Investment Challenges Faced by International Families
More and more people are living abroad or thinking about it, as there is a world of opportunity and adventure outside national borders. Many get too wrapped up in the excitement to educate themselves on the practicalities of life overseas, such as how to manage their investments.
Don’t make these common mistakes, since they will impact your standard of living in the future!
- Lack of Proper International Diversification
A typical account often has between just 10% percent and 20% percent of its total assets held in foreign investments, including both stocks and bonds. For most cross-border families, however, such a low exposure to international investments is inappropriate. Instead, you need a much more global exposure to match your expat lifestyle. Differing interest rates, exchange rates, and single country stock market swings can wreak havoc on your plans.
It’s also important that you have exposure to different currencies – at a minimum your home and host country currencies – rather than having your investments all concentrated in one currency.
Finally, your retirement assets should match your retirement destination. It might be wise to have a substantially higher concentration of the underlying investments in your retirement fund denominated in your eventual retirement currency, especially more conservative income-oriented assets like cash and bonds.
Expatriates may plan to split time between the foreign country they now call home and their home country (for example at a family vacation home they’ve visited since they were young). The ability to spend time in multiple places, of course, is highly dependent on the resources that are available when it comes time to actually retire.
- Not Participating (Correctly) in Foreign Retirement Programs
First, you should always invest money for your future; being abroad is no excuse!
Most people are familiar with the advantages of tax-deferred growth in their retirement plans at home (like the 401k) but may be confused about how it works elsewhere. In general, the answer is yes. When it comes time to withdraw the money, you do need to be informed as to the taxation in your resident country.
However, for U.S. taxpayers it can be more tricky, due to the U.S. system of taxation based on status and not residency.
For American citizens and tax residents who are working abroad, and who are able to participate in a voluntary tax-deferred savings plan, we generally recommend that they do indeed participate, as long as they plan to be abroad for at least a few years. Indeed, in our experience the vast majority of people are doing just that. However, you should be aware that the current benefit of participating means longer-term complexity that comes from owning assets in a foreign retirement plan.
If you live somewhere where the income tax rates are higher than the U.S., you should participate even though the contributions may be reportable income in the U.S. You will usually save taxes in the host country, and may also benefit from some sort of matching component from an employer. And because of foreign tax credits and exclusions from U.S. taxation, you should have no additional taxes to pay in the U.S. Said another way, making pretax contributions (at least pre-tax in the foreign country) to the foreign retirement plan generally does result in an overall net tax savings for the taxpayer. Plus, you may benefit from tax-deferred investment growth.
If you live somewhere where the income tax rates are lower than the U.S., you may be better off not participating, unless an employer-provided match is attractive enough. Tax-deferred, or at least tax efficient, investment growth can be interesting, though, depending on whether the U.S. government views it as a qualified plan.
The most important thing may be the most onerous – keeping careful track of these non-deductible contributions. When the retirement funds are eventually distributed, you will probably only pay U.S. tax on the growth in the account, not on the original contributions (similar to how things work with a non-deductible IRA). You definitely do not want to be taxed twice!
This can actually be very smart planning, since you may take the deduction at the higher tax rate in a foreign country (lowering your foreign taxes), and not pay any “net” U.S. tax at the time because it is covered by foreign tax credits. You can then withdraw the money later in retirement (assuming you have returned to living in the U.S.) and pay no tax on the original contributions, because those were after-tax (non-deductible) for U.S. purposes. In this scenario, you would have effectively paid no tax on that income.
- Holding Investment Accounts Outside the U.S.
Although you should definitely open a bank account where you live, your local bank may be a big mistake for your investment accounts.
First, fees can be very high, whether in investment or insurance-wrapped products (which are common elsewhere). They also may include surrender fees and other penalties, all of which negatively impact your performance results and flexibility.
Secondly, foreign investment brokers tend to have limited investment options. Instead of being able to offer you an “open architecture,” they usually recommend investing in their own branded investment funds, which may or may not be good performers overall.
Thirdly, U.S. citizens and tax residents must be very careful about holding certain kinds of passive investments (PFIC, or Passive Foreign Investment Company) outside of the United States. Most foreign pooled mutual funds fall into this category. The IRS has developed a system of rules whereby holding these generally creates a significant amount of additional tax complexity, and in many cases leads to higher taxes than if the investments were located in the United States.
And, as most expats are painfully aware, the U.S. government has strict reporting requirements on assets held outside the U.S., making the administrative and reporting burden even greater.
All this means that the United States is often the best choice to hold a globally portable portfolio. In fact, the U.S. is now the fastest growing “offshore” investment jurisdiction in the world, as more international people seek to locate some of their wealth within U.S. borders.
The general benefits of the U.S. market include a very transparent system with strong regulatory oversight. U.S. brokerage accounts generally have the lowest fees of anywhere in the world, and they offer significantly more investment alternatives than does any other country. Additionally, some U.S. brokerage houses now offer multi-currency accounts, which enable people to purchase foreign securities in the local currency and to also hold and exchange international currencies within an interest-bearing account.
There are, however, a few negatives for cross-border families investing in U.S-based brokerage accounts—in particular for families residing outside of the United States. The main issue is one of access, for U.S. institutions are restricting or freezing accounts of clients whose primary residence is abroad. Fortunately, there are usually solutions to this.
Get started today to secure the financial independence you desire. Being an expat can be a tremendously enriching experience, personally, professionally, and potentially financially, if you avoid these common pitfalls. Worldview is here to help you, so please contact us.