Foreign Earned Income Exclusion and IRA Contributions

Possibly, but you need to check carefully.

The key issue is whether you have eligible taxable compensation for IRA contribution purposes.

IRS Publication 54 says that, when determining compensation for this purpose, amounts excluded under the foreign earned income exclusion or foreign housing exclusion are not taken into account.

That means an American abroad may earn income overseas but still have limited or no compensation available for IRA contribution purposes if the income is excluded.

For Roth IRAs, there is another layer.

IRS Topic 309 says you can contribute to a Roth IRA if you have taxable compensation and your modified adjusted gross income is within the relevant limits.

A review should usually consider:

• whether foreign earned income is being excluded
• whether the foreign housing exclusion is being used
• whether foreign tax credits are being used instead
• how much taxable compensation remains
• whether self-employment income counts
• whether filing status affects eligibility
• whether modified AGI permits Roth IRA contributions
• whether a traditional IRA contribution is deductible or non-deductible
• whether a spouse has eligible compensation
• whether excess contribution risk exists
• whether a correction is needed
• whether Form 8606 reporting is relevant
• whether Roth conversion planning may be a better route
• whether an employer plan is available
• whether provider restrictions apply because you live abroad

The planning point is simple.

Foreign income and IRA contribution eligibility are not the same thing.

The foreign earned income exclusion can be helpful for US taxpayers abroad.

But it can also create an IRA contribution problem.

The mistake usually happens like this:

1. You live abroad.
2. You earn foreign employment or self-employment income.
3. You claim the foreign earned income exclusion.
4. You assume income earned abroad still supports IRA contributions.
5. You contribute to an IRA or Roth IRA.
6. You later discover that excluded income may not count as compensation for IRA contribution purposes.

That can create an excess contribution problem.

A proper review should look at five areas.

1. Taxable compensation

IRA contributions generally depend on compensation that is includible in gross income.

If all or most foreign earned income is excluded, there may be little or no eligible compensation left.

2. Foreign tax credit versus FEIE

Some Americans abroad compare using the foreign earned income exclusion with using foreign tax credits.

This is not only a tax-return question.

It can affect financial planning because the choice may influence:

• IRA contribution eligibility
• Roth IRA contribution eligibility
• modified AGI
• future Roth conversion planning
• child tax credit planning
• self-employment tax
• overall cash flow
• long-term retirement savings

This should be reviewed with a qualified US tax adviser.

3. Roth IRA income limits

Even if taxable compensation exists, Roth IRA eligibility may still be affected by modified AGI.

A high-earning American abroad may have enough taxable compensation but still be phased out of direct Roth IRA contributions.

4. Spousal IRA planning

A spouse may be able to contribute to an IRA based on the other spouse’s compensation if the couple files jointly and meets the relevant rules.

But this depends on the household’s US tax position, compensation, exclusions, income limits and filing status.

5. Alternatives if IRA contributions are not available

If IRA contributions are not possible or suitable, the plan may need alternatives.

These could include:

• taxable investment accounts
• employer retirement plans
• SEP IRA or Solo 401(k) planning for self-employed clients
• Roth conversions
• foreign pension contributions
• local savings plans
• offshore investment accounts
• cash reserves
• debt reduction
• education funding
• estate planning
• business investment

The right answer is not simply:

Use FEIE.

Or:

Always avoid FEIE so you can contribute to a Roth IRA.

The right answer is:

Coordinate the tax election with the retirement saving strategy.

This page is for general information only and does not constitute personalised financial, tax, legal, pension, retirement, investment, IRA, Roth IRA, foreign earned income exclusion, foreign housing exclusion, foreign tax credit, Form 2555, Form 8606, excess contribution, US tax, local tax or currency advice.

IRA contributions, Roth IRA contributions, taxable compensation, modified adjusted gross income, FEIE, foreign housing exclusion, foreign tax credits, spousal IRA rules, Roth conversions, excess contributions, provider restrictions, local tax, currency and future residence depend on personal circumstances and may change.

US tax advice should be taken from a suitably qualified US tax adviser or CPA. Local tax, legal, pension and retirement planning advice should also be taken where relevant.

Financial planning should be coordinated with tax, legal, pension, investment, retirement and estate planning advice where appropriate.

Do not contribute to, convert, withdraw from, roll over, consolidate or restructure IRA, Roth IRA or US retirement accounts without reviewing tax, investment, provider, beneficiary, local tax, currency and retirement planning implications.

Excess IRA contributions can create tax consequences if not corrected properly.

Investing involves risk. Retirement account, pension and investment values can fall as well as rise, and you may get back less than you invest.

Currency movements can affect the value of US retirement accounts, contributions, withdrawals, transfers, tax liabilities and future spending.