Offshore Pension Basics
Many expats end up with a bit of savings while living outside the US. In addition, moving around to different countries and working for many different companies can leave expats feeling left out (or at least confused) when it comes to pension plans and social security benefits.
This makes expats easy prey for unscrupulous “investment” companies, frequently located “offshore” in tax havens such as Isle of Man, Guernsey, Bermuda, etc., although sometimes in countries that are not tax havens (Ireland seems to be popular also). As sexy as offshore investing sounds, it will probably bring nothing but trouble for you if you are an honest, tax-abiding US citizen. Since US Citizens are taxed on their worldwide income regardless of where they reside, income from offshore investments will be taxed in the US even though there may be no tax where the account is located. Even worse, these investments almost always fall under the punitive rules for “Passive Foreign Investment Companies”, which result in taxation at the highest possible tax rate in the US.
Offshore pensions are sold by convincing the expat on several items, including:
1) They are going to be left without a pension if they don’t act now.
2) By investing in an offshore pension, you will have a pension that you can contribute to regardless of where you reside. Since these pensions are not “qualified” pensions and you don’t deduct the contributions, they are more flexible than a pension in your host country (where the funds may be locked up until you retire).
3) These plans are generally set up as an automatic payment or a lump sum investment, which makes it easy to save.
4) The returns are better because there is no corporate tax in the jurisdiction where the account is located (usually accompanied by historical performance charts that look spectacular).
5) They are appropriate for US citizens, as long as you use an address located outside the US.
All of the above arguments are partially true, which is what makes the sales pitch so effective. The reality is that an offshore pension is just a really, really expensive way to invest in the stock market in unregulated markets where the companies can basically tell you anything without recourse and charge very high (usually hidden) fees. These “pensions” are almost always just a form of “variable annuity”, which means you assume market risk.
I will pick apart the arguments one by one:
1) You will be left without a pension because you are an expat.
Although your situation may be a lot more complex as an expat, there is no reason why you should be left without a pension. With the tax treaty update in 2004, the US and Netherlands generally recognize pensions which are “qualified” in the other country and give them the same tax treatment. For other countries you should discuss with your tax advisor.
2) An offshore pension is better because your money is not locked up until you retire, you can contribute from anywhere and there are no tax implications since it is not “qualified”.
I love this one, because they are basically telling you it is better because it has no benefit! Sure you can contribute from anywhere, but why would you want to? This is not a “real” pension specifically because it is not “qualified” anywhere and there are no tax benefits. Also, the money is not locked up because it is not a pension.
3) It is an easy way to save, with automatic investments in your host currency.
I’m a big fan of automatic savings plans, but not when they lock you in and have no benefit. Typically you sign up for automatic investments ranging from EUR 100 to EUR 2,500 per month, for a period of 1 to 25 years. What do you get in return for locking your money up? Nothing! They may tell you that the longer you invest you get more return by “Accumulator” points or other similar arguments. The reality is that there is no such thing as a free lunch, the returns will generally be based on actual stock market returns, less the outrageous fees and commissions.
4) The returns are better because there is no corporate tax in the jurisdiction.
Guess what – there is also no corporate tax on the investment income of mutual funds located in the US (or most other countries) either. This is because they are flow-through entities. This means that the income earned by the investments made by the mutual fund gets reported by the taxpayer directly. There will be some corporate tax for the fund due to the business profits (they have income and expenses), but I can assure you that the savings in the offshore jurisdictions is not passed on to the consumer, because the only way to do this is by lowering the fees you charge and these accounts have some of the highest fees around.
5) They are appropriate for US citizens as long as you have an address outside of the US.
These types of companies don’t advertise in the US, because then they would be subject to the strict regulations of the SEC. Opening an account for someone located in the US would be seen as a solicitation, so they won’t do this. Note that they are, however, “legal” for US citizens, as long as they are reported properly to the IRS, but they get unfavorable tax treatment.
The bottom line is that you are probably better off either contributing to a pension in your host country (although the money may be locked up until you retire), or just opening a taxable investment account (I recommend doing this in the US since you know these accounts are regulated and also will generally have the best possible tax treatment for US citizens).
Source: Worldview Wealth Advisors, By David Colvin, CPA, CFP – 2008