Some Americans working in foreign countries are able to set money aside in individual retirement accounts or IRAs. But if you think you're one of them, you'll need to pay close attention to technical rules to ensure you get the best tax result. The foreign earned income exclusion coordinates with the rules for Roth IRA eligibility, and this creates a very narrow range of options for Americans who are living and working abroad.
Key Takeaways
- Americans working abroad can contribute to an IRA, but only with money they haven't excluded from U.S. taxes by using the foreign earned income or foreign housing exclusions.
- For Roth IRAs, you're also restricted by measures that limit or bar you from contributing once your income reaches certain thresholds.
- One alternative is to use the foreign tax credit instead of either of the exclusions, but you'll need to evaluate your own situation to determine whether that's worthwhile.
Foreign Earned Income and Housing Exclusions
Many Americans who live and work abroad qualify for the foreign earned income exclusion, which provides that the first $112,000 of foreign wages or self-employed income is excluded from U.S. federal income taxes as of the 2022 tax year ($120,000 in 2023). This threshold is indexed for inflation, so it can increase periodically to keep pace with the economic climate.
People working abroad might also be eligible for the foreign housing exclusion, allowing them to deduct certain housing expenses from their gross incomes. There are limits to the exclusion based on where the expenses are incurred.
Any income that's excluded from taxation as a result of either of these two tax breaks can't be contributed to an individual retirement account. Income that's not excluded from income tax can potentially be contributed to an IRA, however.
So let's say you're an American living in the United Kingdom and you earn $100,000. If you use the foreign earned income exclusion to exclude all of it from your U.S. taxes, you have nothing left to contribute to an IRA.
Now let's say you're making $150,000 and you exclude the maximum amount of $112,000. You've still got income left over that you're allowed to put into to an IRA.
Coordinating the 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 their modified adjusted gross income (MAGI) is under $129,000 for 2022 ($138,000 in 2023). The amount that can be contributed to a Roth is gradually reduced for a single filer whose income falls between $129,000 to $143,999 in 2022 ($138,000 and $152,999 in 2023). No Roth IRA contribution is allowed if your MAGI is more than $144,000 in 2022 ($153,000 in 2023).
These thresholds increase to $204,000 and $213,999 for taxpayers who are married and file a joint tax return ($218,000 to $227,999 in 2023). They're also indexed for inflation, so they tend to increase somewhat from year to year.
Note
The limit plunges to just $10,000 for taxpayers who are married but who elect to file separate tax returns from their spouses.
A taxpayer's AGI is modified to add back any foreign earned income exclusion and/or foreign housing exclusion that they might have claimed. This creates a very narrow range of income possibilities for funding a Roth IRA if you live and work abroad.
Note
As a practical example: In 2022, a single filer claiming the full $112,000 foreign earned income exclusion would have to have foreign wages over $112,000, and modified adjusted gross income less than $129,000, to be eligible to contribute some money to a Roth IRA.
Coordinating the Exclusion With Traditional IRAs
Traditional IRAs are coordinated with the foreign exclusion in two ways. First, like the Roth IRA, an individual can't contribute excluded income to a traditional IRA.
Second, a deduction for a traditional IRA contribution might be limited or eliminated entirely if the individual is covered by their employer's 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 if a taxpayer isn't eligible to participate in a group retirement plan.
Roth IRAs vs. Traditional IRAs
These distinctions can be important because taxation of funds contributed to a Roth or traditional IRA is very different.
Contributions to a traditional IRA are tax-deductible in the year they're made, while contributions to a Roth are not. But taxation will occur eventually with a traditional IRA: Distributions taken from a traditional IRA are subject to income tax at the time they're taken, while distributions from a Roth are not, as long as they're qualified distributions, meaning, they meet certain requirements.
Consider Using the Foreign Tax Credit Instead
Americans working abroad might find that the foreign tax credit yields more advantageous results than the foreign earned income exclusion in certain situations.
If you claim the foreign tax credit instead, 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. The credit 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's not excluded and you can therefore receive the full benefit of contributing it to an IRA.
Frequently Asked Questions (FAQs)
What happens to my Roth IRA if I move to another country?
Nothing happens to your Roth IRA if you move abroad. The funds will still grow tax-free, and all the same required minimum distribution rules apply once you reach retirement age. The only thing that could change when you move abroad is your ability to contribute more money to a Roth IRA.
When do I have to file taxes by if I'm a U.S. citizen living abroad?
U.S. citizens living abroad are automatically given a two-month extension if they don't file their returns by Tax Day. In other words, the deadline for U.S. citizens filing returns from abroad is June 15. You can request an additional extension to push back the due date until October 15, but only the first extension will happen automatically.
