The IRA rules for Americans working abroad are particularly important for those who work overseas and wish to save their money in Individual Retirement Accounts or IRAs. However, there are technical rules to consider to ensure the best tax outcome. The foreign earned income exclusion aligns with the eligibility rules for contributing to a Roth IRA, creating a very narrow range of options for Americans living and working abroad.
Foreign Earned Income Exclusion and Housing Exclusion
Many Americans living and working abroad may qualify for the foreign earned income exclusion, which states that the first $112,000 of foreign wages or self-employment income is excluded from U.S. federal income taxes starting in 2022 ($120,000 in 2023). This threshold is adjusted for inflation, so it can periodically increase to keep pace with the economic situation.
Individuals working abroad may also be eligible for the foreign housing exclusion, allowing them to deduct certain housing expenses from their total income. There are limits on the exclusion based on where the expenses occur.
No contributions can be made to an individual retirement account for any income that is excluded from tax due to either of these tax exclusions. However, contributions can be made to an individual retirement account for income that is not excluded from income tax.
Suppose you are an American living in the United Kingdom earning $100,000. If you use the foreign earned income exclusion to exclude this entire amount from your U.S. taxes, you have nothing left to contribute to an individual retirement account. Now suppose you earn $150,000 and exclude the maximum amount of $112,000. You still have leftover income that you can put into an individual retirement account.
Coordinating the Exclusion with Roth IRA Accounts
There are limits on Roth IRA accounts based on income. An individual taxpayer can fund a Roth IRA at the maximum contribution limit if their modified adjusted gross income (MAGI) is less than $129,000 in 2022 ($138,000 in 2023). The amount that can be contributed to a Roth IRA is phased out for single taxpayers with incomes between $129,000 and $143,999 in 2022 ($138,000 and $152,999 in 2023). No contribution to a Roth IRA is allowed if your MAGI exceeds $144,000 in 2022 ($153,000 in 2023).
These limits increase to $204,000 and $213,999 for married taxpayers filing jointly ($218,000 to $227,999 in 2023). They are also adjusted for inflation, so they tend to rise somewhat from year to year.
The taxpayer’s adjusted gross income is adjusted to add any foreign earned income exclusion and/or foreign housing exclusion they may have claimed. This creates a very narrow range of income possibilities for funding a Roth IRA if you are living and working abroad.
Coordinating the Exclusion with Traditional IRA Accounts
Traditional IRA accounts are coordinated with the foreign exclusion in two ways. First, like a Roth IRA, an individual cannot contribute excluded income to a Traditional IRA. Second, a deduction for a Traditional IRA contribution may be limited or completely eliminated if the individual is covered by an employer’s qualified retirement plan. Traditional IRA accounts will only be available on foreign wages or net self-employment income exceeding the amount of the foreign earned income exclusion if the taxpayer is not eligible to participate in the employer’s qualified retirement plan.
Accounts
Roth IRA vs. Traditional IRA Accounts
The differences can be significant because the taxes on contributions to a Roth IRA or a Traditional IRA are very different. Contributions to a Traditional IRA can be deducted from taxes in the year they are made, while contributions to a Roth IRA are not deductible. However, taxes will occur later with a Traditional IRA: withdrawals from a Traditional IRA are subject to income tax at the time of withdrawal, while withdrawals from a Roth IRA are not taxable, as long as they are qualified withdrawals, meaning they meet certain requirements.
Consider Using the Foreign Tax Credit Instead
Americans working abroad may find that the foreign tax credit yields better results than the foreign earned income exclusion in some cases. If you choose to use the foreign tax credit instead, you will have taxable wages or net self-employment income that may allow you to fund an IRA account in the United States. The foreign tax credit also provides a tax reduction in the U.S. based on the taxes paid to the country where you work. This income is taxed, so it is not excluded, and thus you can fully benefit from contributing to an IRA.
Frequently Asked Questions (FAQs)
What happens to my Roth IRA if I move to another country?
Nothing happens to your Roth IRA if you move abroad. The money will continue to grow tax-free, and all required minimum distribution rules apply once you reach retirement age. The only thing that could change when you move abroad is your ability to contribute more money to your Roth IRA.
When should I file my tax return if I am a U.S. citizen living abroad?
U.S. citizens living abroad are granted an automatic two-month extension if they do not file their returns on tax day. In other words, the deadline for U.S. citizens living abroad to file their returns is June 15. You can request an additional extension to postpone the deadline until October 15, but the first extension will be automatically granted only.
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Sources:
– Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2023.”
– Internal Revenue Service. “Foreign Earned Income Exclusion.”
– Internal Revenue Service. “Foreign Housing Exclusion or Deduction.”
– Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2023.”
– Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2022.”
– Internal Revenue Service. “Traditional and Roth IRAs.”
– Internal Revenue Service. “Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.”
– Internal Revenue Service. “U.S. Citizens and Resident Aliens Abroad.”
Source: https://www.thebalancemoney.com/ira-for-workers-abroad-3193218
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