How to Stay on Top of Your Finances While Living Abroad
For many American expats, the years they spend living abroad are some of the most enjoyable and financially rewarding of their lives. However, staying on top of your finances as an American living outside the U.S. can be extremely challenging. From navigating the complexities of cross-border investing to making sense of potentially conflicting tax laws, American expats are often too busy — or too overwhelmed — to develop a solid investment strategy and financial plan to maximize their wealth.
Access Now: Expat Guide to Investing and Financial Planning for Americans Living Abroad
This expat guide identifies common financial challenges American expats face when it comes to investing and financial planning. Learn how to identify common investment mistakes Americans expats make and key issues that confront almost all expatriate Americans when it comes to investing and managing their finances.
Investing and Banking for U.S. Expats
Where Should American Expats Invest?
One of the first decisions Americans living abroad face when it comes to managing their finances is where their investments should be managed. Should it be in the U.S., in their country of residence or offshore?
American expats often end up investing through financial institutions in their country of residence or in popular financial centers, such as London, Amsterdam or Hong Kong. This is especially true when living abroad becomes a permanent or semi-permanent situation. However, upon closer examination of all relevant factors, investing through non-U.S. financial institutions might be a costly mistake for Americans. Read on to understand why.
Fees
Whether you choose to go with a large and reputable broker-dealer or decide to invest somewhere offshore, you’ll likely be hit with high fees if you choose a non-U.S. financial institution. Fees are generally high worldwide but tend to be significantly lower in the U.S. A study of mutual fund fees by country published in The Review of Financial Studies found that among 18 developed European, American and Asian markets, fees in the U.S. were the lowest by far. Moreover, a different study outlined the factors making U.S. mutual funds more competitively priced than their EU counterparts.
Investment Access and Liquidity
U.S. financial markets provide global investment access and liquidity. There are few investments that can’t be bought easily and inexpensively in U.S. markets.
For example, publicly traded companies around the world list their shares on U.S. exchanges as well as in their home country. Liquidity for investments such as global stocks, bonds, commodities and exchange-traded funds (ETFs) can be higher in the U.S. than in other global financial centers and can be a great investment planning tool for Americans abroad.
Taxes
Taxes are another major reason American expats should generally stay away from non-U.S. registered investments. Long-term investors in U.S. securities benefit from a low capital gains tax rate (15%-20%). Additionally, taxes are paid on a deferred basis (only when the investment is sold).
Moreover, by investing in U.S.-registered investments, expats avoid the risk of investing in passive foreign investment companies (PFICs), which are subject to a special, highly punitive tax regime. PFIC rules can easily push tax rates on investment income to as high as 60%-70%. These are some of the reasons why we believe U.S. expat investors should avoid owning non-U.S. mutual funds.
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Expat Guide to Investing and Financial Planning for Americans Living Abroad
Reporting
The U.S. tax code is complex — even more so for investors. Because of this complexity, U.S. brokerage firms like Schwab and Fidelity send clients detailed activity reports in the required IRS format. Important categories are separated out, such as dividends, qualified dividends, taxable and non-taxable interest income, and short- and long-term capital gains, all of which require distinct tax treatment. Non-U.S. institutions generally don’t provide this kind of detailed reporting.
Compliance
Even if your assets are held outside the U.S., they still may need to be reported. Per the Report of Foreign Bank and Financial Accounts (FBAR), U.S. persons must report their foreign financial accounts to the U.S. Treasury if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year.
As a consequence of the Foreign Account Tax Compliance Act (FATCA), financial assets exceeding $50,000 held at non-U.S. financial institutions must be reported on U.S. tax returns. For U.S. taxable persons not resident in the U.S., this threshold is $300,000. Penalties for not filing or misreporting can be severe.
Safety
Regulatory standards in global banking centers range from very high to almost nonexistent in some of the more exotic offshore banking locales. FDIC deposit and SIPC investment insurance automatically cover all U.S. accounts but are unavailable for non-U.S. accounts.
Where Should American Expats Bank?
Americans living abroad should open local bank accounts in their country of residence. Doing so allows them to manage their local income and living expenses in the same currency of the country they reside in, avoiding the expense of constantly converting between currencies.
On the other hand, money allotted for savings and investments should usually be moved to a U.S. account and invested at a U.S. financial institution. However, the downside for American expats is that establishing a U.S. brokerage account with a U.S. custodian while living abroad can be quite challenging. Many U.S. banks and brokerage firms have stopped accepting non-U.S. residents as a consequence of FATCA, leading to many U.S. brokerage firms closing American expat accounts. This change has led even large brokerage firms and banks to close the international accounts of non-U.S. residents. Fortunately, there are still ways to open a U.S. brokerage account, including partnering with an advisory firm like Creative Planning International. Request a meeting with a wealth manager experienced in expat investing and financial planning needs to explore your options further
Currency Management and Global Investing
Managing Currency Swings
Managing the impact of currency swings is a common concern for U.S. expats. However, matching currency to future expenses is a lesser-known strategy for financial planning.
For example, Americans abroad can manage their long-term currency risk by matching the currency denomination of their investments with the currency of future expenses, such as home mortgage payments, college costs and retirement expenditures.
For example, American expats who are long-term residents of France should consider having a large share of their investments in European stocks and bonds to match the currency of future expenses with that of their assets so as to limit the risk of large currency swings impeding long-term planning objectives.
Conversely, for Americans expecting to return to the U.S. after only a few years abroad, a more dollar-focused investment strategy is warranted. In this case, U.S. stocks and bonds would constitute the largest part of the portfolio, with a smaller allocation to international securities to maintain diversification.
Invest in a Diversified, Multicurrency Portfolio of Global Assets
Americans abroad should pay particular attention to the importance of maintaining global diversification and avoid a common bias toward U.S. investments. This is because many expatriate Americans are uncertain about their future career path and living arrangements (i.e., whether they’ll stay overseas long term or return to the U.S. after a few years).
For these investors who are unsure of their long-term residency, a broadly diversified multicurrency portfolio usually makes sense. On the other hand, for Americans planning to live in Europe long term, a portfolio with a large component of European stocks and bonds may be appropriate. Importantly, buying foreign stocks and bonds doesn’t require working with a foreign broker.
For example, a diversified portfolio of European stocks can usually be bought more affordably using a U.S. broker than through a European broker.
Expat Portfolio Management
No matter where you live, the fundamental principles of portfolio management remain the same. However, there are special considerations when it comes to asset allocation that depend on where you live. Local currency and economic conditions need to be factored into your investment portfolio to get the right mix of exposure, with currency and global diversification being the most salient factors. In the long run, investors should consider at least the following four issues when making investment choices.
Currency and Geographic Diversification
Currency management strategy is a complement to — but not a substitute for — proper investment portfolio diversification. For currency, it’s not just about evaluating potential swings and risk but also working within your overall investing strategy.
All investors, regardless of their location, usually benefit from investing in a diverse array of assets that includes U.S. stocks, international stocks, bonds, emerging markets and real estate. Proper asset diversification can substantially mitigate losses incurred during a severe market downturn, thereby maintaining portfolio stability.
Risk
For all investment portfolios, the risk-return tradeoff needs to match the risk profile of the individual investor. Even within a broadly diversified portfolio, this applies to the relative weight of higher return/higher risk investments (stocks) versus lower risk/lower return investments (bonds). As retirement approaches, investors generally tend to reduce exposure to a large market downturn by steadily increasing the weight of bonds in their portfolio. This is something that depends on someone’s unique situation.
Other factors, such as job security or expected college expenses, also impact this calculation. Factoring in the right amount of risk is critical to providing the returns necessary to meet your financial planning goals without becoming overwhelmed by the impact of market volatility.
Expenses
Professional stock pickers and strategists rarely “beat the market” on a consistent basis. A Quantitative Analysis of Investor Behavior (QAIB) report on mutual fund investor returns during the period 1990-2019 found that the average equity fund underperformed the S&P 500 Index by 4.92% per year.
A reason for this dismal record lies in the fees charged by fund management companies and brokerage firms. With long-run, annual stock market returns averaging around 9.96%, sacrificing 4.92% of an investment to annual fees and expenses will reduce the total return on an investment by 75% over 30 years. Over a half century, the investment return will be reduced by 90%.
Therefore, it’s important that investors pay close attention to the cost of investing their money and work with fiduciary advisors who invest in their best interests.
Tax Management
A less obvious but still very serious impediment to long-term investment success is poor investment tax management. Portfolios with high turnover not only incur high commission and trading expenses but also trigger the taxation of capital gains earlier and at higher rates for short holding periods.
A stable, low turnover portfolio that defers taxation and benefits from a lower long-term capital gains tax rate will usually generate better after-tax returns than a fund performing equally well on a pre-tax basis with a high turnover.
Retirement Planning for Americans Abroad
A critical issue for many American expats is understanding how to properly employ foreign tax-advantaged retirement accounts, commonly known as retirement plans. This is because expats often don’t have the option of simply enrolling in their company’s 401k plan. Rather, Americans working abroad must proactively learn how to employ IRAs, Roth IRAs and SEPs in parallel to retirement accounts in their country of residence to fill the gap.
Thus, for many Americans living abroad, benefiting from the significant tax advantages of qualified retirement accounts is difficult because of their complexity — especially when the special tax implications of living abroad are factored in.
Over a lifetime of saving and investing, these accounts can provide enormous benefits not only in terms of tax savings but also for asset protection in litigation situations and estate planning. Investors should carefully navigate the complex rules governing these accounts in order to avoid mistakes that might trigger unnecessary taxation, or even the loss of tax-deferred status.
Furthermore, optimizing the tax advantages of these accounts requires careful calculation of how stock and bond investments are allocated between taxable and tax-deferred or tax-exempt accounts.
For self-employed expats, proper use of retirement savings accounts is particularly important. U.S. tax legislation is especially onerous on Americans with self-employment income if it’s derived from non-U.S. sources.
Generally, Americans employed abroad by non-U.S. employers can escape the self-employment tax altogether. But Americans living abroad with Schedule C self-employment income must pay the full 15.3% tax (unless exempted by a bilateral totalization agreement). The burden is compounded by the fact that U.S. tax rules limit deductions when calculating the amount of non-U.S. sourced self-employment income subject to the tax.
However, these disadvantages can be offset by the unique ability of self-employed individuals to shield large amounts of income from federal income tax through the recent innovation of the individual 401k. Called the one-participant 401k or solo 401k, these plans are a simplified version of company 401k plans and offer self-employed entrepreneurs a chance to defer up to $69,000 per year in self-employment income in 2024.
Most Americans abroad likely have some sort of tax-advantaged account(s) in the U.S. However, before you contribute to any of your U.S. qualified retirement accounts, make sure you understand the tax treatment of such accounts in your country of residence.
Bilateral tax treaties between the U.S. and some countries recognize the special tax status of these accounts in the country of residence. However, other countries treat U.S. retirement accounts as any normal taxable investment account.
Read more on U.S. expat IRAs and Roth IRA conversions, or watch a short video on four questions for U.S. expats investing in IRAs and Roth IRAs.
Make Full Use of Retirement Accounts
Investors have zero ability to affect the performance of stock and bond markets. However, taxpayers have the power to pay more or less in taxes, depending on how well they manage the tax impact of their investment strategies.
As an example, if proper tax management is able to preserve 3% of total annual return to a stock portfolio, an investor can preserve an additional 100% of total return to their investment account in 24 years simply by making strategic tax choices. Proper employment of tax-deferred or tax-exempt investment accounts is a critical element of long-term investment success. Americans abroad should take full advantage of these opportunities; the trick is to understand how they work.
Understanding these details requires thorough research or the advice of a qualified international advisor. Investors should tread carefully when dealing with non-U.S. retirement accounts unless recognized as U.S.-qualified by a bilateral tax treaty. Such accounts have no special tax status as far as the IRS is concerned and may fall under the highly punitive passive foreign investment company (PFIC) taxation regime. Finally, expats should make sure to understand how the tax law of their country of residence treats U.S. retirement accounts.
Challenges for Cross-Border Families
Americans living outside the U.S. may end up marrying non-American citizens. For such mixed-nationality couples, special considerations need to be taken into account when it comes to investment planning, as their financial affairs extend across countries. Thus, cross-border families, from an investment and financial planning perspective, are typically subject to taxation by more than one country — which can create opportunities as well as dilemmas.
Using the U.S. Tax Code to Your Benefit
For cross-border families, the planning strategy should usually be to minimize income subject to taxation by the IRS. There are various ways to achieve this in mixed marriages. For example, if the non-U.S. spouse is earning significant income, then electing to file as married filing separately is often the most appropriate election for U.S. taxes. Even though this election limits deductions and credits, it prevents the IRS from taxing the non-citizen spouse’s income.
Married couples also need to plan carefully around estate and gift tax issues. At death, there’s no limit to the size of the estate that can be transferred tax-free to a surviving U.S. citizen spouse. However, if your spouse isn’t a U.S. citizen, estate taxes will be imposed at a rate of up to 40% of the estate amount.
The U.S. estate tax exemption amount is $13.61 million per person in 2024. This means only assets exceeding this amount will normally be subject to estate tax. However, for a wealthy U.S. citizen with a non-resident alien spouse, this exemption also applies to amounts left to the non-citizen spouse, as they won’t benefit from the unlimited marital exemption a U.S. citizen spouse would benefit from. In certain circumstances, trusts can also be used to address this problem.
Spouses can also gift up to $185,000 per year (in 2024) to their non-citizen spouse tax-free. This provision can provide a very useful planning device for Americans with spouses who have residence in a country with lower tax rates.
By making an annual spousal gift, the money can be removed from the tax purview of the U.S. government in terms of capital gains, dividend income taxes and estate taxes.
The U.S. tax code provides a plethora of tax-advantaged ways to save for your children’s educations. Coverdell accounts and 529 plans are usually good options. Americans abroad are often surprised to find that many universities outside the United States are qualified institutions: this means tax-exempt distributions from these accounts can be used to pay tuition and expenses at these non-U.S. schools.
Furthermore, because of the large amounts of money that can be sheltered from taxation through 529 plans, these accounts have great value as long-term estate planning tools under the right circumstances.
Finding the Right Financial Advisor
Brokers and advisors outside the United States might not understand how U.S. taxation works. Likewise, U.S. brokers and advisors who haven’t previously worked with expat investors might lack experience in navigating special issues for Americans living abroad. How should expats choose a proper financial advisor?
Work With a Fee-Based Registered Investment Advisor (RIA) Who Has Experience Working With Expats
Fee-based advisors are usually compensated by their clients based on a percentage of the assets they manage (whereas broker-dealers often earn commission). By not taking commissions on advisory products, the potential for conflicts of interest between the client and advisor is reduced. RIAs are legally bound to act as a fiduciary financial advisor in every aspect of the relationship, meaning they have a legal obligation to put their clients’ interests ahead of their own at all times. Brokers aren’t RIAs and are instead held to a “suitability standard” and “best interest” when recommending a product to clients.
Avoid conflicts of interest such as taking investment advice from advisors who are compensated for selling products through commissions and fee-sharing agreements with the issuers, such as stockbrokers or insurance agents. In these situations, the advisor has an incentive to recommend investments based on the size of their potential compensation.
Additionally, investors should be especially careful when considering investments registered in offshore locations. There can be a high incidence of fraud among these operations, and even legitimate investment schemes in certain jurisdictions typically lack the investor safeguards that exist in the U.S. Finally, these non-U.S. investments may not understand, or provide the proper documentation to comply with, the reporting obligations of U.S.-connected individuals.
At Creative Planning International, we work with Americans living abroad and cross-border families to help maximize their wealth. We understand expats face unique financial challenges, and we can help you plan and invest for the future. If you’re an American living abroad, request a meeting.
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