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The Tax Impact of Retiring Abroad

Retiring abroad on a tropical island or in a quaint village may feel like a dream — until the reality of the first tax bill sinks in.

Without careful planning and help from international tax advisors, unexpected foreign taxes can put a sizable dent in retirement income. Fortunately, there are international tax advisors who can help. Here are some steps retirees should take before filing foreign taxes.

Research International Tax Laws

Since tax laws are shaped by a variety of factors, such as a nation’s culture and politics, the tax structure in a different country may not account for foreign retirement funds, says Brian Dooley, CEO of International Tax Counselors, a tax strategy firm based in Silverado Canyon, Calif.

An unfavorable exchange rate can have a significant impact on the value of money that is converted from domestic accounts into foreign currency.

Social Security benefits, for instance, are largely tax-free in the United States. But a country with a less nuanced tax regime, like Costa Rica, may tax those benefits like regular income, Dooley says. For this reason, the U.S. has tax treaties with certain nations to avoid double taxation. The terms of each treaty differ, but the objective is to offset foreign taxation through U.S. tax credits. In some cases, a treaty allows only one country to tax income.

To get a sense of the terms associated with each treaty, the Internal Revenue Service (IRS) website offers free access to a directory of treaties. However, the IRS advises that individuals only use this resource for quick reference. “[International tax treaties] are not written for a popular audience — it’s very technical,” says Mark Ritter, managing director and Atlanta compensation and benefits practice leader, Grant Thornton LLP in Atlanta.

Also, individuals should centralize their research efforts to websites with the most up-to-date information, since treaties change rapidly depending on political relations between countries.

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Work with Cross-border Tax Advisors

When retiring abroad, individuals should consider retaining a tax advisor in their home country, as well as the host country. “It’s important to have people on the ground in both places who know what they’re doing,” says Katrina Haynes, international expatriate services manager, Grant Thornton LLP in Atlanta. “Look for accountants with an active practice. Generally, we suggest that the home and host country accountants be employed at the same firm for consistency to assist the expatriate with coordinating the timing and filing of the home and host country tax returns and tax payment efforts.”

When meeting with advisors, retirees should discuss how each of the following factors impact how their retirement funds are taxed:

1.     Country of retirement:  Consider the tax rates before financially committing to retire in another country. “The Netherlands and Switzerland are beautiful places to retire in, but they have heavy tax regimes that could affect your quality of life,” Ritter says. “Therefore, retirees should consider the local tax regime as one of many factors that may affect their quality of life down the road.”

By contrast, Haynes says the United Arab Emirates and Turks and Caicos have no individual income tax.

2.     Citizenship: Citizenship affects which foreign taxes an individual is subject to. For instance, all U.S. citizens and Green Card holders must pay U.S. taxes on worldwide income, Ritter says.

3.     Treaties:  To encourage foreign trade and investments, some nations, like the countries that comprise the U.K., have more favorable treaties with the U.S. than others, Dooley says. As long as a foreigner does not deposit his or her income in a U.K.-based bank account, any income withdrawn from retirement funds is tax-free. However, he notes that, “Today’s news is reporting a change in the U.K. attitude because of the French citizens fleeing France’s ‘tax-the-rich’ policy.”

4.     Types of accounts:  Generally, treaties excuse accounts such as pensions and 401(k) plans from double taxation. But individual retirement accounts (IRAs) are so unique to the U.S. that they often end up being taxed twice, even in countries with treaties.

5.     Currency value:  An unfavorable exchange rate can have a significant impact on the value of money that is converted from domestic accounts into foreign currency. Therefore, it’s crucial that retirees talk with tax advisors and foreign exchange providers about strategies to preserve their funds in times of both favorable and unfavorable exchange rates. On an ongoing basis, individuals can also sign up for market-rate alerts via an online foreign exchange service, in order to keep tabs on a country’s currency value.

While foreign taxes will always be complicated, tax advisors can help retirees navigate the critical issues. “The idea of retiring is to do something else with your time — not taxes,” Ritter says.

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