The benefits of a Roth IRA are widely discussed. The Roth IRA is a personal retirement vehicle by which one pays taxes on one’s income upfront, rather than after withdrawal from a taxable investment. Essentially, the accrual is tax-free.
The Roth IRA is designed for US Nationals and Permanent Residents who are not high-income earners. It is for persons with a Modified Adjusted Gross Income less than $137,000. Here are the limits for 2019:
Many US Nationals, however, believe they may be ineligible to contribute to a Roth IRA. The IRS does not require that US Nationals be present in the country to contribute to a Roth, however, there are a few nuances to be aware of.
First, one’s adjusted income must fall within the limits noted above. Most US Nationals working abroad are keenly aware that their income earned outside the country is subject to the Foreign Earned Income Exclusion. This is a generous reduction (set at $105,900 in 2019), and one should take it. One must then consider the remaining income, not sheltered by the Foreign Earned Income Exclusion (or "FEIE"), to determine if they may be eligible to contribute to a Roth IRA.
It should be noted that the income window for Roth contributions is limited, as MAGI for Roth purposes includes amounts that are excluded from taxable income. It requires one to add back in amounts deducted under the FEIE and Foreign Housing Act exclusions. The window for being able to contribute to Roth in 2019 is thus foreign income amounts greater than the FEIE ($105,900), but less than $137,000 (if one is single).
Income Too Low
Often, US Nationals realize that if they accept the FEIE, they will have no income remaining to report. If one’s taxable income, after the FEIE, is $0, one cannot contribute to a Roth IRA, and can be penalized for attempting to do so. Furthermore, if one’s remaining taxable income, after the FEIE, is less than $6,000 (or the amount of permissible Roth contribution for that particular year), the maximum amount one can contribute to their Roth is the remaining taxable amount (so if one’s remaining taxable amount, after exclusion, is $4,000, one can only contribute $4,000 to their Roth IRA).
A person whose remaining taxable income is too low to contribute, or contribute a full $6,000 (or the amount of permissible Roth contribution for that particular year), should consider developing a separate income source, preferably one which is not subject to the FEIE. To do this, one should consider procuring an active income source from inside the United States, which one can do remotely or when visiting the country. The potential benefits of developing additional contract work, from which one can contribute to a Roth IRA, are significant. Consider the following hypothetical.
Abu Dhabi Anna works in Abu Dhabi from 2010 – 2019 for a local hospital. She earns between $90,000 - $100,000 annually, and never earns beyond the FEIE limits. During this time, however, she also works remotely, performing remote web design for medical technology companies in the United States. She earns $6,000 annually in her private contracting work. She does not have to pay income tax on this amount, and she pays FICA tax at 15.3% ($918), which is a particular benefit as this helps her accrue Social Security and Medicare credits, which she would not otherwise accrue while abroad. Anna invests the remainder ($5,082) in a Roth IRA ($5,000 for 2010-2012, when the Roth IRA contribution limit was $5,000).
If Anna invests these amounts in a Roth IRA, which is itself a vehicle for a diversified index fund, from 2010 - 2019 (10 years), does not contribute further, and seeks to begin withdrawing when she is 67, she will have accumulated $788,113, on which she will not have to pay taxes. If she contributed the same initial amount of her earnings, after FICA reductions, directly into a taxable investment, she would accrue the same amount, however, she would be subject to up to a 20% capital gains tax upon withdrawal, leaving her with only $630,490.
The wisdom inherent in contributing to a Roth IRA is thus not affected by one’s status abroad. Instead, the procedure for contributing may require greater diligence and creativity. To read more about how to develop a remote side hustle, which offers the benefits of allowing one to accrue Social Security and Medicare credits, as well as increasing one’s taxable income for Roth purposes, see my article on how to improve your Social Security entitlement while abroad.