If you search online for the “best retirement account,” most websites will hands-down recommend the Roth IRA for most people (although the health savings account, or HSA, is starting to get its due recognition).
The Roth IRA is a Great Retirement Account
Many students of finance would say that your first retirement priorities are:
- Invest in our Roth 403b (or 401k) up to our employer’s match. Hey, if our employer is willing to give a $1 for every $1 we put in up to say $500, well, that’s free money. I suspect that most of us nonprofit workers don’t have such a match (though I’ve heard of at least one missions organization that does), so we skip to step 2.
- Invest to your Roth IRA up to the maximum allowed by law. That maximum for 2018, for example, was $5,500 (or $6,500 if over 50 years of age). Please note that a Roth IRA seems almost always preferable to a so-called “traditional” IRA, so I am only speaking of the Roth version here, but all of these principles should apply to both versions.
- Only then do we begin discussing putting more in the Roth 403b, in an HSA, in a taxable account, etc.
As you can see, except for an employer’s free matching gift in a Roth 403b, the Roth IRA is generally considered the crème de la crème among retirement accounts! However, it is not the ideal or even legal retirement account for many expats.
Many of Us Cannot Contribute to a Roth IRA
The catch is that you cannot contribute to any sort of IRA if you do not have US earned income. If you claim the Foreign Earned Income Exclusion (and many of us should), that will probably “exclude” all of our “income” which was “earned” in “foreign” lands. (Now you know why the FEIE is called that!)
Vagabond Finances is written by and for missionaries and nonprofit workers who generally live on lower than average wages. Many US expats are earning large amounts of money. They will claim the FEIE but still make enough to have $5,500 or $6,500 in US taxable, earned income over and above the limits of the FEIE (which are currently a bit over $100,000 for the single taxpayer). If you have a 6 figure income or don’t claim the FEIE, please talk to your tax planner about adding some funds to your Roth IRA. (Alas, if you are an expat executive with a 6 figure income who just happened across Vagabond Finances, you have just figured out that this blogsite wasn’t really designed for you. Sorry about that.)
If you’ve determined that the FEIE is your best friend (and it might be!), then the Roth IRA is not your best friend. In a normal year in which we nonprofit workers and missionaries work outside of the USA for the entire year, the Roth IRA isn’t going to be very friendly at all. In fact, you need to avoid it in this situation. Avoid the Roth IRA, but don’t forget about it. There are moments when you can renew that wonderful relationship much to the benefit of yourself, your organization, your financial donors, your favorite charities and, yes, even your heirs.
The Penalty is Stiff
The very informative Roth IRA website has this to say about ineligible contributions:
The penalty…is 6% of the ineligible amount…. If you don’t correct the mistake you will have to pay the penalty each year until it is corrected. If you’re not able to take a qualified distribution from your Roth IRA (to correct the mistake) you will pay an additional 10% early withdrawal penalty on earnings (interest).
I’m no math guru, but this seems like a pretty significant penalty. I’ve decided to not invest in a Roth IRA unless I’m sure it is a legal contribution. Better safe than sorry!
Can a Nonprofit Worker Ever Contribute to a Roth IRA?
There are several occasions in which we can and probably should contribute to a Roth IRA. Generally, it comes down to finding those windows of opportunity when you have US earned (not passive like interest but earned) income. Here are a few:
- Not claiming the FEIE: If our tax preparer determines that it is better not to claim the FEIE in a certain tax year, then “poof” we suddenly have earned income. Please inform yourself before opt to stop taking the FEIE. It is my understanding that once stopped, it cannot be reclaimed again in most circumstances for a full five years. Be sure to know your situation.
- Not living abroad: If you return to the US for a long furlough or between terms of service or even because you’ve moved on from expat life abroad, your income starts becoming earned when you land in the US.
- Trips stateside: So, this can be a bit tricky, but if you are in the US for several weeks or months for a conference, a brief furlough or whatever, you very likely will have some US earned income. How much depends on what percentage of your earnings in the calendar year were earned while in the US.
How Much Can We Contribute?
As if you couldn’t tell, I am a bit enthralled with the Roth IRA. It is usually preferable to the Roth 403b, because the fund options are often much better and less expensive in the Roth IRA and the money seems more accessible to me than in the Roth 403b, so on those rare occasions in which I can legally slip some money in there, I want to contribute every penny I can. If I have to, I’ll divert money from my planned 403b contributions, but how do I know how much to contribute.
I think it is an amazing retirement tool for me when I have the chance to use it. So when I take a trip to the US for part of a year, I estimate how much I’m going to earn in the US. Because of the high penalties for being wrong, I always aim low in this calculation. If I think I’ll earn about $5,000 in the USA, then I’ll throw $3,500 into my Roth IRA (or into my wife’s Roth IRA).
The Trick to Get the Amount Exactly Right
Now, if you are using a US tax preparer who is experienced in working with US expats, there is a simple way to know exactly how much you can contribute to your Roth IRAs (without going over!). Because I claim the FEIE and earn well under 6 figures, I can only contribute as much as I earn while physically in the USA. The key then is knowing exactly how much I’ll earn while in the USA. The simplest way to know that exact amount is to wait until the year is over.
Let’s return to our example above. During the tax year (let’s say 2018), we estimated my US earned income would be about $5,000, but I only contributed a safe amount of $3,500 early in 2018 (so it would hopefully grow in value all year long). It’s not bad at all to just stay with the low-estimate of $3,500, but if we want to contribute every dollar possible, then we can simply wait until we are filing our US taxes at least a week or so before the deadline in April of 2019. As our US tax preparers go through their machinations, they will inevitably calculate our US earned income and maximum Roth IRA contributions limit down to the exact dollar amount. They have to do this to make sure that the $3,500 amount fell under the 2018 contribution limit.
The worksheet that the tax preparers use will spit out our official “Roth IRA Contribution Limit” for the past year. Let’s say the number that came out was $4,500. If we would have contributed $5,000 as we’d guessed, the extra $500 would have been an ineligible contribution. That’s bad news, so it’s good we played it safe. However, we kind of wished we’d put $4,500 into our 2018 Roth IRA instead of only $3,500. That’s an extra $1,000 of money plus years and years of growth in CDs, bonds or stocks that will never be taxed in the USA (we’re not talking about foreign taxes here, but if you plan to retire overseas, you’ll have to know your tax treaty!).
As odd as it may seem, you can contribute money before tax day this year and designate it for last year. So even as our tax preparers are submitting our taxes and asking for our fee, we are quickly organizing a fund transfer to put another $1,000 into last year’s Roth IRA. (Most IRA websites will actually tell you to “Check here if this is a current tax year contribution…” or “here if this is for the last tax year.”) We duly inform our US tax preparers of our new contribution and they take a note of it. There is nothing illegal or shady about this. I suspect the IRS created this April deadline precisely because they know it is difficult to know our contribution limit until we prepare your taxes.
While I’ve written this scenario referring to US tax preparers, I think that online tax tools and even hand-written tax forms must certainly also automatically spit out these same figures. I have no experience with those methods.
It’s important to not wait until the last minute and not to take the extension generally given to US citizens abroad because the prior year’s contribution to the Roth IRA must be effectuated before this year’s April filing date.
Friends from Afar
Whenever we’ve got a window of opportunity to contribute money to a Roth IRA as expat humanitarian and missionary workers, I think we should jump on that. If we are long-term residents of a foreign land, claiming the FEIE, those opportunities will be few and far between. The Roth IRA would like to be our best friend. Lot’s of Americans have enjoyed a great relationship with the Roth IRA. However, once again, we see that our expat Vagabond Finances are infinitely more complicated the average American’s finances. For many of us, we and the Roth IRA will have to remain friends from afar.