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US Pension Contribution While On Overseas Assignment

US citizens who are working abroad have unique tax challenges that include the treatment of pension contributions made while on foreign assignment.  Pensions such as IRAs and 401(K)s among others, have specific contribution limits and rules that may be affected by an expat worker’s presence in a foreign country.  There are several key factors that must be considered when deciding how to contribute to a US pension while overseas, but there is no hard fast rule that will apply in every situation.  A qualified accountant or financial advisor can evaluate your unique situation, but you can consider the following points for reference as you research your options.

Key Factors to Consider For US Pension Contributions

The Requirement of US Source Income

 The use of IRAs for retirement planning and tax deferral is widespread among US workers, including those on foreign assignment.  There are annual IRA contribution limits, and this type of pension does not involve any employer contributions because it is individually managed by the employee.   However, one essential requirement of an IRA is that the worker must have ‘earned income’ on their US income tax return in order to contribute and enjoy the tax deferral benefits.  The amount of earned income must be at least equal to the contribution amount.

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The use of a 401(k) for retirement planning also relies on ‘earned income’ to determine contribution limits and eligibility, but there may be more options available for qualification due to the fact that it is an employer managed plan.

Use of an FEIE

This requirement of ‘earned income’ can be an issue where an expat worker uses the Foreign Earned Income Exclusion (FEIE) to exclude their foreign sourced income from US taxation.  If the worker’s ‘tax home’ is in another country, then they are eligible to use the FEIE.  If a worker elects to use this exclusion for 100% of their income they will not be eligible to deduct IRA contributions from their income, unless they have another source of US earned income.  Further, any contributions made when using the FEIE election will be subject to a penalty as ‘excess contributions’ under IRS rules, so the contribution has little benefit given these penalties.

A 401(k) can include employer contribution amounts depending on a variety of factors, as well as much higher contribution limits, and there may be ways for an employer of an expat worker to continue 401(k) contributions while the employee is on foreign assignment.  Some employees are able to make 401(k) contributions whilst on an overseas assignment by working under a shadow, split or dual payroll.

Use of an FEIE and the resulting tax liabilities should be assessed by a qualified accountant, and take into consideration the tax rate of the foreign country as well as the effect of the Foreign Tax Credit on taxable income in the US.

Continuing Contributions to a US Pension While Working Abroad

If the worker chooses not to use the FEIE election, and as long as the pension contributions qualify under IRS rules, any contributions would be treated the same as if the worker were located in the US. Deferral of taxation and the benefit of retirement savings are not affected if an US citizen works abroad for a period of time.  Even an employer-sponsored plan could be maintained if the employee continues to be payrolled in the US.

Is There Any Effect of Stopping Contributions?

Stopping contributions for any period of time has the effect of losing the ability to increase retirement savings using annual contribution limits.  There are some ‘catch-up’ options for IRAs after a certain age, but generally any time period where contributions are stopped cannot be recaptured.  This fact should be considered when making choices surrounding one’s tax home and income elections.

The Effect of Enrollment and Contributions to a Foreign Pension

 When a US expat contributes to a foreign pension (which may be required by statute in some countries) then it is unlikely that the foreign pension would qualify for favorable tax treatment under US tax rules.  Therefore, contributions would be included in taxable income, just as if the worker were making deposits to a normal savings account.  There could be an offset by using foreign tax credits on the US tax return, which could be used by the worker to reduce taxable income. 

Additionally a foreign pension is likely to trigger Passive Foreign Investment Company (PFIC) reporting which is an additional administrative burden. Expats need to be careful to ensure that their fund provides the necessary information for PFIC reporting.

The US does have tax treaties with some countries that allow for deductability of contributions to foreign pensions, so the relevant treaty should be researched and understood before deciding on a contribution strategy.

How to Handle Pension Contributions at the End of a Foreign Assignment

Once the foreign assignment ends, the worker will return to a standard US income with all applicable rules regarding pensions.  The only question is how to re-start pension contributions, and how a foreign pension can be transferred to the US.

Moving a Foreign Pension to the US

Generally, many foreign pension plans cannot be simply transferred or rolled over into an existing IRA account in the US, since they will not qualify.  Unless there is a specific tax treaty that addresses the transfer of pensions from a foreign country to the US, there are only a few options to preserve the tax deferral benefit of your foreign pension:

1.      You can leave the pension funds in place in the foreign account until retirement age and then take allowed withdrawals, which would then be taxed as normal income (but presumably at a lower rate).

2.      Take the funds out of the foreign pension all at once, or preferably periodically to reduce the tax effect of the withdrawals, and then place the after-tax funds in a US retirement account.

3.      Leave the funds in the foreign pension account for inclusion in your estate plan and tax free distribution to heirs.

Re-starting Pension Contributions

Assuming that the worker is eventually returning to a US sourced income, the regular schedule and contribution limits would apply, and contributions could be easily re-started as though the worker had never left.  There are no rules on how often contributions must be made or the amount, as long as the contribution limits are respected.

A GEO Employer of Record Solution to Manage Pension Contributions at Home and Abroad

For an employee on international assignment there are strategies for maximizing pension contributions while meeting host country statutory withholding requirements.  A GEO employer of record can assist with structuring the payroll and withholding amounts in the foreign country, ensuring compliance with local payroll and employment laws.  Because each country has different rules, the GEO can advise the client on the optimal approach to accommodate specific retirement benefits and goals.  The GEO can also assist in securing foreign pension contributions when the assignment ends, making this a valuable service to companies that may not have access to local experts and providers.

Summary

US pension contributions by expat workers on foreign assignment are subject to the same rules as for any US taxpayer.  The use of foreign income exclusions can affect the eligibility of contributions, especially to an IRA & 401k.  Foreign pension amounts are not easily transferred to a US pension while preserving the tax deferred benefit, and so the worker needs to make a careful evaluation of how pension contributions are allocated both at home and abroad. Lastly careful planning is advised to strike the right balance between tax considerations and the benefits derived from pension contributions.

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