Americans Aboard: Key Guidelines for Investing and Planning

Americans and green card holders living outside the U.S. face unique challenges. The global taxation that is applied to income, assets, and estates creates complexity and confusion. Even worse, many Americans find themselves with very limited resources to get the advice and services they need. Many international institutions have concluded that advising Americans is too difficult, while many U.S. based firms refused to take on clients who live outside the U.S., leaving families with limited options for support.

This guide was written to introduce the key issues Americans abroad face with regards to the following topics:

• Offshore financial services – Onshore vs. Offshore
• Tax reporting of foreign investments – FBARs and FATCA
• Tax efficient portfolio management
• Passive Foreign Investment Companies – PFIC planning
• Double Tax Treaties
• Retirement Planning for Americans Abroad
• Cross border financial planning

Cross border estate planning is another important area that impacts almost every family living outside the U.S. and requires expert advice, and we’ve addressed that topic separately in a guide of its own.

Onshore vs. Offshore

While offshore investments and planning can be beneficial for other expatriates and global citizens, U.S. citizens are often treaty unfavorable if they invest or bank outside the U.S. for tax and reporting purposes. Many Americans abroad are not aware that banking and investment solutions outside the U.S. are governed by different tax regulations. At their worst, these regulations can create phantom tax – an obligation to report and pay tax on an investment gain you haven’t realized. Many families who come to us have gotten incorrect advice previously, resulting in years of amended returns, back taxes and penalties. At a minimum, before you consider investing through an offshore fund, investment account, bank account, insurance product or other non-U.S. financial product, ensure you’ve gotten qualified advice with regards to the tax reporting and the tax treatment that will be required. There are investment opportunities that warrant the cost and complexity associated with them, and advance planning will avoid any nasty surprises.

In addition to the tax cost, offshore investments typically incur higher imbedded fees and management costs compared with a similar U.S. investment. For mutual funds, the total fees are typically 0.50 – 0.75% higher on average compared to an identical U.S. fund. For insurance products, the numbers are often far worse. When we compared several offshore investment linked insurance contracts and annuities with a similar range of U.S. variable annuities, the offshore contracts were anywhere from 2x – 5x more expensive when considering all of the associated costs (many of which are required to be disclosed clearly). In addition, the offshore contracts did not provide the tax deferral that U.S. contract does, and the offshore contracts will cost hundreds if not thousands of dollars every year to report to the IRS correctly, given the complexity of the offshore insurance wrapper and the underlying offshore funds.

Other advantages of allocating through U.S. traded investments are the global access, regulatory protection and liquidity that U.S. markets have to offer to investors. Compared to some other financial centers around the world, exchange traded funds, global stocks, bonds and commodities have some of the highest available liquidity when traded in U.S. markets. Many publicly traded companies on the globe list their trade shares on both U.S. and their home country stock exchanges. And because the fund industry in the U.S. is enormous and competitive, any global asset class can be made open to efficient, low cost investment through U.S. accounts and products, with high liquidity increasing your return and low transaction costs. In addition, the U.S. regulatory framework is strong and offers consumers protection in the form of a strict licensing regime and recourse in the event of unsuitable advice. That same framework requires clear fees disclosures and transparency in products and advice that are sold to consumers. Many of the common offshore markets offer no protection to consumers, who bear the full responsibility of determining what investments are both sound and suitable. Safety is also a priority for most investors. Although regulatory standards exist in the global banking centers of the world, they are almost non-existent in some offshore havens. In the U.S. with U.S. institutions, the Federal Deposit Insurance Corporation (FDIC) and Securities Investor Protection Corporation (SIPC) are two different types of coverage that may aid in the protection of your assets. FDIC and SIPC automatically cover all U.S. accounts, but aren’t available for non-U.S. accounts.

FBARs, FATCA and Reporting

Under the long-standing Bank Secrecy Act, you must report certain foreign financial accounts, such as bank accounts, brokerage accounts, investment linked insurance policies, and mutual funds, to the Treasury Department and keep certain records of those accounts. If you hold any cumulative assets that exceed $10,000 at a financial institution outside the U.S., you must report them to the U.S. Treasury for that year on a form called the FBAR (See includes a variety of assets you might not have thought of, including cash value foreign life insurance, certain foreign pensions and provident funds, and foreign bank accounts. The Foreign Account Tax Compliance Act (FATCA) is a more recent development in the U.S. efforts to combat tax evasion and a failure to report assets abroad. This FATCA requirement is in addition to the long-standing requirement to report foreign financial accounts explained above. Under FATCA, certain U.S. taxpayers holding financial assets outside the United States must report those assets to the IRS on Form 8938, Statement of Specified Foreign Financial Assets. There are serious penalties for not reporting these financial assets or failing to correctly capture all assets on the FBAR.

FATCA will also require certain foreign financial institutions to report directly to the IRS information about financial accounts held by U.S. taxpayers or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. The reporting institutions will include not only banks, but also other financial institutions, such as investment entities, brokers, and certain insurance companies. Some non-financial foreign entities will also have to report certain of their U.S. owners. This means that if you’ve inadvertently omitted an account from your own reporting, the IRS will be notified by the institution, potentially triggering audits and penalties. The practical result of this requirement on institutions is that many firms no longer offer services to Americans or small businesses with American shareholders.

Tax reporting is also far easier when using U.S. institutions. By working with U.S. brokerage firms you benefit from their detailed activity reports, made available to you in the required IRS format segregating dividends, qualified dividends, taxable and non-taxable interest income, and short and long-term capital gains, to mention only some of the most important categories, each of which requires a specific tax treatment. Most financial institutions outside the U.S. do not provide any detailed reports or formal U.S. tax documentation such as a 1099 or K1 and are unwilling to provide tax information or answer questions related to the taxation of your investments.

Managing your investment portfolio

The basic fundamentals of portfolio management apply regardless of where you live. If you want to achieve the ideal mix of exposures for your portfolio and be successful in the long run, you should consider different factors in your long-term planning, such as currency management, geographic diversification, market risk, expenses, asset allocation and tax management.

If you live overseas and expect to remain outside the U.S. for long or indefinite periods of time, then you will have to consider managing your long-term currency risk, by matching your current denomination in which you have your investments with the currency in which you expect your future expenses will be (e.g. mortgage costs or college tuitions). If you live in Europe and want to raise your children and retire there, then it makes absolute sense to invest in European stocks and bonds. If you are based in the UK, you may want to allocate to Gilts and UK equities. Asian investors may want to be exposed to Asian equities and currencies. Parts of Europe and the UK have a potentially more onerous tax framework for the local treatment of passive income and capital gains so local tax planning may supersede U.S. planning. It’s worth noting that you do not need a foreign broker if you are interested in buying stocks and bonds overseas. Often you can purchase an Asian, European, or U.K. stock and bond portfolio more easily with lower costs from a U.S. broker rather than from an overseas broker or bank.

Many Americans abroad are unsure where their careers and futures will take them, and so a diversified multi-currency portfolio will be the best option to consider.
Regardless of your location on the globe, most investors should invest in a wide array of assets (real estate, bonds, international stocks, real estate, etc.). How you buy and hold these assets can have a significant impact on your long-term net of tax return. Americans living abroad need to consider tax management of the actual portfolio assets. High turnover portfolios have high commissions and trading fees levied on them, and also trigger capital gain taxations earlier and at higher rates. A stable and diversified portfolio with a low turnover that has the right amount of risk invested in it, delays taxation and benefits from the long-term capital gains rate will produce better results for you than a pre-taxed account with a high turnover.

Passive Foreign Investments Companies (PFICs)

Passive Foreign Investment Companies (PFICs) are defined as any non-U.S. incorporated investment funds that derive 75% of their income through passive activities. PFIC rules are complex and have been created to discourage any U.S. citizens from moving money out of the country to avoid taxation. There are options as to how the IRS will treat PFICs that go beyond the scope of this guide, and you should obtain qualified advice before purchasing or reporting any PFIC.

PFICs include:

– Offshore insurance contracts (including saving plans and portfolio bonds);
– Offshore private equity and venture capital funds;
– Government pension schemes (MPF, CPK, U.K. pensions and Japan 401ks);
– Foreign mutual funds;
– Foreign listed ETFs.

Although PFIC rules are complex, it all comes down to the IRS’s default taxation formula, wherein all capital gains have levied on them the highest marginal tax rate, which is currently 37%. PFICs do not benefit from any favorable long-term capital gains treatment, and the IRS presumes that all gains from them were made ratably over the entire holding period, thus assessing interest on any delayed gains during the holding period. Everything added up in time will lead to an exorbitant taxation rate of over 50% for PFICs.

Taxations are so punitive that is less likely that any non-U.S. investment funds will generate the necessary returns to compensate for the losses incurred to taxes. Before FATCA, the IRS did not have the proper tools for taxing PFICs, but now the legislation imposes new reporting regulations on all non-U.S. financial institutions and requires them to provide the IRS with a detailed reporting on any accounts owned by Americans abroad. Through this, the IRS can determine whether investments in those accounts are PFICs or not.

Double Taxation Treaties

The United states has income treaties with around 70 countries from all around the world. These treaties were created in order to reduce the incidence of double taxation for Americans living abroad. Although these treaties do not lower the tax burdens for expat Americans, they do reduce double taxation considerably and may provide relief for certain types of pensions and government sponsored accounts. Some of these treaties offer mutual recognition of tax preferences for retirement plan accounts (e.g. IRAs, 401ks company provision plans and their non-U.S. parallels). Some bilateral treaties also provide special provisions for public pension plan taxed benefits, such as social security. In addition Tax Totalization Agreements have been created to help avoid the double taxation of income in respect to social security taxes and self-employment taxes (where the self-employed person pays both the employer and employee portion of Medicare and social security). if you are self-employed and are working abroad, these agreements can mitigate or even eliminate, in some cases, the 15.3% self-employment U.S. tax.

The U.S. has treaty agreements with ten member countries of the E.U., as well as Australia, Japan, China, Switzerland, and South Africa. These treaties are essential in judging the intricate interaction of U.S. estate tax regulations and foreign estate and inheritance tax rules. The U.S. does not have a tax treaty with Hong Kong or Singapore, which results in unfavorable treatment of the local provident funds in those countries.

Retirement planning abroad

If you’re living abroad, you need to understand how to correctly use tax advantaged retirement accounts. As a U.S. citizen living overseas, depending on your employer and employment contract, you may not have the option of enrolling in a traditional 401k, 403b, profit sharing or defined benefit pension plan. You may be eligible to fund an IRA, Roth IRA, or SEP IRA depending on your income and how you file your taxes. Almost all Americans abroad have options to set up non-qualified retirement plans, and while these grow tax deferred, they do not offer a current year tax deduction.

For an Individual Retirement Account (IRA) and other pre-tax contribution accounts you gain a tax deduction for the contributed amount if it has already been taxed. Contributions to a Roth account are done after taxes are paid. The benefit to this is that earnings and contributions withdrawals in retirement aren’t subjected to income tax. A Simplified Employee Pension (SEP) account is useful because it is set up with ease, carries low administrative costs, and also allows the employer to determine annual contributions. SEPs have the same investment options as traditional IRAs have and are also tax deferred. As a general rule, unless your employer offers to make employer or matching contributions, you should usually avoid non-U.S. retirement accounts, unless they are recognized by a bilateral tax treaty. In cases where this isn’t possible, such as the Hong Kong mandatory provident fund, you should speak with a professional advisor on how to report these accounts correctly.

Getting the right Advice as an American Abroad

Navigating through different financial and tax systems is an intricate process, which requires you not only to understand U.S. legislation, but also that of your current country of residence abroad. With careful planning and advice from qualified professionals you can use the tools mentioned in this guide to build a successful long-term investment plan and manage your financial life better living abroad.

When selecting an advisor, you should work with someone who is a fee-based fiduciary, meaning they are held to a higher standard of putting your interests first. You need an advisor who is licensed and regulated in the US by the SEC and ideally in your home country of residence. Ideally your advisor has in-house international tax and estate expertise, or if not, then access to strong network of these resources. While it can be challenging to find firms that offer this true cross border coverage, they do exist. If there isn’t one in your area, you can likely find someone in your region, for example a Luxembourg advisor who covers Europe or a Hong Kong or Singapore advisor who covers most of Asia.

Some firms such as ours have regulated entities in multiple locations, ensuring comprehensive cross border advice. Our presence in Hong Kong, London and the US, allow us to serve a variety of clients with high quality cross border advice in their time zone. As your global wealth advisor we can provide comprehensive expertise and guidance. Our in-house capability and expertise in tax and estate matters is reinforced by strategic collaboration with an extensive network of dedicated outside accountants, lawyers, trustees, and investment managers. Together, we can advise on any financial issue you may have and ensure that as an American abroad, you are managing your financial affairs in the best way possible incorporating tax and other factors that are important to you.