IRAs for Americans Working Abroad
Americans working in foreign countries are often able to set money aside in an IRA, but some technical rules call for close scrutiny to make sure that their 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 who are living and working abroad.
The Foreign Earned Income and Foreign Housing Exclusions
Many Americans who live and work abroad qualify for the foreign earned income exclusion, which provides that the first $105,900 of foreign wages or self-employed income is excluded from U.S. federal income taxes as of the 2019 tax year. The amount of the exclusion is indexed for inflation so it may increase periodically to keep pace with the economic climate.
People working abroad may also be eligible for the foreign housing exclusion.
Effect of Excluded Income on IRAs
Any income that is excluded from income taxes as a result of either of these two tax breaks is considered the income that cannot be contributed to an individual retirement account. Any income that is not excluded from the 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 is eligible to fund a Roth IRA up to the full contribution limit if his modified adjusted gross income (AGI) is under $122,000 as of 2019. The amount that can be contributed to a Roth is gradually reduced for a single filer whose income falls between $122,000 and $137,000. No Roth IRA contribution is allowed if your MAGI is more than $137,000.
For Roth IRA purposes, a taxpayer's AGI is modified to add back any foreign earned income exclusion and/or foreign housing exclusion that he may have claimed. This creates a very narrow range of income possibilities for funding a Roth IRA if you live and work abroad. A single filer claiming the full $105,900 foreign earned income exclusion would have to have foreign wages over $105,900 and modified adjusted gross income not more than $137,000 to be eligible to contribute some funds to a Roth IRA, and this is a somewhat narrow range.
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. Second, 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 taxpayer 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 Instead
Americans working abroad might find that the foreign tax credit might yield more advantageous results than the foreign earned income exclusion in certain situations. If you claim the foreign tax credit, you'll have taxable wages or net self-employment income that will provide you with an opportunity to fund an IRA in the United States. It also provides a tax reduction in the United States based on taxes paid to the country where you work. You're taxed on this income so it is not excluded and you can receive the full benefit of contributing it to an IRA.