Many Americans don’t have enough retirement savings to stay here.
That helps explain why many of them are leaving the U.S. to retire in places where the cost of living is cheaper, according to financial experts. “This is becoming a huge trend,” says Christian Gulizzi, an international CPA at Gulizzi Consulting, a tax and accounting firm based in Italy.
One in four non-retired Americans reports having no retirement savings or pension, according to the Federal Reserve’s latest Report on the Economic Well-Being of U.S. Households. What’s more, 44% said their retirement plans are “not on track.” The report also cites a disparity among the Black and Hispanic population being “more likely than Whites to have no retirement savings.”
But while retiring abroad is a solution for some people, it’s not an easy one. The financial implications are serious, especially when it comes to taxes. Depending on which country you move to, you could even face double taxation — getting taxed from both the U.S. IRS and the country you reside in.
Even if you live abroad full-time, you’ll still need to file a U.S. tax return every year, according to expats abroad as well as experts in international tax law. The United States taxes your global income, not just what is earned while in its borders, says Ryan Deters, financial advisor at Fiduciary Financial Advisors in Michigan.
Vanessa Menchaca-Wachtmeister knows this firsthand. The creator of Wander Onwards, a finance and travel blog, she is an American expatriate currently earning income while living in Germany. Menchaca-Wachtmeister’s LLC is set up to do business in the U.S. Since there is a tax treaty in place between Germany and the U.S., she’s not double-taxed on that income. Menchaca-Wachtmeister pays taxes to Germany, but she still has to file IRS paperwork every year to show the U.S. that Germany is collecting on those taxes.
On the other hand, residing in Germany has some negative effects on her taxes. “Some of the retirement accounts that you thought were tax free forever, like the Roth IRA, are not recognized by Germany as being really forever,” says Menchaca-Wachtmeister.
We asked tax professionals and experienced expats for their advice on taxes and living abroad.
How to Determine Your Taxable Income Abroad
When choosing to live in a new country, you can put your income sources into four main buckets and then figure out how the new country may tax it, according to Nathalie Goldstein, an American expat and CEO of Austria-based tax software company MyExpatTaxes.com.
Bucket one: U.S. Social Security Benefits
Most countries won’t double tax Social Security. You’d have to check the tax treaty in place to be sure. “Most of the time that tax treaty will tell you which country is allowed to tax your U.S. Social Security benefits, and most of the time, it’s only the U.S. that can tax it,” says Goldstein.
Bucket two: Retirement Accounts and Pension Income
- Examples: IRAs, 401(k)s, Roth accounts, or pension plans.
Pension income can be fair game. Sometimes your new country will tax it, but you can then claim it on your U.S. tax return using the Foreign Tax Credit. “This allows you to take dollar for dollar credit for foreign income taxes paid against your U.S. tax liability to prevent double-taxation” says Goldstein.
Distributions from pre-tax accounts like traditional IRAs or 401(k)s are taxed by the U.S. government. “Because contributions to those are made pre-tax, the U.S. government wants to ensure it gets its cut regardless of where you are living,” says Deters.
The “tricky one” is the Roth IRA, says Goldstein. Contributions to a Roth IRA are taxed already by the U.S. so that when you withdraw, you withdraw your contributions and earnings tax-free. “But some countries, like Germany and Austria, don’t recognize this U.S. tax benefit and will tax it again at withdrawal,” she says.
“For a Roth account especially, this defeats the purpose of the account, which is to pay taxes upfront but not on gains earned thereafter,” says Deters.
For example, withdrawals from Menchaca-Wachtmeister’s American tax-advantaged accounts that are funded with dollars already taxed by the U.S. are subject to German taxes too. “You have to be prepared to stay on top of your American reporting,” she says.
Bucket three: Passive Income
- Examples: Rental income, investment income.
Same as pension income, passive income will most likely be taxed where you live. And then you can claim the foreign tax credit on your U.S. tax return, says Goldstein.
Bucket four: Active Income
- Examples: Salary or business income.
If there is a tax treaty in place, your active income will be taxed based on that guideline. But you could apply for the Foreign Earned Income Exclusion (FEIE) or the Foreign Tax Credit. The FEIE and Foreign Tax Credit are IRS exclusions you can claim on earned income and meant to offset potential double-taxation. But they have a ceiling, says Deters.
The FEIE allows income to be tax-free up to $108,700 per person (as of 2021). But if you earn over the FEIE limit, you pay taxes on the difference.
Menchaca-Wachtmeister says she earns more than the FEIE limit, so she applies the Foreign Tax Credit. “This lets America know that I’m paying significant tax in Germany, and therefore, most of my income should be excluded from American double taxation.”
Jackie Lange is an expatriate from Texas who moved to Panama in 2010. Lange is a real estate investor and operates a local business called Panama Relocation Tours, which provides transportation, lodging, and tour guide services for potential expat retirees visiting the country.
As an example, Lange tells us she was able to exclude up to $107,600 (using 2020 rules) from her United States tax returns using the FEIE. “Let’s say I made $127,600 in Panama. I could deduct $107,600 from that income. Then I only have to pay U.S. taxes on $20,000 in the US,” says Lange.
Advice from the Tax Professionals
As you can see, international taxes can get complicated. Here are six big takeaways from the international tax experts we talked to:
1. There are no legal tax loopholes.
The biggest takeaway from speaking with international tax experts is this: Plan to pay taxes no matter where you live. “Retiring abroad does not mean that you leave the U.S., take all your U.S. retirement income, and you just live off that, tax-free,” says Goldstein.
It’s a common misconception to think you can avoid paying taxes altogether when you move. “U.S. citizens will always be required to report their income to the IRS wherever they are, just because of their citizenship,” says Gulizzi. “It’s very hard to get to a situation where you pay no taxes at all.”
2. Figure out how long you plan to live in your new country.
The amount of time you spend there will determine whether you will become a tax resident or not, says Goldstein. “Some people retire abroad, but they only spend a little bit less than half a year abroad, and then the rest of the time back in the US, so they’re still a U.S. tax resident and not really a tax resident in other countries,” says Goldstein. “If you decide to become a tax resident in a new country, then they will most likely tax your retirement income,” says Goldstein.
Goldstein has a few clients that live in Mexico a few months out of the year. They call themselves “retired to Mexico,” but they never become tax residents there and only file tax returns in the U.S.
3. Find out if there is a tax treaty in place.
You can find a list of countries with existing tax treaties on the IRS website. Many treaties will say that the U.S. Social Security benefits are only taxable by the U.S., says Goldstein.
But not all tax benefits, including those for Roth IRAs, will transfer over to your new country. If you decide to invest in a tax-advantaged plan in one country, make sure that those tax advantages will be recognized in your new country, says Goldstein.
4. Consult with a tax professional and check the country for double taxation.
Do plenty of research and consult an experienced tax professional before making any big decisions.
Everyone’s tax situation is different and with different outcomes, says Gulizzi. Having lived in Germany, Italy, and the U.S., Gulizzi emphasizes how seeking a tax professional is crucial to determining the tax implications when you relocate. You don’t have to necessarily use a tax advisor specific to the country. “A U.S. CPA that has experience and knowledge about foreign countries and how different pensions can be taxed in an international context may already be a wise choice for a first determination of the tax consequences” says Gulizzi.
Gulizzi tells us that the international landscape for how tax-advantaged retirement accounts are being treated is changing. Some countries are adding clauses to their tax treaties allowing pension income to be taxed in the new country as well as in the country that provided the tax-break on the pension contributions. “That is why you need to have a global tax consultant that is able to give you proper advice, in the long term, not only in the short term,” says Gulizzi.
5. Taxes aren’t everything.
“People may be very allergic to taxes. They may have a list of 10 benefits, but if they have to pay more taxes, they forget about the other 10 bonuses,” says Menchaca-Wachtmeister.
Make sure you’re compliant with tax rules, but taxes should not necessarily be the driver of your decision to move or not. If there are other benefits to moving abroad, such as lowering your cost of living, then taxes are what they are.
“A lot of Americans don’t realize that the cost of living outside of the United States is so low that you can still afford to be taxed on some income once you’re abroad,” says Menchaca-Wachtmeister.
6. Plan ahead
If living or retiring outside the U.S. is in your long-term vision, plan ahead, says Deters. Research and find an advisor or tax professional you trust and talk to them about your long-term plans. “There’s only so much that can be done once you’ve already moved or retired,” says Deters.