Roth because I will not have any US-based earned income. Even if I declare my taxes (IRS 1040) that I did indeed earn income, albiet in a foreign country and therefore I exempt myself from US taxes via IRS form 2555, this does NOT qualify me to contribute to the IRA. He said if I were to earn more than the $76,000 exemption level and therefore pay US taxes, THEN it would be counted as US earned income and thus I could contribute to my IRA. ?!?
Is this true? Has anyone ever dealt with this issue or have suggestions where I can turn? I can't believe that I will be penalized on my pension just because I am an American citizen but am working for a foreign company. My adviser said about my only other pension plan options were mutual funds and annuities, the latter which really turns me off. I am 31 and don't want to pay into the German system for x number years then not get my Pension, AND not have a US-based pension fund.
Any other advise on pension building abroad? Thanks for all help!!
-Amy"

Reply from Barbara Frew, Author of Personal Finance for Overseas Americans

"Amy,

Your advisor is correct. Foreign earned income you exclude via Form 2555 is not "taxable compensation" with regard to fulfilling the first requirement for making Roth IRA contributions. If you (or if your are married, and your spouse will have some taxable compensation) then the second requirement comes into play. Once you have some taxable compensation then you must calculate your "modified adjusted gross income" which requires you to add back any foreign earned income exclusion taken via Form 2555. (Note: once you use Form 2555, you will be required to use it during your entire time abroad.)

From your note, it seems that the above is not an option. However, you generally have the option to use Form 1116, instead of Form 2555, and receive credit for foreign taxes you pay. (Chances are that during your initial year abroad you may not be in country long enough to qualify to use Form 2555.) When deciding whether or not to use this option, you need to weigh the additional taxes you may pay by using Form 1116 rather than Form 2555 and the additional income you may garner from placing your retirement savings in a tax-deferred account rather than a taxable account. Please note that I am not a tax specialist, so you may wish to consult with one who has experience with expatriate tax issues for further details. (The tax experts on the tax forum can give you further guidance.)

As to social security retirement benefits, Germany is one of the 18 countries that have a social security totalization agreement with the United States. If the firm you will work for is a U.S. affiliate that has agreed under Section 3121(1) of the Internal Revenue Code to pay U.S. social security taxes for its U.S. citizen employees then you will pay U.S. social security taxes. If you will be a "local hire" for a German company, which it sounds like you will be, then you will pay German "social security" taxes. The good news is that the totalization agreement allows you to use your German social security "credits" to qualify for U.S. social security benefits. The bad news is that your benefits will be based solely on income on which you pay U.S. social security taxes. (Please see the article "How an Overseas Career Can Impact Your Social Security Retirement Benefits" just posted on this forum. Also you can read a copy of the German - U.S. Totalization agreement on www.ssa.gov/international.)

Your options for saving in a tax-deferred account may be limited while you are abroad. You always have the option to save for retirement in a taxable account. As you noted, annuities are not a good choice. Mutual funds with good long-term returns, but lower turnovers are a good starting point. Funds with lower turnovers generally make fewer distributions and when they do, the distributions are often subject to lower long-term capital gains taxes rather than higher income or short-term capital gains taxes.

I hope this helps.

Barbara Frew
Author of Personal Finance for Overseas Americans"

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