The recent implosion of the major stock market indices has hit Baby Boomers pondering retirement particularly hard - right in the proverbial nest egg. Many people are opting to remain in the workforce longer given the loss in their retirement portfolios. With this longer work horizon, planning for retirement and the location of retirement is still a goal for many.
However, the more adventurous among us may want to explore the world to find the right place to call home during retirement.
Whether people fall in love with places that they have visited on vacations, or have worked abroad during their career, many Americans each year decide that they want to pack up their nest egg and move to a location that is best suited for this next phase of their life - retirement. But when retiring to a new location, there are many factors to consider beyond the cost of living and how friendly the locals are.
Some of the questions that retirees should be posing to themselves before making this move from a non-tax perspective include:
* Does the lifestyle in the new country match my financial situation? Do I have enough retirement savings to live in the lifestyle to which I am accustomed, or will I have to downgrade those expectations?
* Will my departure to another country trigger a deemed disposition of any property that I own in my home country? Do I need to sell any assets prior to leaving in order to avoid the complexity associated with owning and reporting on properties in multiple countries?
* Medicare only covers treatment in the U.S. Does my supplemental medical insurance cover me in the country I plan to retire in? Do I need a different policy? And if anything should happen to me, is the medical system advanced enough that I will be treated there, or would I prefer to return to the U.S.?
* Will I be able to obtain the proper immigration status in order to retire in my chosen country? Do I want to live there permanently or just for part of the year?
* What are the cost of living and inflationary issues that will affect my standard of living in the retirement location?
* Will I be able to withdraw from my retirement savings and my pension plan while living abroad during my retirement? Are there any foreign exchange rules that I need to be aware of?
* From a tax perspective, individuals must also ask themselves:
* What are the estate tax implications?
* What are the social tax implications?
* What are the income tax implications?
* It is this final series of questions that may be both the most complex, as well as the most important to answer prior to making any decision with regards to retiring abroad.
For the purposes of this article, we have provided a high-level perspective of issues specifically related to income tax. When it comes to estate tax matters, the rules are very complex and vary from country to country. A discussion with a tax professional on the estate tax implications of retiring abroad is recommended before making any decisions.
However, with regards to income tax issues, citizens of the United States and resident aliens of the U.S. are required to file U.S. tax returns, even when residing outside the country. However, you may qualify to exclude from taxable income up to $91,400 (for 2009) of your foreign earnings (earned income, not investment income or Social Security or pension income). This amount is indexed for inflation. In addition, you can exclude or deduct certain foreign housing amounts.
YOU CAN'T LEAVE 'HEART' BEHIND
The Heroes Earnings Assistance and Relief Tax Act of 2008, enacted on June 17, 2008, contained provisions intended to deter high-net-worth U.S. citizens and long-term residents from avoiding the payment of U.S. taxes by imposing an immediate exit tax on both the U.S. and foreign assets of individuals who relinquish their citizenship or who give up their green cards. Those who are subject to the exit tax under these new rules would meet one of the following three tests:
* A net income tax test, whereby for the period of five taxable years ending before the year of expatriation the individual would have an average net annual income tax liability in the U.S. of at least $145,000 (for 2009);
* A net worth test, whereby an individual's net worth at the date of expatriation is at least $2 million; and,
* A certification test, whereby the individual would have failed to satisfy all applicable U.S. tax obligations for the five tax years before the year of expatriation.
The HEART Act imposes income tax on any unrealized net gain in excess of $626,000 (for 2009) from a "deemed sale" of all property held by the individual. The net gain is based on the properties' fair market value on the day before expatriation or residency termination. In addition, certain deferred compensation, tax-deferred accounts and distributions from non-grantor trusts may be taxed under special rules.
Furthermore, U.S. citizens and residents who receive a gift or inheritance from someone who is subject to the expatriation rules of the HEART Act may be subject to a tax upon receipt of the gift or inheritance. All of these factors must be considered prior to making any decisions about relinquishing citizenship or giving up a green card.
How significant could the tax impact be? As an example, let's take a U.S. citizen who relocates to Hong Kong, with an important choice: The retiree can remain a U.S. citizen, or renounce their citizenship. It is important to first understand some basic tax rules in Hong Kong and United States. In our example, the individual has investment income (interest, dividend or capital gain), Social Security and qualified pension distributions.
In general, investment income, Social Security and pension distributions would not be subject to income tax in Hong Kong. In contrast, the U.S. will tax the investment income, as well as Social Security and pension distributions (full or partial taxation based on the type of plan).
Furthermore, the U.S. typically allows for exclusions of foreign earned income and foreign tax credits to reduce the overall tax impact for citizens or permanent residents (green card holders) residing overseas. Pension income and investment income are not eligible for this foreign earned income exclusion, and in the case of Hong Kong there would be no foreign tax to reduce the U.S. tax obligation. Individuals not tied to the U.S. through citizenship or green card status may have a lower tax liability based upon their particular circumstances.
In general, distributions from pension plans and Social Security benefits will be taxed in the U.S., even to a person who gives up U.S. citizenship or permanent residence. An income tax treaty might affect the U.S. taxation of such payments. Depending on the country, the difference in the tax rates could be material.
THEY HAVE TAXES THERE, TOO
Renouncing U.S. citizenship is a serious personal decision, and the statistics show that relatively few people have done this in the past few years. In fact, 2008 saw only 231 individuals renounce citizenship. As tax rules change around the world, it will be interesting to see if this statistic significantly changes in future years.
But there is more to consider than just income tax. In some countries that have very low income tax rates, there may be very high sales or use taxes. There may also be high stamp duties on everything brought into the country (as is the case with the Caribbean Islands). Another issue to consider is exchange rates. Retiring in a country that does not use the U.S. dollar as its currency may put you at a disadvantage.
Additionally, the increased debt in the U.S. may, as many experts suggest, lead to increased taxes - particularly on the wealthy. It is critical for anyone considered "wealthy" to consider this heavily, as the tax implications will undoubtedly result in shrinking nest eggs. Couple this with the portfolio devaluation many experienced as a result of the economic turmoil, and retiring to a tax-friendly country can seem more appealing to continue with one's current lifestyle.
What countries may make sense as possible retirement locations? Generally there is not a "one country fits all people" spot. Family ties drive retirement location decisions for some, while low tax rates compared to a home location may be another factor.
A retirement location decision is a very personal one where taxes play a part. Retirement can be a productive and positive stage in one's life, but the person contemplating retirement in another country should clearly be wary that taxes might pose a significant array of challenges. Consulting a tax professional with global knowledge before putting a foreign move into place is critical to understanding all the tax implications.
Cheryl Spielman is a partner and Serena Hubbell is a senior manager in Ernst & Young
