More U.S. citizens are retiring outside of the United States than ever before. The U.S. Social Security Administration estimates that the number of retirees who draw Social Security outside the United States increased approximately 40%, to more than 413,000, between 2007 to 2017.1 Another U.S. government survey estimates that approximately 9 million U.S. citizens live abroad.2 Professional advisors increasingly see clients move to foreign jurisdictions and should familiarize themselves with the impact of investment, income tax and estate-planning decisions on their relocated clients.
For U.S. citizens retiring abroad, there’s considerable confusion surrounding many of these areas. This confusion stems primarily from the fact that U.S. citizens remain subject to U.S. income and U.S. estate and gift taxation even if they’re no longer physically resident in the United States. Additionally, a new country of residence has its own laws regarding income and estate taxation, estate documents and administration, treatment of trusts and country specific estate-planning tools that now must be planned for.
Successful cross-border retirement planning focuses on understanding nuanced interactions among each jurisdiction’s laws and customary practices. Failing to consider these multi-jurisdictional planning areas may create dramatic unforeseen consequences, including assets passing to the wrong beneficiaries and excessive taxation. Fortunately, your client can avoid many of these unwanted financial and emotional ramifications with proper planning.
U.S. Income Taxation
The United States taxes its citizens and residents on their worldwide income. This is true even if they’re living and paying taxes in another country; the United States imposes taxes based on citizenship, not residency. Fortunately, many popular retirement destinations, such as Canada, Mexico and the United Kingdom, have bilateral income tax treaties with the United States that alleviate double taxation and simplify income tax reporting.
U.S. expat retirees must thoroughly review how retirement income is taxed in their new country of residence. Certain jurisdictions only tax local source income derived from employment or business activities in that country while exempting investment income from taxation. Other countries impose tax on all worldwide assets and income immediately on becoming a tax resident.
Understanding the income tax laws related to U.S. retirement accounts and pensions is particularly complex. Tax treaties allow the country of residence to tax these accounts under domestic law unless a treaty provision amends that treatment. Some treaties provide that the country of residence may not tax amounts that wouldn’t have been taxable by the other country. In other cases, government pensions or Social Security payments may be taxable only by the government making the payments.
Your client should consult with an experienced cross-border accountant to properly source income between the United States and a country of residence. There may be certain tax elections and reporting methods that reduce overall taxation. The strategies vary dramatically depending on the specific language of the double tax treaty.
U.S. Estate Tax
The United States also imposes estate and gift taxes based on citizenship. A U.S. citizen retiring abroad remains liable for U.S. estate tax in addition to possible local country transfer taxes. Like income tax treaties, the United States is signatory to estate and gift tax treaties with a handful of countries to alleviate transfer tax burdens.
These treaties alter specific local rules and commonly include a provision to determine residency, situs of assets, availability of a marital deduction for bequests to a non-citizen spouse and other provisions related to the imposition of taxes at death. There are far fewer estate and gift tax treaties than income tax treaties. Most of these treaties are with European countries that have significant transfer taxes of their own.
Foreign Jurisdiction’s Tax Laws
As part of the Tax Cuts and Jobs Act of 2017, the U.S. estate tax exemption amount increased to $11.4 million per individual or $22.8 million per couple (2019). Note that this exemption doesn’t apply if one spouse is a non-U.S. citizen. See “Mixed Nationality Marriages,” p. 40. Many Americans are no longer subject to this tax due to the high exemption amounts. However, other countries have significantly smaller exemption amounts or even apply the tax on the recipient of the bequest rather than the estate of the individual who died. Thus, the focus for many international retirees is centered on the foreign jurisdiction’s laws that now apply and efficiently passing assets to the correct beneficiaries.
Forced heirship. Many jurisdictions impose restrictions on who may receive assets at death. U.S.-based practitioners are familiar with common law principles that allow for a free disposition of a decedent’s estate. However, foreign legal codes often compel individuals to distribute a decedent’s assets under forced heirship principles. In civil law systems such as France, Italy and many Latin American countries, children must inherit some assets on the first parent’s death. Sharia law, common in the Middle East, also places restrictions on how assets are transferred.
U.S. citizens now have more freedom in the disposition of their assets if living in the European Union. E.U. regulation 650/2012 may allow E.U. residents under certain circumstances to select their home country’s laws as those governing the distribution of their assets rather than the law of their country of residence. Although this E.U. regulation allows flexibility in distributing assets, it doesn’t reduce transfer taxes imposed by the country of residence.
Estate tax versus inheritance tax. U.S. advisors are familiar with planning for an estate tax. Estate taxes are levied on the net value of property owned by a decedent on the date of his death. In contrast, inheritance taxes are levied on the recipients of property left by a decedent. Many countries around the world impose transfer taxes on the individual receiving the assets rather than the decedent.
This may affect retirees receiving assets from others in the United States. For example, a U.S. citizen domiciled in Spain may owe Spanish inheritance taxes when inheriting certain assets from someone in the United States. Similar concepts are applied to lifetime gifts received. In many European countries, the relationship between the decedent and beneficiary plays a critical role in determining the amount of tax. A closer lineal relationship (parent to child) generally implies less tax than an unrelated person passing assets.
When Does Foreign Law Apply?
Cross-border families must understand issues relating to residency, domicile and situs. Every country is unique in determining who and what may be subject to its income, estate, gift or inheritance taxes. A retiree dividing time among multiple countries may be surprised by the jurisdictions where he’s tax resident or deemed to be domiciled.
Many countries codify their requirements to determine when someone is resident and domiciled. This is common in Europe, where spending a specific number of days in a country will subject worldwide assets to local law. Generally, “residency” is where an individual is expected to live for a temporary period and pay income tax. “Domicile” is defined as more of a permanent home where an individual will live for an indefinite period. Domicile is more closely linked to the application of transfer tax laws and probate.
Finally, situs rules affect how certain types of property will transfer. “Situs” refers to the location of the property for legal purposes. A vacation home in Italy owned by a U.S. citizen living in New York will be considered Italian situs property and be fully subject to Italian inheritance and transfer laws. If the U.S. citizen living in New York dies, N.Y. state law will direct how most of his U.S.-based assets pass. However, this may not apply to the Italian vacation home, and Italy may place restrictions on the recipient and tax the transfer.
Cross-Border Estate Plan
When moving across borders or acquiring assets in a different jurisdiction, it’s essential to help your client prepare an international estate plan. A single country-focused estate plan may create unforeseen and undesirable consequences when executed in a different country. Individuals retiring abroad need to understand the tools used to transfer assets at death in a new jurisdiction, which may vary dramatically from standard U.S. planning techniques.
One Will or Multiple Wills?
Writing a will or last testament is an important part of any estate plan. Often, an expat retiree has a U.S. will prepared in accordance with the state law of his last residence. Although many foreign courts will admit a legacy U.S. will as evidence of a decedent’s intentions, it’s certainly not a guaranteed way to control the transfer of assets at death.
A retiree should rescind prior wills and create a new will in his retirement destination that conforms with local law. This may involve working with various attorneys, notaries and government officials who can ensure final wishes are adhered to. In addition to drafting a will, expats should review account titles, power of attorney documents and medical directives ensuring that these are legally binding in the country where they now live.
Multiple wills may be used when owning property in different jurisdictions. An ancillary will may be written to dispose of a specific property in accordance with local law. However, clients should exercise caution when using more than one will. There should never be confusion of what’s truly a client’s “last will and testament.”
Trust Structures
It’s essential for practitioners to review trust structures with their clients who are international retirees. U.S. estate planners commonly use a variety of trusts when developing an estate plan for probate avoidance, control of assets and U.S. estate tax planning. Trusts may be an excellent strategy in the United States, but frequently trust planning structures don’t travel well across borders.
Trustees and settlors of trusts moving to a new country must carefully examine how the new jurisdiction views trusts. Many jurisdictions don’t recognize trusts, including many continental European countries. The United Kingdom and New Zealand may impose entry and exit taxes on trust assets. Moving a trust, possibly unknowingly by actions of a trustee or settlor, may create unforeseen tax consequences.
A U.S. taxpayer who’s a beneficiary of a foreign trust faces complicated U.S. tax reporting. If a foreign trust has a U.S. owner or beneficiary, U.S. tax reporting is required by the trustee and beneficiary. Transfers to, distributions from and annual income and expenses of foreign trusts must be reported and possibly taxed by the United States.
Beyond taxation issues, other laws of the foreign jurisdiction may make trusts less desirable. Forced heirship regimes, marital rights and other foreign property laws may apply and may alter the interests beneficiaries have in the trust property that differ from the trust terms. Individuals who are settlors, trustees or beneficiaries should consult with a tax specialist before relocating to a new country.
Cross-Border Charitable Giving
Often, U.S. citizens have philanthropic intentions while living abroad. This may be to charities in the United States or local organizations in their new communities. They should pay attention to maximizing the possible tax benefits of charitable donations.
Direct donations to a non-U.S. registered charity aren’t deductible for U.S. income taxes. To obtain a U.S. tax deduction, individuals should donate to a U.S. public charity that operates abroad through a foreign branch office. A donor-advised fund or private foundation is another conduit for which U.S. tax benefits may be received, and funds eventually end up in a foreign charity.
A tax deduction received only in the United States may not lower overall taxes. If the country of residence tax rates are higher, there will be no net reduction. Some foreign jurisdictions offer special tax incentives to encourage philanthropy, but most don’t. Coordination between U.S. and foreign income tax law is essential to ensure overall tax efficiency.
Investment Portfolio Considerations
The key to a successful retirement abroad is more than income and estate tax planning. Managing an investment portfolio with an eye towards cross-border efficiency is essential but often overlooked by many retirees and their advisors.
Choosing an investment custodian. It’s essential to confirm that U.S. financial providers will continue working with an individual who’s resident in another country. Many U.S. brokerage firms restrict their services and products when U.S. citizens reside outside of the United States. These restrictions vary greatly among countries and custodians.
Selecting tax-compliant investments. Purchasing non-U.S. listed investment products is a common mistake made by U.S. expat retirees. Foreign listed mutual funds are classified as passive foreign investment companies (PFICs) by the Internal Revenue Service and punitively taxed. U.S. citizens should avoid PFICs and invest tax efficiently by using only U.S. registered investments, such as mutual funds or exchange-traded funds.
Many other countries have similar rules to the U.S. PFIC regime. Investors who are a tax resident of and domiciled in the United Kingdom must be mindful of the U.K. tax authority’s “reporting funds regime,” which limits funds eligible for U.K. capital gains treatment. Germany, Austria, Australia and New Zealand also have similar rules discouraging the ownership of non-transparent offshore funds by their tax residents.
Understanding currency implications. Retirees must create a long-term plan for cash reserves and develop a portfolio that matches current assets with future liabilities. For example, an individual retiring in France should have more exposure to Euro investments than someone retiring in the United States. An international retiree must diversify a portfolio’s income away from solely U.S. dollar-focused sources to mitigate currency risk.
What to do Before Leaving?
An unplanned estate involving assets or beneficiaries in multiple countries may cause immense stress, financially and emotionally, for family members who must deal with different legal systems. On deciding to retire outside of the United States, your client should start planning. Many financial, tax and estate-planning strategies are harder to implement when subject to multiple tax and legal systems.
Pre-immigration planning before leaving the United States eliminates uncertainty about which laws apply. For example, an individual may gift assets to his children without worrying about how a foreign country views the transfer. A portfolio may be rebalanced without taxation in both the United States and another tax system. Trust structures that create problems in another jurisdiction can be unwound. These are some actions that are commonly efficient to take before leaving the United States.
The local legal system can’t be ignored even if spending minimal time in a new country. New laws such as the U.S. Foreign Account Tax Compliance Act and the Organisation for Economic Co-operation and Development Common Reporting Standard give tax authorities around the world more information on taxpayers. With better technology and new information sharing laws, governments are closely scrutinizing the actions of globally mobile families.
Legacy advisors in the United States may not be as experienced working with international families. Creating a team of knowledgeable experts in the United States and local country may help avoid potentially costly planning pitfalls. With proactive financial planning and the right advice, U.S. expat retirees will enjoy a prosperous retirement abroad.
Endnotes
1. “Old-Age, Survivors, and Disability Insurance Benefits in Current-Payment Status,” Table 5.J6 (2017), www.ssa.gov/policy/docs/statcomps/supplement/2018/5j.html#table5.j11.
2. “CA By the Numbers,” Bureau of Consular Affairs (June 2016), https://web.archive.org/web/20160616233331/https:/travel.state.gov/content/dam/travel/CA_By_the_Numbers.pdf.