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Retirement Planning and Taxes for US Expats, Part 1: Social Security

The “Golden Age”, “Second Childhood”, and “Winter of Life” are all fancy descriptors for the period of life many describe, simply, as “retirement”. Whether a person’s retirement begins at age 50, 60, 65, or 70 or later, most people reach a point in their lives when they either no longer have the ability to work or when they no longer need to work.

Of course, to be able to retire without experiencing a financial crisis, once needs to plan, and an essential part of the planning process is planning for the taxation of the income you will be receiving. In addition, US expats have another wrinkle thrown into the process: They usually have to deal with the tax systems of more than one country, which adds a whole new host of variables which your typical American does not have to deal with.


In this series of articles, I will give an overview of how retirement income is taxed in the United States, as well as some pitfalls US expats may run into when trying to plan for their golden years. I will not be going into investment strategies or tips for portfolio management—for that advice please contact your preferred licensed financial planner.

Today’s article will cover the following topics:

  1. How Social Security income is taxed;

  2. How US retirement savings income is taxed;

  3. How various types of foreign retirement income are taxed.

  4. Today, let’s cover the most common type of retirement income Americans can receive, Social Security Retirement.

Social Security

As we discussed briefly in the post about self-employment, Social Security was enacted as part of the “New Deal” and signed by President Franklin D. Roosevelt in 1935. Social Security is funded by payroll and self-employment taxes, and is designed to provide retirees, the disabled, and surviving relatives with an income when they get to the point when they can’t work anymore.

Qualifying for Social Security

Taxpayers qualify for Social Security retirement income when they reach 40 “credits” (or “quarters”) of qualified employment. The amount of earnings it takes to get a credit of coverage changes yearly—in 2020, it takes $1,410 to earn one credit, and a worker can earn up to four credits in a year. The amount of benefits the person will qualify for when they reach retirement age is not determined by the number of credits earned, but by the average earnings from the person’s working years. Typically, people who earn more during their working years will be entitled to more benefits from Social Security come retirement, but the benefit amount will cover a smaller percentage of the worker’s pre-retirement income for high-income earners.


Once a worker qualifies for coverage by virtue of earning enough credits, they can begin receiving retirement benefits when they reach age 62. However, the person will qualify for a higher benefit if they wait for “full retirement age” (FRA), which is between age 66 and 67, depending on the year the person was born. If the person waits past FRA, the benefit will continue to increase, until it reaches its maximum when the person reaches age 70.


For expats, earning enough credits to qualify for Social Security can be challenging, as foreign employment is not usually covered by Social Security (although self-employment is). Therefore, if an expat left the United States before having worked for 10 years in the US, they may not qualify for Social Security benefits when they retire. Different rules apply if the expat lives in a country with a “totalization agreement” with the US, so consult a local expert or a Social Security representative to see what your rights are.

Taxation of Social Security Benefits

Social Security benefits are taxed according to a special formula which is determined by your income level and filing status. For Social Security purposes, your income is made up of your Adjusted Gross Income (AGI) plus nontaxable interest and half of your social security benefits. As of 2020:

  • If you are unmarried:

  • If your income is more than $34,000, 85% of your benefits will be considered taxable.

  • If your income is between $25,000 and $34,000, half of your benefits will be considered taxable.

  • If you are filing jointly with your spouse:

  • If your income is more than $44,000, 85% of your benefits will be considered taxable.

  • If your income is between $32,000 and $44,000, half of your benefits will be considered taxable.

  • If you are married to a nonresident alien or if you are filing separately from your spouse, your benefits are usually 85% taxable.

Other Social Security Concerns for Expats

Once you begin receiving benefits, that’s all there is to it, right? Not so fast. Let’s go through a few more things expats should know about Social Security:

  • If you elect to receive benefits before reaching FRA, there may be restrictions on how much you are allowed to earn from employment and still receive your full benefit.

  • In the US, Medicare Part B premiums are often deducted automatically from Social Security benefits. However, Medicare is typically useless if the beneficiary is living outside the US, so discontinuing premium payments can save $144.60 a month.

  • Many countries have tax treaties with the US regarding taxation of Social Security benefits—in those countries, Social Security benefits may be taxed by the beneficiary’s country of residence instead of the United States. If this is the case, make sure to include Form 8833 (“Treaty-Based Return Position Disclosure”) with your return, or the IRS may decide that your Social Security benefits are taxable anyway.

  • US expats can often get their Social Security benefits direct-deposited into their foreign bank accounts in the currency of their country of residence at a market exchange rate and without conversion fees. Contact your local US embassy or consulate for the correct form to send to the Social Security Administration and other required documents.

Foreign Social Security

Unless a tax treaty applies, social security from a foreign country is taxable in the United States under the same rules as US Social Security. In addition to tax, if you became entitled to the foreign social security income by working for a foreign employer, you may also be affected by the “Windfall Elimination Provision” (WEP) of the Social Security Act, which can potentially reduce your US Social Security Income if you are receiving a foreign pension.

Conclusion

According to the Social Security Administration, approximately 413,000 Americans living outside the US were collecting Social Security benefits last year, and that number is expected to increase in the coming years (although the coronavirus pandemic has probably thrown a monkey wrench into many people’s retirement plans). Whatever your situation, retirement planning is an essential part of a comprehensive financial strategy, and making sure your tax situation is under control is vital.

Are you retired in a foreign country, or do you have questions about reporting your foreign retirement accounts? Contact us, and we will help make sure that your tax returns are prepared correctly and that you won’t have to worry about the IRS when the time comes to finally retire.

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