What U.S. Expat Should Know About IRA Distributions

An Individual Retirement Account (IRA) is a tax-deductible retirement account that grows tax deferred until it is withdrawn. Account holders may only contribute “earned income” into an IRA and may be subject to early withdrawal penalties and taxes on distributions made prior to age 59 ½ of the account owner. At the age of 72, IRA account holders are required to start taking Required Minimum Distributions (RMD) and pay ordinary income taxes on the amount withdrawn. Failure to take your RMD will result in substantially higher penalties. These rules are quite basic of U.S. tax advantaged retirement accounts for Americans until they leave U.S. soil to live abroad, then it becomes a nightmare if you’re not careful.

Most U.S. custodians will likely force a full distribution of the IRA account when you switch to a foreign address. This can cause all sorts of problems with your income taxes and penalties especially if you are below the age of 59 ½. There may be ways around this but that is beyond the scope of this article. The following are some basic concerns and solutions on IRA distributions while living abroad:

• Distributions from an IRA are not regarded as earned income

Due to the fact that IRA distributions are not regarded as “earned” income, they are not exempt from the foreign earned income tax. Hence, you must utilize the foreign tax credit in its place to reduce your tax burden.

The foreign tax credit reimburses US citizens living abroad for taxes paid to foreign governments on their income, particularly passive income from distributions from traditional IRAs and other tax-deferred retirement accounts.

• You may owe more U.S. taxes if you reside in a country with lower taxes

The tax laws in your country of domicile may have an effect on how much tax you owe to the United States. You may be able to reduce your overall U.S. tax burden, avoid paying more U.S. taxes, and possibly have a tax credit carry forward if you reside in a nation with higher taxes than the United States.

On the other hand, if your country of residence has lower taxes than the U.S., you will probably owe more money in taxes on your IRA distributions.

• Tax treaties between the United States and your nation of residence may heavily influence how much you pay in IRA distribution taxes

Because the tax treaty between the United States and your country of domicile affects how RMDs are treated tax-wise, it’s critical to comprehend all its clauses. Working with a competent cross-border tax expert who is familiar with the ins and outs of any potential tax treaties is advisable, as it is with so many other U.S. expat tax considerations.

• A Qualified Charitable Distribution (QCD) from your IRA may enable you to reduce your U.S. tax liability

A QCD is a direct transfer of funds from your IRA custodian, payable to a qualified charity. You may still profit from the U.S. tax benefits linked to charity giving even if you reside abroad, and a QCD can be a useful tool for doing so. IRA owners over the age of 70 ½ can directly transfer up to $100,000 per year in IRA distribution to a qualifying charitable organization without incurring U.S. taxes on the amount donated to charity.

• RMDs do not apply to Roth IRAs but may be subject to double taxation in other jurisdictions

Roth IRA contributions are made with post-tax “earned income” in the United States. Withdrawals may be tax-free for U.S. residents and RMDs are not required for Roth IRAs. About 10 other nations, aside from the United States, explicitly recognize the Roth IRAs’ tax-free status. Roth IRAs are at risk of double taxation for residents of countries that do not recognize the tax-free benefits of the Roth IRA. Working with a knowledgeable cross-border accountant and wealth manager who has experience guiding clients through the complicated international ramifications of owning a Roth IRA is essential, especially if you intend to retire overseas.

• Be vigilant of your custodian’s customary withholding tax on distributions

Certain U.S. custodians may apply a mandated withholding amount of up to 30% on IRA distributions on IRA accounts with an international address of record. Although this may be acceptable for U.S. expats living in jurisdictions that do not have a tax treaty with the U.S., it may not be necessary in other tax treaties. Being vigilant with these withholding amounts and having a good understanding of the bilateral tax treaties in your country of domicile may help you avoid paying more than what you owe in taxes, only for the IRS to hold on to your cash without paying you interest.