Demystifying Personal Finance for American Expatriates
Overseas assignments have many wonderful benefits, though they can also be uniquely challenging. The complexity of managing one’s financial wealth often tops the list of these challenges. This is particularly true for American citizens. In order to properly guide Americans through the process of expatriation, global mobility and HR professionals ought to have a working knowledge of the financial challenges their American assignees face. This article touches on some of the most critical financial considerations for American expatriates, including banking and asset administration, investment management, taxes, and real estate. It also discusses how the growing trend towards localized employment contracts further complicates matters for Americans.
Banking and Asset Administration
The seemingly simple task of managing one’s cash and banking needs can be surprisingly difficult while living abroad. Often, employees have financial obligations left back in the US in addition to lifestyle expenses and new financial obligations in their host country. To make things easier and less costly, American expats should maintain bank accounts in both countries. The US-based account should offer features like credit and debit cards, and convenient web access to services like online bill-pay and wire transfers. This will make meeting those US-based financial obligations much easier to manage. The host country account should be at a prominent local bank and should be used for day-to-day expenses – this account should hold a minimum reserve of three to six months of living expenses. Some foreign banks also offer US dollar-denominated accounts; these are a wonderful option for assignees as they can simplify foreign currency exchange while also lowering the cost.
As with banking and cash management, many Americans find that managing their investments while living abroad is a difficult and time-consuming burden. Simply finding a suitable US-based brokerage firm willing to hold their assets while living abroad can be challenging. Recent IRS crackdowns on potential tax evaders have led to onerous restrictions on international financial institutions who deal with Americans, as well as stricter IRS reporting requirements for foreign bank and investment accounts. These new restrictions, combined with the bad publicity, have led many institutions to close or severely limit their services for American investors.
Further complicating matters, there are very few advisors qualified to give financial advice to expatriate Americans. Most advisors don’t understand the unique tax and investment implications American expats face. While living and working abroad, it is also important to consider the currency and regional exposure of the investment portfolio. For Americans planning a move abroad, it is wise to find an advisor who specializes in advice for American expats prior to leaving the US. Fee-only investment advisors who operate in the US as Registered Investment Advisors (RIA’s) are the best choice, as their compensation is not tied to product commissions. Also, RIA’s are held to a fiduciary standard which requires them to always act in the best interest of their clients.
American expats should also be aware of how the various tax-advantaged savings programs offered around the world (such as a 401(k) in the U.S.) are treated by the IRS. While Americans generally should take advantage of these programs, it is important to consider the “worldwide” tax implications (both the US and the foreign country), especially if the plan is not a “qualified” plan for US tax purposes. Due to the complexities surrounding the tax deferral elements and future taxation of such accounts, it is wise for American expats to get advice from a qualified US tax advisor that specializes in expat taxation prior to participating in such a program. The same problem may arise in reverse for an assignees balance in a US-based qualified retirement plan – these assets may not be considered qualified by the tax authority of the host country.
Taxation is another area with many layers of complexity for expatriates. When Americans move abroad, they are often uncertain about what impact their move will have on their annual US tax liability and reporting requirements to the IRS. All US citizens are required to file an income tax return every year, regardless of their country of residence. This is because the US imposes a worldwide tax, based on citizenship, not residence. As mentioned previously, the US has recently been very public in its war against offshore banking and tax evasion, driven partly by the drive to disrupt terrorist funding and also by a need for increased tax revenue. Governments everywhere are stepping up enforcement, raising awareness of this issue. Recent requirements imposed by the US government on its citizens, which include more strict reporting of foreign bank accounts and more onerous rules related to the international movement of funds, have only further complicated tax matters for Americans living abroad.
Though Americans abroad are obligated to pay taxes both at home and in their host country, the IRS does offer a “Foreign Earned Income Exclusion” (up to $92,900 for 2011) for Americans living and working abroad. There is a misconception that this exclusion eliminates the need for Americans to file taxes if their income falls below this amount. This is not the case. Generally, all US citizens working abroad must file a tax return each and every year. This causes concern among some that they will be double-taxed on their income – once by the US, and again by their host country. American assignees need not worry, as there is a system of exclusions and credits in place to avoid double taxation. The four pillars of this system are: the Foreign Earned Income Exclusion, the Foreign Housing Exclusion, the Foreign Tax Credit (General Limitation) and the Foreign Tax Credit (Passive). Since every individual’s circumstances are unique and regulatory and tax regulations vary substantially country to country, it is wise to seek the advice of an expatriate tax specialist, even if you do not have substantial income or assets.
Further adding to the tax burden for Americans moving abroad is the trend among large multinational employers away from offering tax-equalized expatriate assignments, which protect employees from the responsibility of arranging and filing their own taxes. Traditional tax-equalized contracts promise a tax structure “as-if” the employee still works and resides in their home country. An emphasis on cost control has led many employers to offer more localized contracts. This often dilutes the financial benefit of a foreign assignment for the employee. It has also shifted the burden of tax filing onto the employee. Americans fare somewhat worse than citizens of other countries under the local contract scenario because Americans must deal with multiple tax authorities and a worldwide tax, making their financial picture much more complex.
When it comes to residential real estate, the conventional wisdom that owning a home is better than renting is not necessarily true for American expats. While there is often a tax advantage to home ownership from mortgage-interest deductions (similar to in the US), expats often can deduct certain rental housing expenses as well. This benefit diminishes the appeal of foreign homeownership. Further lessening the appeal of ownership is a higher likelihood of mobility among expats, expensive sales fees, and transfer costs. American expats may also face a significant tax risk due to exchange rate fluctuations when owning real estate abroad, especially if the purchase is financed with a mortgage. It is possible to incur a significant tax liability due to either a capital gain on the sale of a home, or a currency gain on the retirement of a foreign mortgage. It should be noted that a currency gain can occur and result in a tax liability even if there is a real loss on the sale of the home. Finally, investors should not expect significant returns on real estate after expenses, and should be aware that ownership of foreign property can create complicated estate planning and tax issues. Because of these added risks and complications, Americans considering the purchase of foreign property should proceed with caution and only consider property purchases for the long-term.
Often, Americans moving abroad struggle with the decision of what to do with the home they leave behind. The decision to keep or sell their US residence is often highly personal and emotional, and not purely financial. From a strictly financial perspective, it is generally wise to sell one’s home if planning to be abroad for more than two years. This is especially true if the employer offers reimbursement of selling expenses. When analyzing this question from an investment perspective, rarely does the net rental income provide a reasonable return on investment. An adequate return would also need to adequately compensate for maintenance costs and property management time. This rarely happens. Finally, the conversion of a home to a rental can have negative tax consequences which should be thoroughly researched. The decision to hold on to a home and convert it to a rental is quite complex and it should be discussed in advance with a qualified tax advisor.
Americans moving abroad face a wide range of complicated financial decisions and concerns. In order to avoid costly mistakes, it is imperative that they have access to knowledgeable and experienced professionals to help guide them through the process of expatriation. This is true for all Americans, but even more particularly so for those accepting a localized employment contract in a foreign country. All too often, the assignees questions are mistakenly directed to mobility and human resource professionals, who cannot be expected to have the answers. However, in order to best assist their American assignees, employers should have a good understanding of the key issues in order to guide assignees to the appropriate advisors.
Source: Worldview Wealth Advisors, By Andrew Fisher, CFA, CPA – 2010