If you decide to join the almost 800,000 Americans who have retired abroad and moved to spend your golden years in an overseas retirement haven, there will be some tax consequences you need to take into account -- and not all are favorable.
Here they are:
Only by giving up your U.S. citizenship can you completely avoid U.S. income taxes ... no matter where you live. However, you will - at least in some cases get tax credits for income taxes you pay to the government where you live. The wrinkle here is that you'll get no refund if the tax rate in your new country of residence is higher than that in the United States ... and in most instances it is.
It's not all that easy, in any case, to renounce your citizenship since the IRS can still tax your U.S. income (dividends and interest) if it can prove -- up to 10 years after you give up your status as a citizen - you renounced your citizenship simply to avoid taxation.
As an expatriate (foreign resident), you won't, however have to pay state and local taxes in the United States.
For IRS purposes, you become a foreign resident when you live abroad for a full calendar year or have a physical presence outside the United States for 12 of any 13 consecutive months.
While the IRS will not consider your home in the United States a "principal place of residence" if it is not used as a permanent abode for at least 183 days a year, many retirees prefer not to sell their stateside homes, keeping them, instead, to generate rental income and some tax breaks or just to have a place to visit.
The IRS will apply your once in a lifetime tax-free capital gain of $125,000 on the sale of a principal residence to your foreign home provided you've used it as a principal residence for three of the last five years.( make plan here)
If you move to live abroad, you have four years, not two as in the United States, to buy a home of equivalent value following the sale of your principal residence if you want to qualify for the one-time capital gains deferral.
If you're able to establish a so called "personal company" which pays you for work you do while living abroad (see your tax man) , you may be able to get a tax exemption on the first $70, 000 of earned income annually, along with a living allowance exclusion, provided you meet certain criteria.
While the profitable sale of a large home may make economic sense in that it can provide a newly retired couple with a nice nest egg, and because you can make that $125,000 profit without having to pay any tax, there's a good reason to look very carefully at such a plan: If you or your spouse ever needs to qualify for Medicaid, funds are very likely to disqualify you. Home ownership does not. Plan ahead.
An increasing number of retirees are using this novel plan to raise cash needed for comfortable retirement living while continuing to live in their homes.
Here's how it works
A reverse mortgage lets you sell your home to a broker who then allows you to continue living there while paying you a fixed amount each month. When you die, the broker settles with your estate for the remaining equity value of your home. Very popular plan
A cautionary note: Talk to your banker to learn exactly how this kind of deal could benefit you and your heirs and then check any prospective deal very carefully with an attorney you trust.
In order to know in advance what your retirement is going to be like, you need to know exactly where you're headed financially. The earlier you start mapping your route, the better chance you have of tailoring your investments, your budgeting and your tax strategies to make sure you arrive at your destination safely. (with peace in mine)
Some thoughts to keep in mind
The first thing you need to do is take a pen and some paper and figure exactly how your expenses will change. You won't, for example, be spending money commuting to work, and in all likelihood, your clothing costs will drop dramatically.
Next, you must determine exactly what retirement income you can expect. This includes income from all sources: Social Security, any employer-provided pension plan, an IRA or Keogh plan, plus the investment income from your savings, stocks, bonds, etc.
Then, taking tax consequences into account, you'll have a firm idea how much money you'll have left to cover expenses. And that's what is important. The good old bottom line.
If you have an IRA
While the biggest tax benefit that accrued to Individual Retirement Accounts was written out of the law in 1986, many individuals have continued contributing to such accounts simply because they offer tax deferred income. How, though, will such an account impact the life of the retiree?
You have a choice when the time comes for you to withdraw IRA money: You can either take a lump sum and pay taxes immediately on the entire amount then reinvest that money, paying taxes on the income it earns; or you can take a gradual pay-out.
If you decide to take a gradual pay-out, you should know how long your money will last.
How long your IRA money will last:
Annual withdrawal
Annual rate of return
9%
10%
11%
12%
9%
forever
forever
forever
forever
10%
26 yrs.
26 yrs.
26 yrs.
26 yrs.
11%
19 yrs.
25 yrs.
25 yrs.
25 yrs.
12%
15 yrs.
18 yrs.
23 yrs.
23 yrs.
13%
13 yrs.
15 yrs.
17 yrs.
21 yrs.
14%
11 yrs.
13 yrs.
14 yrs.
17 yrs.
15%
10 yrs.
11 yrs.
12 yrs.
14 yrs.
Safe ways to use your home to generate retirement income
Here are some ideas that could net you a substantial increase in your income and at the same time help you live an easier, less expensive and freer life. Put your home to work for you in your retirement. Let it return to you some of the love, attention and money you've lavished on it over the years. Your house is a substantial asset that can help make your so called golden years truly golden.
Here's how
Trading down. While we've already said this is an option that's not wise for everybody, it does fit some retirees. This tactical move trades "too much house" with all its cost and maintenance burdens for a more modest home and a large block of money, the prudent investment of which can provide you with income to cover living costs and even a few luxuries.
Obviously, you have to figure carefully the difference between the amount you realize from the sale of your current home and the price of an adequate replacement. (Don't forget, the lower maintenance costs and taxes you'll be paying with a smaller residence) Also remember that after age 55, you may exclude up to $125,000 in capital gains if the house you're selling has been your principal residence for three of the preceding five years and if you've never taken this exemption before.
N.B. For "trading down" to be effective, you need to generate enough cash to pay for your new home and sufficient investment income to improve your lifestyle.
Selling and renting. You need not buy a new home. On the plus side, if your plan is to rent, you can sell your home at any time, thus taking advantage of strength in the real estate market; at the same time, since you won't be spending a big chunk of money on a new home, you'll have more money to invest to increase your income.
On the negative side, though, you will be leaving yourself open to the vagaries of the rental market, including rent hikes.
Most people, unfortunately, don't know if they're ready for retirement until they actually retire.
According to the experts, there are three steps you must take in order to be ready to fully enjoy your retirement.
Here they are;
Set your goals.
Determine exactly how you want to live ... on a South Sea Island eating fish or in a golf course condominium, for example. Know how much money you need to save NOW to reach your goals.
Find the best possible retirement investments.
Stay away from highly speculative investments (unless you have discretionary money you can afford to lose). Concentrate on investments that give sufficient yields to let your nest egg grow - such investments as single premium life insurance, mutual funds that have performed well historically, utility stocks with dividends reinvestment programs, etc.
Protect yourself against disaster, con artists, etc.
Get good advice and follow it; make sure you have adequate insurance and a solid investment base that's as risk-free as possible.
According to the experts, some retirement rules that are almost axiomatic
When you retire, you'll need between 70 and 80 percent of your preretirement income to live comfortable
Social Security and pensions together should account for no more than half your retirement income.
You should have 10 percent of your investments in bonds for every 10 years of your life. For example, a 60 year old should have 60 percent of his total investment portfolio (excluding home equity) in bonds.
Don't forget the impact of inflation. During the last two decades, prices have risen at about 6 percent annually - nearly doubling every 12 years.
Save just as much as you can without crimping your life style. Whatever age you are, you need to invest in an Individual Retirement Account, a Keogh plan or something similar. Allow your money to grow tax-free. (You're then taxed, at a substantially lower rate, upon withdrawal after you retire.)
While virtually every investment expert in the land agrees that IRAs are good news for virtually every taxpayer, there are some things to watch out for when setting up your account.
Read the fine print in any
IRA agreement (just as you should any investment). Some instructions charge setup fees, management fees, etc., as well as penalties. All these charges and penalties can cost you a bundle.
Don't put your IRA investment in a vehicle that's already tax-free or tax-advantaged. It makes no sense, for example, to put IRA money into tax-free municipals, giving up the higher yields of taxable instruments, since your IRA grows without tax penalties.
Avoid the government's so-called Individual Retirement Bonds. These bonds must be redeemed whether you need all the money at once or not. Other IRA investments can be redeemed as needed, in a tax-advantage manner provided you start the redemption process at age 59 1/2.
Consider this: Even though your benefits are reduced if you retire at age 62 rather than at age 65, it may be in your best interests. If full benefits, for example, are $750 per month at age 65 and you can get $600 monthly by retiring at age 62, you would have to collect full benefits for a dozen years to make up the $21,600 you'll get during your three years of early payments.
So called deferred annuities, part insurance and part investment, are an attractive alternative - for some investors - to traditional IRAs which lost some of their allure following tax reform.
Here's why
As with an IRA, deferred annuity contributions are tax deductible and earnings accumulate tax deferred. With a deferred annuity, however, there's no limit to the amount of money you can invest annually.
Long-term gains from stocks (now taxed as ordinary income) can be sheltered in a deferred annuity with income not taxed until withdrawal.
A deferred annuity is purchased, with a lump-sum payment, from an insurer who guarantees growth at a tax free rate. On a specified date, you begin receiving monthly payments which then last for the rest of your life.
Options allow you to have payments continue to your spouse or other heirs. Should you die before you start receiving payments, your spouse or heirs are guaranteed payment of your entire principal amount.
In these days when jargon and acronyms seem to reign supreme, what with IRAs, Strips, Cats and LBOs, it helps to know what's what. So, what is a 401 (k) and, how does one work?
As simply stated as possible, a 401 (k) is a cash or deferred profit sharing plan that lets a salaried employee significantly reduce his or her tax liability while building a retirement nest egg. These plans also allow employers to find some tax savings.
How they work
A company sets up a qualified profit-sharing program or changes its current program to conform to the tax lawa's 401 (k) requirements.
This plan then allows an employee to defer (put off until later) a portion of his salery - say 5 percent. This 5 percent is then contributed directly into the plan by the company. The employee pays no tax on the contribution, and income earned acculates tax-free.
An employee is allowed to contribute up to $7,000 annually.
Distributions from such a plan may qualify for five-year forward income tax averaging, allowing the contributor to take a large distribution in one year, followed by four years of small distributions, with little or no tax disadvantage.
