Many people working in the US are accustomed to saving for retirement by making annual contributions to a Traditional or a Roth IRA account. When you move overseas, if you choose to claim the Foreign Earned Income Exclusion, you may discover that you are no longer eligible to contribute to these kinds of accounts. Unfortunately, many financial advisers don’t realize that you may no longer be eligible. You might not find out until a few years later that contributions you made after you moved overseas should not have been made. Below you will find information for overseas taxpayers explaining who is eligible to contribute, what happens if you contribute when you shouldn’t have, and how to fix the problem if you made one or more “excess” contributions.
Fine print: This information is summarized from a variety of IRS and other tax research sources. We have focused on the aspects of the issue that pertain specifically to overseas filers. However, there may be other rules that apply to you as well which are not discussed here. In addition, the purpose of this document is to give you an overview of the issues pertaining to IRA investments for overseas filers. It should not be construed as an exhaustive discussion of these issues. To determine the best course of action in your particular circumstances, please consult your tax and/or financial advisers.
For information on COVID-Related Distributions and 2020 changes to Required Minimum Distribution rules, see the COVID-19 page.
Who can contribute to an Individual Retirement Account (IRA)?
You can contribute to a Traditional IRA if
- you received taxable compensation during the year, and
- you were not age 70 ½ by the end of 2019. Starting in 2020, there is no age limit on Traditional IRA contributions.
You can contribute to a Roth IRA if, in 2021,
- you received taxable compensation during the year, and
- your modified Adjusted Gross Income is less than
- $208,000 for married filing jointly or qualifying widow(er) (phase-out begins at $198,000)
- $10,000 for married filing separately and you lived with your spouse at any time during the year, or
- $140,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year. (phase-out begins at $125,000)
The key point here for moderate-income overseas filers is that in either case you must have taxable compensation. For higher income overseas filers—those with taxable compensation—take note of the income limits for Roth contributions and see the definition of modified AGI below.
What is “taxable compensation”?
Generally, compensation is what you earn from working. However, any amounts you exclude from income, such as foreign earned income and housing amounts, are specifically identified by the IRS as not being taxable compensation for this purpose. If you do not claim the Foreign Earned Income Exclusion (e.g. if you use the Foreign Tax Credit instead), then all of your salary would be considered taxable compensation. Note that if you claim the Foreign Earned Income Exclusion, you must apply it to all eligible income–you may not elect to exclude only a portion of it.
What is “modified Adjusted Gross Income” for purposes of the Roth IRA?
The modified AGI for Roth IRA purposes is your adjusted gross income (AGI) as shown on your return modified by a number of items, most notably the following: You must add back the amount of your Foreign Earned Income Exclusion and Foreign Housing Exclusion or Deduction.
In what situations can I, as an overseas filer, contribute to an IRA?
Assuming you meet the other requirements mentioned above (pertaining to age and income limits) there are some situations in which you may have taxable compensation and thus can contribute to an IRA.
- Income from work performed in the United States. The following are some examples of items that are not foreign earned income, and therefore are taxable compensation:
- income from a job you held in the US before moving overseas during the year
- income from a summer job you worked in the US (e.g. If you’re an overseas teacher)
- the portion of your income allocable to any business trips you made to the US during the year.
- Not all of your foreign income is excluded under the Foreign Earned Income/Housing Exclusions. If, after taking the Foreign Earned Income and Foreign Housing Exclusions, you have additional foreign income that is not excluded, the excess is taxable compensation.
- You choose not to, or are not eligible to, claim the Foreign Earned Income Exclusion. e.g. If you opt to use the Foreign Tax Credit and not claim the Foreign Earned Income Exclusion, then you can contribute to an IRA (provided you meet the general requirements for doing so).
- Pay you receive as an employee of the US Government.
- Amounts you include in your income because of your employer’s contributions to a nonexempt employee trust or to a non-qualified annuity contract.
What happens if I made one or more IRA contributions that I wasn’t entitled to make?
A contribution you made in violation of the above rules is called an “excess contribution.” A 6% excise tax applies when excess contributions are made to traditional or Roth IRAs. This tax is applied for each year that the contribution remains in the account.
Example: In 2019 and 2020 you incorrectly contributed $3000 per year to your Roth IRA. You will owe $180 tax for each year that each contribution remains in the account. It should have been paid with your tax return each year, but if that didn’t happen you can file Form 5329 on its own (without amending your full tax return) for each prior year necessary. In this scenario, if you discovered your mistake (but did not correct it) in 2021, you would owe $180 for 2019, $360 for 2020, and another $360 for 2021.
How do I correct my excess contributions?
There are four ways to correct an excess contribution. Which one to use will depend on such issues as how long ago the contribution was made, whether you expect to be eligible to make a contribution in the near future, and so forth. The options are these:
- Withdraw the excess contribution plus any earnings (or minus any loss) by the due date (including extensions) for the tax return of the year the excess contribution was made. This avoids the 6% excise tax altogether. However, any income earned on the contribution must be included in income in the year the excess contribution was made, and may be taxed as a premature distribution.
- Withdraw the excess contribution after the due date (including extensions) for filing the tax return. This stops the 6% tax beginning with the year of the withdrawal. In this case, any earnings on the contribution remain in the account.
- Carry forward the excess contribution to a future year. If you expect to be eligible to contribute in the next year, for example, the excess contribution from a previous year can be applied as a contribution for the year you become eligible. (You will continue paying the 6% tax until the year you are eligible to apply the amount as a legitimate contribution.)
- Distribute funds from the IRA. Prior year excess contributions are reduced to the extent that distributions are made from the account. (But if you aren’t eligible for normal distributions, there may be early-withdrawal taxes to pay.)
All of these actions can have tax ramifications. It is necessary to look at the full picture of your situation to determine which correction will be best in your particular circumstances.
OTS can help you navigate these issues. Be sure to discuss with us any questions you might have about how these rules pertain to your situation.