Roth vs Traditional IRA for taxpayers abroad with foreign excluded income

[ahos]

I am a 47 year old US citizen who has lived in Europe for the past 25 years. As a US citizen I have the honor (ugh) of filing a tax return every year even though I have no US-based income. Because I'm permanently resident here, and my income falls under the threshold for paying income tax, I just pay self-employment tax each year. Two years ago I set up a traditional IRA. When filing my 2018 tax return (using Turbo Tax), I responded affirmatively when prompted about whether I have an IRA. That caused the system to prompt me to add the details (I contributed around $4000 in 2018). After submitting my return, I received a correspondence stating that this was an overpayment - I gathered that the deduction, since I was effectively not responsible for income tax, was regarded as not allowed.

I have two primary questions:

1. If I keep it as a Traditional IRA, am I obligated to report it?

2. If I convert this to a Roth IRA, I suspect that this would not longer be an issue since there is no immediate benefit in terms of deductions in the current year. Is that right, and should someone in my position (ie with no income tax required due to the foreign income exclusion) go ahead and covert to a Roth? Seems to be the case but would like to hear from someone who knows what they're talking about. Thanks!

 

[Just Blue]

@Taxing Matters is a site vetted tax attorney...I have tagged him to assist you.

 

[ahos]

@Taxing Matters is a site vetted tax attorney...I have tagged his to assist you.

Thank you!

 

[FlyingRon]

You can not contribute more than your taxable income to either a traditional or Roth IRA.
You will owe a 6% tax on the excess contribution until you withdraw the excess. Converting the account won't make a difference.

Read here: https://www.irs.gov/pub/irs-pdf/p590a.pdf

 

[davew9128]

The problem you have is that if you are excluding all of your earned income with the Foreign Earned Income Exclusion, you no longer have any eligible earned income with which to make ANY US retirement plan contributions. I have many expat clients and for the ones in no tax countries, this isn't a problem. For the ones in high tax countries, taking this exclusion is usually not optimal, several reasons including this.

 

[ahos]

Thanks for those quick (and detailed) responses, @FlyingRon and @davew9128. My workplace (a US non-profit 501c3 foundation where I am on a self-employed contract) has stated that they will match 5% of my yearly salary if I make contributions into an IRA or IRA-like account. What retirement savings options are there be that would, at the very least, match that requirement and not penalize me for doing so? We're talking less than $5000 a year total (my portion + matched funds). I just want to be able to take them up on their offer to match 5%...

 

[Zigner]

Thanks for those quick (and detailed) responses, @FlyingRon and @davew9128. My workplace (a US non-profit 501c3 foundation where I am on a self-employed contract) has stated that they will match 5% of my yearly salary if I make contributions into an IRA or IRA-like account. What options would there be that would, at the very least, match that requirement and not penalize me for doing so?

That sounds like a policy-question that you will need to take up with your workplace.

 

[davew9128]

Thanks for those quick (and detailed) responses, @FlyingRon and @davew9128. My workplace (a US non-profit 501c3 foundation where I am on a self-employed contract) has stated that they will match 5% of my yearly salary if I make contributions into an IRA or IRA-like account. What retirement savings options are there be that would, at the very least, match that requirement and not penalize me for doing so? We're talking less than $5000 a year total (my portion + matched funds). I just want to be able to take them up on their offer to match 5%...

Missed my point entirely. Don't use the foreign earned income exclusion if you want to contribute to a US based retirement account. Most European nations have higher tax rates than the US. You should be able to use a foreign tax credit to offset most if not all of the US tax. Problem is you need to revoke your FEIE election for five years to do it. This is why consulting with a US tax advisor is always recommended for expats filing US returns, so you have these options ahead of time and can plan accordingly. If you were in the UAE making $200k in salary and paying no local tax, then the answer changes.

ETA: Seeing that you are self employed changes things a lot. You really need to consult with someone who work through this. There are far too many conflicting parts here to ask on a free forum.

 

[ahos]

@davew9128 Points taken. Obviously free advice is worth exactly what you pay for it, but getting educated suggestions on a free forum is helpful as I examine the options that might be available to me. And your (and others') comments are greatly appreciated.

 

[LdiJ]

Thanks for those quick (and detailed) responses, @FlyingRon and @davew9128. My workplace (a US non-profit 501c3 foundation where I am on a self-employed contract) has stated that they will match 5% of my yearly salary if I make contributions into an IRA or IRA-like account. What retirement savings options are there be that would, at the very least, match that requirement and not penalize me for doing so? We're talking less than $5000 a year total (my portion + matched funds). I just want to be able to take them up on their offer to match 5%...

Have you researched whether or not there is an IRA like account you could open in the country you are living in, that would meet your employer's requirement for the matching funds?

 

[davew9128]

Have you researched whether or not there is an IRA like account you could open in the country you are living in, that would meet your employer's requirement for the matching funds?

Perhaps but it could lead to tax professional fees exceeding the match in handling IRS reporting of the asset on FBAR, FATCA, 3520, 8621, etc.

 

[LdiJ]

Perhaps but it could lead to tax professional fees exceeding the match in handling IRS reporting of the asset on FBAR, FATCA, 3520, 8621, etc.

That is true, but if he is going to live in Europe permanently he is going to need retirement income. Maybe its time to give up the US citizenship if he does not plan to return to the United States.

 

[davew9128]

That is true, but if he is going to live in Europe permanently he is going to need retirement income. Maybe its time to give up the US citizenship if he does not plan to return to the United States.

I don't disagree. The better solution would be for Congress to amend 402 to recognize non-US retirement plans as qualifying instead of the few and far between tax treaties that get negotiated to do so.

 

[Taxing Matters]

Perhaps but it could lead to tax professional fees exceeding the match in handling IRS reporting of the asset on FBAR, FATCA, 3520, 8621, etc.

The OP may have foreign accounts already subject to that reporting. It can be difficult living in a foreign country without local financial accounts and services, after all. If so, then he/she likely is familiar with the reports that need to be done and can simply add the new accounts to the reporting he or she is already doing.

 

[davew9128]

The OP may have foreign accounts already subject to that reporting. It can be difficult living in a foreign country without local financial accounts and services, after all. If so, then he/she likely is familiar with the reports that need to be done and can simply add the new accounts to the reporting he or she is already doing.

Retirement accounts are different. Not in that they aren't subject to FBAR and FATCA, they are. It's that very few US taxpayers realize that under US law that they AREN'T the same as an IRA or 401(k). Thats a whole other realm of reporting. I've lost track of people who even participate in government mandated retirement programs who are stunned to find out that not only is the income inside the plan not deferred with the US, but that employer contributions are income, and they may even have 3520 requirements.