For many Americans, Social Security income plays an integral role in retirement planning, and while retirement planning is generally straightforward for Americans with income solely from US employment that pays into Social Security, the situation becomes more complex when income from multiple countries is involved. As working in a foreign country may not count towards US Social Security benefits, either reducing benefits or even rendering the worker with insufficient quarters of coverage to be eligible for Social Security benefits at all. In addition, receiving non-US pension or foreign Social Security benefits can impact US benefits, and there is the potential for double-taxation of benefits when more than one country seeks to tax the same individual (the foreign country because the US citizen lives there, and the US because it taxes all citizens on all of their income worldwide!).
In this guest post, Jonathan Lachowitz – Founder of White Lighthouse Investment Management, which specializes in cross-border retirement planning – explores some of the cross-border planning issues that financial advisors and their clients face in the context of Social Security when there is residency or past work experience outside of the United States. For these clients, the main factors that will affect their Social Security benefit are how long they contribute to the US Social Security system, whether they are entitled to a foreign Social Security pension, and the presence of a tax treaty and/or a Totalization Agreement with the country in which the overseas work has been (or is being) done.
Totalization Agreements are currently in place with 30 countries and serve not only to eliminate double taxation (i.e., taxes paid by employers and employees in both the US and the foreign country) of the same income being taxed for Social Security programs by more than one country but also to coordinate the accrual of worker’s benefits when they have been employed in multiple countries. These agreements also typically include a “detached worker” provision that exempts an employee from their local (temporarily-foreign-country) Social Security taxes for up to five years while continuing to pay into their own national Social Security program.
The Windfall Elimination Provision (WEP) is another consideration to take into account when planning for an individual’s Social Security benefit when they have years of service abroad. As while the WEP was initially established to more fairly adjust Social Security benefits for workers who earned income eligible for Social Security benefits alongside other income from US state and local government jobs that were not covered by Social Security, it also applies to individuals who receive both US Social Security benefits and a foreign pension benefit that does not pay into the US Social Security system. The WEP prevents workers who receive benefits from a non-covered plan (that did not pay into Social Security, and thus would not be factored into the employee’s income history used to calculate their US Social Security benefit) from receiving more US Social Security benefits as though they were long-time lower-wage earners.
Fortunately, Congress has provided for a Foreign Tax Credit, which prevents a US taxpayer from having to pay tax on eligible foreign income taxed by both the foreign country and the US, and the Foreign Earned Income Exclusion, which allows a US taxpayer who meets either a bona fide residence test or a physical presence test to exclude up to $107,6000 in foreign income from US income taxation. However, only the Foreign Tax Credit or the Foreign Earned Income Exclusion – not both – can be used by an eligible worker. And in practice, the FEIE generally will not apply to Social Security and other retirement benefits, as it’s not considered earned income at the point of receiving payments or taking retirement account withdrawals.
Ultimately, cross-border retirement planning can be a complex yet rewarding area that financial advisors can address with clients who have earned income from more than one country. By understanding the role of international tax treaties, Totalization Agreements, and the social security benefit systems offered by other countries, financial advisors can help their cross-border clients optimize their retirement income and Social Security benefits.