Retirement planning is a challenge for anyone. Navigating the ins-and-outs of various account types, taxes, and Social Security can feel daunting, not to mention the giant question of whether you'll have enough saved when you choose to retire. Add in the complexity of living abroad, and planning for retirement can feel overwhelming.
The good news is that as much as retirement planning for expats can be different and more complex than planning for their Stateside peers, it's still rooted in the same basic processes. What's needed is simply to explore the fundamentals of retirement planning and how that process is different for Americans living abroad.
The Retirement Planning Process
Planning for retirement involves forecasting two basic things: how much you'll be able to save before retirement and how much you'll need once you actually retire. At the outset of making a plan, the first task is to take stock of how you're currently saving. This includes what assets you currently have, such as Roth IRA's, 401k Plans, Pensions, etc., as well as what contributions you're currently making and to which accounts. The next step is to explore what your retirement picture looks like and what kind of expenses that comes with. You'll want to be as specific as you can here. If you plan to retire to an expensive golf club on the beach, that'll take more money than a little bungalow in a rural area. If you're able to lay out roughly what kind of retirement you'd like and what that will cost, those estimates can be used to determine what kind of nest egg is needed to fund your plan. Finally, once you know what you'll need to have saved, this can be matched up with how you're currently saving to see if you're on track. If there's a gap between what you're currently on pace to save and what you think you'll need, there could be an opportunity to explore how you could save more efficiently now or reduce expenses (especially tax-related expenses) in retirement.
Retirement planning is all about the details
While the general process for planning is the same for Americans living abroad or Stateside, the details can be very, very different.
First of all, some of the usual rules-of-thumb for retirement planning won't apply to an expat. For example, many retirement experts tout the "80% Rule" as a good starting point for estimating your retirement expenses. The 80% Rule asserts that a person's retirement expenses will be about 80% of what they needed prior to retirement. However, an expat's current living expenses may have little-to-no relationship with what they'll need in retirement. Many expats plan to retire in areas other than their current country of residence, such that cost of living differences render their current budgets more or less useless for projecting retirement expenses.
We analyzed cost of living data from 137 countries and found that 89% of the countries for which we had data had costs of living that were less than the U.S. The 80% Rule could leave an American living in a low-cost country woefully underprepared if they planned to retire back in the U.S.
Furthermore, the highest cost of living location - Bermuda - was 697.2% more expensive than the lowest cost of living nation - Pakistan. Not everyone dreams of retiring to Bermuda, but the implication is clear. Even for those planning to retire outside the U.S., the relative costs of living could be very different between their future and current places of residence. Rather than making a blanket assumption that they'll need 80% of their current expenses, people should take the time to research potential retirement locations and put together an appropriate budget for their chosen location.
Another commonly quoted rule of thumb is that a typical saver should plan to put away 15% of their current income for retirement. In our experience, compensation arrangements for Americans living abroad are quite varied and somewhat disconnected from retirement needs. For example, someone living in a low cost area may be living quite comfortably on what appears outwardly to be a somewhat lower salary. In such a situation, it could be appropriate to save much more than 15%, especially if it is likely that this person will retire to a more expensive area. What matters much more than the percent saved is whether the dollar amount projects to match up with needed funds for retirement.
Options for saving can be different for expats
Not only is the planning process somewhat different for Americans living abroad, but their options for where to save can be different as well.
One common avenue for retirement savings, the IRA, can function differently for expats depending on what tax credits and exclusions they claim. In order to contribute to an IRA, a U.S. taxpayer must have income left over after deductions and exclusions. Taxpayers who exclude all of their income using the Foreign Earned Income Exclusion and don't have any other source of earned income may not be able to contribute to an IRA. In contrast, by taking the Foreign Tax Credit instead, Americans living abroad may still be able to contribute.
Furthermore, corporate retirement plans may be treated differently if an expat is employed by a foreign organization. Many corporate retirement plans in the United States, such as 401k's or 403b's, provide tax benefits such as tax deductions for those who contribute. However, contributions made to a foreign pension plan may not provide tax benefits, and contributions made by the employer can actually increase tax liability for the taxpayer.
Social Security and Medicare can work differently for expats
Social Security can be an important source of income and medical benefits for retirees, but the details can be a bit complex for those living abroad.
Those who are self-employed or work for an American employer should still pay social security and medicare taxes, which means they'll accrue social security benefits normally. Those who work for a foreign employer may not have to pay these taxes, but that comes at a cost: their years working for a foreign employer won't factor into their Social Security benefits at retirement. The details are complicated, but it's possible that they may not receive as great a benefit when they retire. This could mean that retirees who spent significant parts of their working lives employed by a foreign employer might be more reliant on personal savings than their Stateside peers.
Adding further complexity, the U.S. has Totalization Agreements with 26 countries. Totalization Agreements are treaties designed to reduce double taxation for those responsible for both U.S. Social Security/Medicare taxes and the social security taxes of another country. The rules of these agreements can vary substantially, so consult a tax professional for further guidance.
Lastly, under most circumstances, Medicare benefits won't be useable for Americans who retire abroad. This means that retirees who plan to live overseas should take extra care factoring in healthcare costs.
The Bottom Line
For Americans living overseas, it's important to recognize the differences between their specific situations living abroad and the conventional wisdom geared toward Stateside retirement planning. Not only may cost of living differences create unique planning scenarios, but their savings options and retirement benefits may be different as well. Significant planning is required to navigate the complexity of saving for retirement abroad.
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