IRAs for Americans Working Abroad

Coordinating IRAs and the Foreign Earned Income Exclusion

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Americans working in foreign countries may be able to set money aside in an IRA. However, there are some technical rules that call for close scrutiny to ensure that your savings achieve the maximum tax savings. In particular, the foreign earned income exclusion coordinates with the rules for IRA eligibility, and this creates a very narrow range of options for Americans living and working abroad.

As a general overview, many Americans who live and work abroad qualify for the foreign earned income exclusion, which provides that the first $91,500 of foreign wages or self-employed income is excluded from US federal income taxes.

People working abroad may also be eligible for the foreign housing exclusion. Any income that is excluded from income taxes as a result of either of these two tax breaks will be income that cannot be contributed into an individual retirement account. Any income that is not excluded from tax, however, can potentially be contributed to an IRA.

Coordinating the Foreign Earned Income Exclusion with Roth IRAs

Roth IRAs have income limitations. A single taxpayer, for example, is eligible to fund a Roth IRA up to the full contribution limit if his or her modified adjusted gross income is under $105,000. The amount that can be contributed to a Roth is gradually reduced for a single filer for income between $105,000 and $120,000. After income exceeds $120,000 no Roth IRA contribution is allowed.

For Roth IRA purposes, a person's adjusted gross income is modified to add back any foreign earned income exclusion and/or foreign housing exclusion.

This creates a very narrow range of income possibilities for funding a Roth IRA. A single filer claiming the full $91,500 foreign earned income exclusion would have to have foreign wages in the range over $91,500 and modified adjusted gross income not more than $122,000 to be eligible to contribute some funds to a Roth IRA.

Coordinating the Foreign Earned Income Exclusion with Traditional IRAs

Traditional IRAs are coordinated with the foreign exclusion in two separate ways. First, like the Roth IRA, a person cannot contribute excluded income to a traditional IRA. Secondly, a deduction for a traditional IRA contribution might be limited or eliminated entirely if the person is covered by their employer's retirement plan. In the case where a person is not eligible to participate in a group retirement plan, a Traditional IRA would be available only on foreign wages or net self-employed income in excess of the foreign earned income exclusion amount.

Consider Using the Foreign Tax Credit

Americans working abroad may find that in certain situations, the foreign tax credit might yield advantageous results compared to the foreign earned income exclusion. That's because under the foreign tax credit, you'll have taxable wages or net self-employment income, thereby providing you an opportunity to fund an IRA in the US, while providing a tax reduction in the US based on taxes paid to the country where you work.