Your retirement income is in excess to your excluded income – therefore as an expat living overseas, it will be bumped into higher tax rate. However, there are still standard reductions which have the potential to reduce your taxable retirement income. Don’t think you are being taxed at a higher rate because you’re an expat, as it will likely average out.
Receiving a retirement fund while working for a US company is possibly the best way to save for retirement under 401(k) or 403(b), which allows you to contribute up to $18,000 – substantial savings for retirement. The idea is that by deferring taxes while working, once you withdraw this money when you are retired, your non-existent or lower income will reduce the tax rate and you will save.
Which retirement plan is best?
The 401(k) and 403(b) plans are similar and one isn’t necessarily better than the other, and there is no yes or no answer to whether you are being taxed at a higher tax rate just because you are fully excluded.
401(k) is provided only through a US employer, which means they can contribute more – $18,000 a year. However, money has to be taken out starting from when you’re at retirement age (59 and ½). In comparison, with a Roth IRA
you can contribute until you are 65 and can defer distributions until you are 65. Giving you an extra 7 years of contributions and not needing to withdraw money.
Whether you can contribute to a Roth IRA depends on you income level, as you need to have a net positive earned income. If you are fully excluded, your AGI is already at 0 and you will not be able to contribute. You will need an analysis of your income and see if adjustments can be made. For traditional IRAs, your positive earned income is used to contribute and you are still able to contribute and save for your retirement even if fully excluded. It requires a case by case analysis.
Generally, 401(k) or 403(b) is a good option if you are planning to save for retirement. If you need more assistance or want to know how it works, we are here to have a chat and provide you with a quick calculation.