Expats, Pensions & Taxes – Oh My!

Recently, I received a message from a client in Mexico. After years of suffering the indignities that US citizens living abroad experience, courtesy of Congress and the IRS, he’s now considering expatriation – giving up his US citizenship and passport.

My client, whom I’ll call “Mike,” asked me about our clients’ experience receiving Social Security payments after expatriation. When I explained that there’s no obligation to be a US citizen to receive Social Security payments in some countries, he was surprised.

“My understanding is that non-US citizens must visit the US at least once monthly in order to receive Social Security,” Mike wrote. “But there’s no way to go back if you don’t have a visitor’s visa or can’t get one.”

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When I told Mike that this wasn’t true and that residents of almost every country can receive Social Security benefits regardless of their citizenship, he responded:

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“This is huge. Many people where I live in Mexico are afraid of expatriating because they believe they will lose their Social Security.”

Expatriation is an admittedly radical step. But it’s the only way that a US citizen or Green Card holder can permanently disconnect from future tax obligations. And increasingly, it’s the only way that a (former) American can “exist” outside the US, since US citizens living abroad are now routinely denied banking services, mortgages, insurance, and employment.

The good news, though, is that with a couple of exceptions, an expatriate can receive Social Security payments, income from pensions, and other US source income without needing to ever return to the US.

Social Security payments. No restrictions exist on Social Security payments sent abroad unless you live in a country upon which the US government has imposed trade or financial restrictions – e.g., North Korea or Iran. In addition, if you live in Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova,
Tajikistan, Turkmenistan, Ukraine, Uzbekistan or Vietnam, then the belief Mike had is partially correct. You must make a monthly visit either to the US or to a US embassy to pick up your payment.

One country where Social Security recipients really get screwed is New Zealand. A New Zealand citizen living in New Zealand who isn’t also a US citizen must visit the US at least once every six months in order to receive Social Security payments. The visit must last at least a full calendar month. In other words, if you’re in this situation, you would need to spend at least two calendar months in the US annually to maintain your Social Security benefits. (If you’re interested in learning why this policy exists, read this post.)

Here is a tool you can use to determine your eligibility for Social Security payments if you live outside the US.

If you’re not a US citizen, a withholding tax of 25.5% applies to your monthly payment. This tax may be reduced or eliminated if there’s a tax treaty between the US and your residence country. Whether or not you are a former US citizen has no effect on your eligibility for payment of this tax.

Other pension payments from US sources. Most such payments are distributions from a “qualified” retirement plan. The term “qualified” refers to the Employment Retirement Income Security Act of 1974 (ERISA). ERISA-qualified plans include 401(k) plans and most state and federal pension plans.

The general rule for pension payments to non-US citizens living outside the US is that they’re subject to a 30% withholding tax. With one exception, if you live in a country with a tax treaty with the US, that withholding tax may be reduced or eliminated.

And that exception? If you’re wealthy enough to be a “covered expatriate,” (click here, then scroll down, for the definition), you still pay the 30% withholding tax. But you can’t use a tax treaty to reduce this withholding tax. If the country you live in taxes pension income, your total tax burden on these payments could easily exceed 50%.

Military pensions have a special status. If you receive a military pension, you’ll generally lose it completely if you expatriate. Forewarned is forearmed.

Individual Retirement Accounts. An IRA is not considered an ERISA-qualified plan, but if you’re not a US citizen, it’s generally taxed the same way. You pay a 30% withholding tax on the taxable portion of the IRA, less if you live in a country with a tax treaty that reduces such withholding.

But once again, there’s an exception if you’re a covered expatriate. In that event, your IRA terminates when you expatriate and you must pay tax on the entire untaxed portion of the plan. A small consolation: If you’re under 59½, the early distribution penalty doesn’t apply.

In summary, you generally do NOT forfeit Social Security or pension benefit if you expatriate. The payments are taxed differently, but with minor exceptions, there are no restrictions on such benefit payments.

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