Retire abroad all you'd like: Uncle Sam and the states still want their cut of your livelihood elsewhere.
Folks retiring abroad may have considered how they'll pay for health care, make money and cover federal income taxes will work. They even may have consulted a financial advisor about the Foreign Account Tax Compliance Act (FATCA) that was passed in 2010, went into effect in July 2014 and ordered all non-U.S. financial institutions (including banks, insurance companies, investment funds and pension funds) to report the financial information of American clients who have accounts holding more than $50,000 directly to the Internal Revenue Service. But they often overlook issues such as state income taxes and estate plans.
"Retiring outside the U.S. involves more than researching the cost of living," says Shomari Hearn, managing vice president of Palisades Hudson Financial Group. "Without planning, you could be hit with surprises that cost time and/or money."
Nigel Green, founder and CEO of U.K.-based deVere Group says it's had negative repercussions for both his firm and its U.S. clients abroad. Thousands of U.S. citizens have taken drastic measures just to escape FATCA's reach. Last year, 5,411 U.S. citizens gave up their long-term U.S. residency, according to the Treasury Department. That's up 26% from 4,279 individuals in 2014 and adds to the 10,693 total who dropped their citizenship between 2013 and 2015. That's more than the 10,189 who did the same between 1998 and 2012.
"Tackling tax evasion is a noble and worthwhile objective," Green says, "yet FATCA's dragnet approach will be highly ineffective at achieving this as well as being prohibitively costly."
Green estimates that there are 8 million U.S. citizens living abroad, which makes the number who revoke their citizenship tiny by comparison. However, Green notes that FATCA's stringent reporting rules for overseas banks and investment firms that hold the assets of U.S. citizens and U.S. citizens who hold money in foreign accounts have had an impact on those renouncing citizenship. Thanks to criminals who held money in accounts in Switzerland, the Cayman Islands and elsewhere to hide taxable income from the U.S. government, FATCA drops huge penalties on folks who won't comply.
As the non-partisan Tax Foundation notes, those penalties pushed foreign banks to avoid U.S. clients altogether. While that takes away tax shelters, it also burdens a lot of innocent citizens abroad.
"Many U.S. citizens cannot even now hold a bank account in their country of residence as foreign banks routinely feel Americans are too much trouble thanks to FATCA's onerous and costly rules by which they would need to abide to take them on as clients," Green says. "This makes normal life extremely challenging, to say the least. By using its super power status, the U.S. has over the last few years been coercing foreign financial institutions around the world into accepting FATCA, or facing stiff financial penalties and extraterritorial sanctions."
Hearn notes that FATCA and other factors can make complying with U.S. tax law difficult while living in a foreign country. As he points out, U.S. citizens are taxed on worldwide income above a foreign earned-income exclusion, which is currently $102,100. That earned income includes salary, wages, commissions, bonuses, professional fees and gratuities earned abroad. Unfortunately for retirees, it doesn't include Social Security benefits, pensions, annuities, interest, dividends, capital gains or alimony.
You can claim a tax credit or a deduction on your U.S. income taxes for foreign taxes you paid, which should reduce your federal income tax dollar-for-dollar instead of simply reducing your taxable income. You can take the foreign tax credit even if you do not itemize deductions. The U.S. has tax treaties with several countries that can affect your individual tax situation, whether you are a U.S. citizen or resident, so it's wise to investigate before you go.
"With three out of four expats finding some part of personal finances more complex, the expat life clearly brings with it personal benefits as well as many complications, often times from unfamiliar financial regulations and tax obligations," said Jacques Herman, head of international retail banking and wealth management for HSBC Bank USA.
Last year, a deVere Group survey found that 73% of American expatriates were considering relinquishing their U.S. passports as a direct result of the FATCA. However, giving up on U.S. citizenship doesn't make all of your financial problems go away. To renounce citizenship, you have to prove five years of U.S. tax compliance. If you're wealthy and have a net worth greater than $2 million or average annual net income tax for the five previous years of $157,000 or more, you'll pay an exit tax.
If you aren't wealthy, you'll still have to pay a fee for renouncing your citizenship. That fee just jumped jumped from $450 to $2,350 in 2014. If that sounds steep, it's because exit fees in other developed nation are 20 times lower.
Even once you've renounced citizenship, your former state of residence may try to squeeze state income tax out of you under domicile law. Some states says that your domicile doesn't change until you demonstrate that you have no intention to return to the state. Keeping a home in the U.S. might show that intent to return, but staying in that home for more than 180 days a year definitely sends that signal.
Hearn suggests filing a part-year state tax return to end your residency, but some states won't take that for an answer. Virginia, for example, says that Virginians living abroad retain their Virginia domicile. They thus owe Virginia income tax on worldwide income until they establish residency in another state — which they can't do when living abroad.
"If your state's rules are similar, consider first shifting your domicile to a state that does not have a state income tax before moving abroad," Hearn says.
Moving your money with you also helps, but do so cautiously. Hearn suggests keeping the bulk of your assets in U.S. accounts and transferring them only when needed. That will protect you if your new country's economy is unstable, but also makes it easier to return to the U.S. if necessary. Also, if you keep less than $10,000 abroad, you won't have to file weightty disclosure forms annually.
Just make sure you do your research at banks in both the U.S. and abroad before making the leap. Banks in your new country may want identification documents, letters of credit and references from your U.S. bank if you plan on shifting U.S. dollars into your account. If your company in the U.S. restricts you from buying new mutual funds, switching holdings from one fund to another and redistributing assets among funds already held, you could place investments in a revocable trust and appoint a U.S. resident as co-trustee who could make the desired trades. Conversely, you could just switch to a more useful financial firm.
Just realize that if you maintain U.S. citizenship or residency, you must file an annual Report of Foreign Bank and Financial Accounts (FinCEN Form 114) if you have a financial interest in or signature authority over at least one financial account outside the U.S. and the total value of your foreign financial accounts exceeded the equivalent of $10,000 at any time during the year. Exceed higher thresholds, and you'll have to report assets to the IRS on Form 8938.
If you think Uncle Sam is no help financially when you're living abroad, just wait until you sort out your health care benefits. Medicare generally doesn't cover any medical expenses outside the United States and its territories and only provides emergency coverage in Canada and Mexico. You can stop paying Medicare premiums, but you'll be penalized if you return to the U.S. and re-enroll. Unlike the U.S., however, many countries have national health systems. Eligibility requirements vary, as do services and the quality of care. Even if your new home country will cover your basic medical care, you may wish to consider health insurance to cover private medical and dental care, as well as emergency medical evacuation to the U.S.
"Consider buying an international health plan that can travel with you," Hearn says.
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Editors' pick: Originally published June 29.