Non-resident alien retirement taxation

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Eneus
Posts: 3
Joined: Fri Apr 14, 2017 8:21 pm

Non-resident alien retirement taxation

Postby Eneus » Wed Apr 19, 2017 12:43 pm

Dear Bogleheads,
First of all, I kindly thank you for all the knowledge and wisdom that I learn from this website each time I visit. To me this forum is a treasure of experience.
About myself
Emergency funds: 6 months of expenses
Debt: None.
Tax Filing Status: Single
Tax Rate: 15% Federal, 3.75% State
State of Residence: IL
Age: 25
Desired Asset allocation: 100% stocks, a topic for a separate thread.
Desired International allocation: 0-10%
Citizenship: Ukraine
Current assets
Cash in a savings account: 92% - $23k (not counting emergency fund)
403b at Vanguard
8% - $1900 (just opened) Target retirement 2055 (0.16%)
No match.
Contributions
I intend to invest for retirement 18k this year and 10k next year.
Available funds in 403b:
Over 70 Vanguard funds. I’m interested in tracking S&P500 or total US stock market. Examples of funds in my plan
Vanguard Prime Money Market Fund Admiral Shares (VMRXX) 0.10%
Vanguard Long-Term Bond Index Fund (VBLTX) 0.16%
Vanguard Total Bond Market Index Fund Institutional Shares (VBTIX) 0.05%
Vanguard Wellesley Income Fund Admiral Shares (VWIAX) 0.15%
Vanguard Growth Index Fund Admiral Shares (VIGAX) 0.08%
Vanguard Institutional Index Fund Institutional Shares (VINIX) 0.04%
Vanguard Total Stock Market Index Fund Institutional Shares (VITSX) 0.04%
Vanguard Total International Stock Index Fund Institutional Shares (VTSNX) 0.09%
Vanguard REIT Index Fund Investor Shares (VGSIX) 0.26%
Tax situation:
I am not sure whether US-Ukraine tax treaty https://www.irs.gov/pub/irs-trty/ukrain.pdf affects 403b accounts and retirement plans in general. Article 10 limits dividend taxes at 15%,
“3. The term "dividends" as used in this Article means income from shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident. The term "dividends" also includes income from arrangements, including debt obligations, carrying the right to participate in profits, to the extent so characterized under the law of the Contracting State in which the income arises.”
IRS publication 519 https://www.irs.gov/pub/irs-pdf/p519.pdf says that non-resident aliens are subject to flat 30% withholding tax for their Fixed, Determinable, Annual, Periodical (FDAP) Income. And this 30% tax is not refundable, correct? (I must confess, I opened 403b before realizing this)
I plan to invest in a mutual fund, invested in stocks, inside a 403b account. Would tax treaty affect IRS judgment on this? Does my employer’s plan move my retirement income into “Effectively Connected Income” category? Or is it FDAP? Or the tax treaty applies?
I have read that NRA’s without tax treaties should invest in Irish-domiciled ETF’s. In that case I would have to invest after-tax money (15%) with international broker outside of US, and then withholding would be 15%. 15%+15%=30%, and I am no better than with 30% retirement withholding tax (0% pretax403b + 30%). Do I understand this correctly? With Irish-domiciled ETF’s I would just complicate international taxation issues and make investment more expensive through brokers due to commissions, bid-ask spreads, etc. 30% is acceptable for me, I can plan accordingly.
I value an opportunity to invest in USD in a stable country with Vanguard; being a shareholder and not a client helps me sleep.
Also I don’t know in which country I’ll be advancing my career in 5 years from now, yet alone where I will retire. I have read about 40% US estate tax in case I die, and I consider it tolerable; potentially, I’ll invest in other countries too, or at some point my citizenship situation might change to make this less of an issue.
Questions:
1. Is 403b the best option for me at this time?
2. Is 403b considered FDAP income?
3. What will be my tax rate in retirement? If 30%, then 30% withholding tax is not refundable and can’t be reduced in any way, correct?
4. Would Roth IRA potentially open me for 15% now + 30% in retirement = 45% tax? (I am concerned how legislature can affect this during the next 40 years. On a side note, Vanguard doesn’t open “retail” accounts for NRA’s, I have called the customer service).
5. Please, correct me if my understanding of anything above is wrong or incomplete.

Thank you in advance for your replies,
Eneus

TedSwippet
Posts: 1198
Joined: Mon Jun 04, 2007 4:19 pm

Re: Non-resident alien retirement taxation

Postby TedSwippet » Wed Apr 19, 2017 1:14 pm

Welcome to the forum.

Retirement saving for international workers is invariably horribly complex where one end of the international travel is the US. I'll try to cover a few of the questions you posed, though.

Firstly, under the US/Ukraine tax treaty the US tax rate on pensions and annuities is 0% under Article 19(2), with pensions taxable only to the state of residence (in this case, Ukraine). This overrides the 30% standard US tax rate for NRAs. With that in mind, then, saving in a 403b, 401k, tIRA and similar isn't necessarily a bad idea. What you do have to watch out for is that Ukraine does not tax these plans until you withdraw from them. The treaty looks a bit quiet on that to me, but you can research this, both via treaty and Ukrainian domestic tax laws.

With the 30% tax taken care of, your next worry is the US estate tax, and here the news does not appear so great. Ukraine has no estate tax treaty with the US, and your 403b, 401k and so on could therefore be 'in scope' for US estate taxes if you cannot withdraw down to under $60k in time. One potential workround might be life insurance to cover, but that may not be cheap or convenient.

Regarding Irish domiciled ETFs, while you are US resident 'for tax purposes' you should avoid these (in unsheltered accounts) like the plague. Conversely, if/when you move to another country you may then have to consider avoiding US domiciled ETFs like the plague instead. The controlling factor is the status of treaties between your country of residence and the US. Note especially that estate tax treaties are usually governed by your own domicile rather than your residence. Domicile includes residence as one factor, but is broader (and somewhat subjective).

Finally, as far a future law changes are concerned... nobody knows. Over the couple of decades I've been observing it, US tax law for NRAs has done nothing but deteriorate. So one thing to expect might be that it will worsen, because that's the permanent trajectory. How, where, and when it will deteriorate, though, is pretty much impossible to predict. All you can do is try to stay as flexible as possible and keep a very close watch for anything that will blow your plans completely out of the water.

Eneus
Posts: 3
Joined: Fri Apr 14, 2017 8:21 pm

Re: Non-resident alien retirement taxation

Postby Eneus » Wed Apr 19, 2017 3:12 pm

Dear TedSwippet,
Thank you very much for your response. When I was reading the tax treaty, I wasn't sure if 403b would be classified as pension/annuity. Thanks for the clarification. To the best of my knowledge Ukrainian taxes are progressive in the range 15-20%, so that's much better than flat 30%. I'll read more regarding tax-deferred status.
To avoid estate tax, I was considering to withdraw all of the money at age 60 and then reinvest in the country of residence.

TedSwippet
Posts: 1198
Joined: Mon Jun 04, 2007 4:19 pm

Re: Non-resident alien retirement taxation

Postby TedSwippet » Thu Apr 20, 2017 5:15 am

Your 403b plan should count as a pension or annuity for tax treaty purposes. One possible complication with a 403b is that it might be some form of 'government' pension -- paid from "public funds" or similar -- in which treaty Article 18 applies instead. Here the payments are taxable to the US, but normal graduated US rates should apply, so again nowhere near as bad as the non-treaty 30% flat rate. Perhaps also taxable to Ukraine, but credit should be available for an US tax paid so no double-tax.

I don't know anything about such pension plans and treaties, though, so beware that I'm on uncertain ground here. My position is a 401k holder and NRA, and a 401k is definitely not a government pension.

If you were to withdraw everything at age 60 and reinvest, you might face a much higher tax bill than if you withdraw gradually, since the bulk could fall into high tax brackets. While some exceptions exist, as a general rule this probably isn't something to consider as a 'normal' strategy.

Finally, one other thought on something you mentioned in your original post. While Vanguard won't open new accounts for NRAs it is, at least so far and in my experience, okay with you keeping them open if you start out as a 'US person' and later become an NRA.

Depending on the country you move to you might find yourself restricted in some of the things you can do in the account. Canadians, for example, report being unable to do anything except sell holdings, no new investments or even rebalancing allowed. I haven't encountered this in the UK, though. The one Vanguard restriction I have encountered so far is inability to add a brokerage option to my existing 401k and IRA; not really a major issue.

Eneus
Posts: 3
Joined: Fri Apr 14, 2017 8:21 pm

Re: Non-resident alien retirement taxation

Postby Eneus » Thu Apr 20, 2017 12:59 pm

TedSwippet wrote:Your 403b plan should count as a pension or annuity for tax treaty purposes. One possible complication with a 403b is that it might be some form of 'government' pension -- paid from "public funds" or similar -- in which treaty Article 18 applies instead. Here the payments are taxable to the US, but normal graduated US rates should apply, so again nowhere near as bad as the non-treaty 30% flat rate. Perhaps also taxable to Ukraine, but credit should be available for an US tax paid so no double-tax.

I don't know anything about such pension plans and treaties, though, so beware that I'm on uncertain ground here. My position is a 401k holder and NRA, and a 401k is definitely not a government pension.

I work for a private university, so, I think, Article 18 should not apply. And I know for sure, that there is a credit for foreign payed taxes in Ukraine.

TedSwippet wrote:If you were to withdraw everything at age 60 and reinvest, you might face a much higher tax bill than if you withdraw gradually, since the bulk could fall into high tax brackets. While some exceptions exist, as a general rule this probably isn't something to consider as a 'normal' strategy.

I think, I'll need to schedule an appointment with IRS to be on the same page with them about it. Are there limitations on maximum withdrawing pensions/annuities? I have read only about RMD's.

TedSwippet wrote:Finally, one other thought on something you mentioned in your original post. While Vanguard won't open new accounts for NRAs it is, at least so far and in my experience, okay with you keeping them open if you start out as a 'US person' and later become an NRA.

Depending on the country you move to you might find yourself restricted in some of the things you can do in the account. Canadians, for example, report being unable to do anything except sell holdings, no new investments or even rebalancing allowed. I haven't encountered this in the UK, though. The one Vanguard restriction I have encountered so far is inability to add a brokerage option to my existing 401k and IRA; not really a major issue.

I didn't know about the restrictions. Maybe I'll need to stick to retirement funds, so that rebalancing and AA changes would be automatical and inside 1 fund.
Thank you.


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