Expat Guide to Investing and Financial Planning for Americans Living Abroad

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 in a foreign country 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.

This expat guide identifies the common financial challenges American expats face when it comes to investing and financial planning. Learn how to identify common investment mistakes that Americans expats make and the 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 questions that Americans living abroad face when it comes to managing their finances is where should their investments 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, when full accounting is made of all factors that need to be considered, investing through non-U.S. financial institutions is almost always a costly mistake for Americans. 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, in general, are high everywhere in the world, but they’re still much lower in the U.S. than anywhere else. A recent study in The Review of Financial Studies of mutual fund fees by country found that among 18 developed European, American and Asian markets, fees in the U.S. were by far the lowest.

Investment Access and Liquidity

U.S. financial markets provide greater global investment access and liquidity than other markets in the world. There is virtually no investment that can’t be bought easily and inexpensively on U.S. markets.

For example, almost every publicly traded company in the world lists its 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) is also higher in the U.S. than in other global financial centers. Learn how ETFs can be a great investment planning tool for Americans abroad.

Taxes

Taxes are another big 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 only in U.S.-registered investments, expats avoid the risk of investing in a passive foreign investment company (PFIC), 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%. For these reasons, we believe U.S. expat investors should avoid owning non-U.S. mutual funds.

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), if the cumulative assets of a U.S. person outside the U.S. at any time exceed $10,000, they must be reported to the U.S. Treasury for that year.

Moreover, as a consequence of the Foreign Account Tax Compliance Act (FATCA), financial assets exceeding $50,000 held at non-U.S. financial institutions ($300,000 for U.S. taxable persons not resident in the U.S.) must be filed on U.S. tax returns. Penalties for not filing or misreporting can be severe. Learn what American investors need to know about FATCA as well as the tax and legal implications of retiring abroad, including FATCA.

Safety

Regulatory standards in global banking centers range from very high (Switzerland) 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. This is so that local income and living expenses are managed locally, in the same currency of the country they live in. This is so that they avoid the expense of constantly converting between currencies. Learn more about the logistics of opening and maintaining bank accounts as American expat.

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, as mentioned above. 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 — another consequence of FATCA — which has prompted many U.S. Brokerage firms to close 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, such as working with an advisory firm like Creative Planning International. Request a meeting with a wealth manager experienced in expat investing and financial planning needs.

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 may be less known.

For example, Americans abroad who expect to remain outside the U.S. for an extended, or indefinite, period of time can manage their long-term currency risk by matching the currency denomination of their investments with the currency in which they expect to incur the bulk of their future expenses (such as home mortgage payments, college costs and retirement expenditures).

However, for American expats who are long-term residents of France and expect to raise and educate their children — and possibly even retire — there, they should consider having a large share of their investments in European stocks and bonds. Matching the currency of future expenses to assets in this manner limits the risk that large currency swings will impede long-term planning objectives.

So, for Americans who expect to return to the U.S. after only a few years abroad, a more dollar-focused investment strategy is warranted: U.S. stocks and bonds would constitute the largest part of the portfolio, and smaller allocations would be made 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 not sure where their careers and lifestyles will take them — whether that’s staying overseas long-term or returning to the U.S. after a few years.

For these investors who aren’t sure of their long-term residency, a broadly diversified multicurrency portfolio usually makes the most 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 make the most sense. Buying foreign stocks and bonds does not require working with a foreign broker.

A diversified portfolio of European stocks, for example, can usually be bought more cheaply through a discount 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 the 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 these 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, wherever they live, usually benefit from investing in a broad array of assets that include U.S. stocks, international stocks, bonds, emerging markets and real estate. Proper asset diversification can substantially mitigate losses incurred during a severe market downturn. In turn, this helps sustain 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). Generally, as retirement approaches, investors should reduce exposure to a large market downturn by steadily increasing the weight of bonds in their portfolio.

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 big reason for this dismal record lies in the high 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 is 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.

A stable, low turnover portfolio that defers taxation and benefits from the low long-term capital gains rate will usually generate dramatically better after-tax returns than a fund that performs equally well on a pre-tax basis but has high turnover.

Retirement Planning for Americans Abroad

Retirement Accounts for Expats

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 401(k) plan. Rather, Americans who are 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 expats who are self-employed, 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. Read our article, five top recommendations for American expat business owners and entrepreneurs.

Generally, Americans employed abroad by non-U.S. employers can escape the self-employment tax altogether. But for Americans living abroad with self-employment income (Schedule C) must pay the full 15.3% tax (unless exempted by a bilateral totalization agreement). The burden is compounded by the fact that the 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 401(k). Called one-participant 401(k)s, these plans are a simplified version of company 401(k)s and offer self-employed entrepreneurs a chance to defer up to $61,000 per year in self-employment income.

Most Americans abroad likely have some sort of tax-advantaged account or accounts 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 add 3% of total annual return to a stock portfolio, an investor can add 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 a lot of homework or the advice of a well-qualified international advisor. Investors should generally avoid non-U.S. retirement accounts (unless recognized as U.S. qualified by a bilateral tax treaty). These structures have no special tax status as far as the IRS is concerned and will often incur the highly punitive wrath of the PFIC taxation regime. Finally, expats should make sure to understand how the tax law of their country of residence treats U.S. retirement accounts.

Cross-Border Families

Americans who live abroad may end up marrying non-Americans. For such mixed-nationality couples, special considerations need to be taken when it comes to investment planning, because their financial affairs extend across countries. Thus, cross-border families, from an investment and financial planning point of view, 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 usually should be to keep as much income as possible out of the taxation jurisdiction of the IRS. There are a variety of ways to do this in mixed marriages. For example, if the non-U.S. spouse is earning significant income, then married filing separately is likely the appropriate election when it comes to 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 is no limit to the size of the estate that can be transferred tax-free to a surviving U.S. citizen spouse. However, if the spouse is not a U.S. citizen, estate taxes will be immediately imposed at a rate of 40% on the entire taxable estate amount.

The estate tax exemption amount is $12.06 million per person (in 2022). This means only assets exceeding this amount will be subject to the estate tax. However, for a wealthy U.S. citizen with a non-resident alien spouse, it’s important to recognize that this exemption amount applies to assets left to the non-resident alien spouse without benefit of the unlimited exemption amount that prevails when both spouses are U.S. citizens. In certain circumstances, trusts can also be used to address this problem.

Spouses can also gift up to $164,000 per year (in 2022) 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 permanently 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 education. 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 that tax-free 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 rarely understand how U.S. taxation works. Likewise, U.S. brokers and advisors who have not previously worked with expat investors lack experience in navigating special issues for Americans living abroad. How should expats choose a proper financial advisor?

Fee-Based Registered Investment Advisor With Experience Working With Expats

Fee-based advisors are compensated by their clients usually based on a percentage of the assets they manage vs a commission. By not taking commissions on advisory products, the potential for conflicts of interest between the client and advisor is reduced. Why a registered investment advisor (RIA)? 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 always. Brokers are not RIAs and have a fiduciary obligation only when recommending a product to their clients.

What should you avoid? Conflicts of interest that may not be in your best interest such as investment advice from advisors, such as stockbrokers or insurance agents, who are compensated for selling products through commissions and fee-sharing agreements with the issuers. In these situations, the advisor has an incentive to recommend investments based on the size of their potential compensation rather than the quality of the investment and/or strategy.

Additionally, investors should be especially careful when considering investments registered

in offshore locations. There’s a high incidence of fraud among these operations, and even legitimate investment schemes in these regions typically lack investor safeguards that exist in the U.S. Finally, understand the tax rules regarding investments outside the U.S.

At Creative Planning International, we work with Americans living abroad and cross-border families to help maximize their wealth. We understand that 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 with a member of our team.

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This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

“Your wealth works harder when it works together.”

Peter Mallouk

President & CEO, Creative Planning

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