Expatica’s financial expert Russell Hammond considers some of the issues and wider choices affecting expats in planning for their retirement abroad.
Over the last few years, more and more people have come to realise that they must examine their plan for retirement very closely in order to ensure that they are able to retire at a time, and income level, that is in keeping with their objectives. Gone are the days where your employer, or the state, would look after you in your ‘golden’ years.
If we skim through the press, we will find a mass of recent news articles reporting how a significant proportion of the population is coming into retirement to find that they are drastically underinvested and, thus, unable to retire comfortably. They find themselves either needing to keep working (if, indeed, that is possible) or dependent upon family or charity in order to be able to make ends meet.
While it is true that expats will tend to earn more than their local counterparts, the fact that they move from place to place goes against them, as it will often prevent the forming of coherent financial plans, including retirement planning. What it also means is that they build up small bits, in various places, which do not add up to what they would have if they had worked in an equivalent role, in one place, for an equivalent period of time.
So, what do you need to consider for your retirement?
In days gone by, it was the case, for most, that your employer pension scheme would make up the majority of what you would end up living off when you retired. The state provision would come in second place, with your own private provision topping up your retirement nest egg. Fast-forward to the 21st Century and this has, effectively, been turned on its head. Companies can simply no longer afford the once highly generous defined benefit schemes.
Once you have decided you do not wish to be dependent upon the state or companies you worked for to provide for your retirement, what are the options? In simple terms, you can either make use of a ‘state sponsored’ pension/retirement plan or an international private retirement plan. We will examine both below.
A ‘state sponsored’ pension is a pension plan where the local government provides a tax ‘break’ to encourage you to save for your retirement. Just how attractive this break is, and whether such a plan is even available, depends upon where you are in the world. When we invest into these state sponsored retirement plans, we do so from our gross income. Depending on contribution limits, this amount is then deducted from our taxable income. So, in the case of the US, you are able to make use of a 401K. These 401Ks or ‘Individual Retirement Accounts’ plans are subject to IRS limits on how much can be contributed, known as the section 415 limit. In Spain you would make use of a ‘Third Pillar Scheme’ and in the UK you could make use of an ‘SIPP’ (Self Invested Pension Plan).
Now, this tax ‘break’ is not really tax relief, more tax deferral. When you access your money at retirement age, you will pay tax on the income that your pension pot will produce.
The problem for expats is that they may not be able to predict that they will retire in any particular place. Ask a 35-year-old international where he or she is likely to retire in 25 years time and very few would be able to give a concrete answer. Deciding where and when we will retire is very much dependent upon our situation at the time. As there are so many unknown factors that can influence where we will retire, the lack of flexibility within local, domestic, retirement plans can make them seem like an unattractive proposition.
Retirement planning issues for expats
Currently, if you make use of an ‘indigenous’ domestic pension scheme, you may not gain access to the funds or move the money before reaching retirement age. You may see this as a problem when you have only made contributions for a short period of time and, as such, are concerned that the value of the investment will be consumed by ongoing administrative charges and will not be effectively managed when you move. So, you want to take your money back and move it elsewhere? Well, even if you were physically able to, you will usually have to pay back the tax relief that you have been given by the particular government that authorised your plan. What’s more, the tax that you would pay back could be greater than the tax relief you got in the first place and a penalty might also be applied. The whole reason that any particular government has granted you an element of tax relief is because they think you will retire there. If you think about it, it makes sense that individual governments are only going to let you invest into retirement schemes that they sponsor if you do actually end up retiring there. If you leave that country then, quite frankly, you are no longer their problem and will not, thus, drain on their domestic infrastructure.
Solutions for expat pension planning
So we have to ask ourselves, then, what is the solution to the expat retirement need? Having worked as a financial adviser to expats for many years, I have often been asked about a ‘Pan-European’ or even a global retirement plan solution. Is such a solution available? Yes, but it is not about making use of individual state sponsored retirement plans but international or ‘offshore’ private investment plans that exist outside of the standard, domestic, state sponsored solutions.
With offshore retirement plans, you pay into them from your net income; therefore, there is no tax deferral. However, you are not accumulating any future tax liability on the contributions. You are free to have access to your fund at a time of your choosing (not at a predefined retirement age) and you are not committed to buying a life assurance income plan (annuity) when you get to retirement. Offshore retirement plans are geographically portable, so they are unaffected as you move to different places in the world. The plan stays in the same place while you move around, and it grows tax free the whole time, in a tax efficient investment area. The perfect solution to any expatriate’s long-term retirement investment need.
Rule no. 1: get started!
As with any important financial plan, you need to decide with your financial adviser how much it is that you need to save each month in order to reach your target retirement fund. How much you need to save depends on the level of income that you will require in the future. An important factor to always consider is the effect of inflation on future spending power. If you wish to retire on an equivalent income of EUR 30,000 in 30 years time, you will actually need to be generating an income of around EUR 60,000 to be able to maintain the same lifestyle. After making calculations of what you need to save, it may not be financially possible at this time to save at this target level. The important part is getting a plan in place and making a start. You can always increase what you pay in each month, when your salary goes up in the future. Making a start is the golden key to retirement planning.
This type of retirement plan would function in a similar fashion to a locally based one. You contribute into your retirement plan each month. You select whether you wish the fund to grow in EUR, USD, GBP or any other major currency. The money that goes into your plan is then further divided, between different underlying funds. It is these underlying funds that will get your money working for you and building your future retirement nest egg. Sometimes the choice of funds and different investment options is wider when you invest offshore.
We have mentioned, above, that when you make use of an offshore plan, you are not normally accumulating any future tax liability on the contributions that you have made. However, it may also be possible to minimise the future taxation on any gain that you make within your plan. With offshore investing, because the plan will exist in a tax-‘neutral’ investment area, you are able to control when and where you will pay tax on the gain as it is normally dependent upon where you are fiscally resident at the point of cashing in your plan.
To make this easier to understand, let’s take a look at a specific example. Having been working as a contractor in Oil and Gas for many years, you have been paying into an offshore retirement plan for 23 years. You are now working in the Netherlands and have five years left to run on the plan. Over the last 23 years you have been resident in various areas of the world, including the UAE, UK and US. Soon you will be returning to the UK, and it is within the UK that you will start needing the money that has accumulated in your retirement fund. You have EUR 1.5 million in your retirement plan and are, obviously, keen to minimise the tax that you will pay on your investment. Because you are about to move to an area of the world (UK) where a capital gains tax is applied, it may make sense to encash your plan a little early while residing in the Netherlands, where a capital gains tax is not applied. Such a decision to cash in your plan is made on a case-by-case basis; however, it is just to highlight that the tax you pay is normally based on where you reside not where the plan resides. There is no tax taken at source. You decide where and when you pay tax.
In summary, offshore retirement plans offer a great solution to the transient expatriate who, just like his local counterpart, wishes to invest and make financial plans for his or her future. The inconvenience and disruption of needing to re-establish a new retirement plan every time you ‘country hop’ is negated by this geographically portable solution.
Russell Hammond is one of Expatica's financial expert and an investment specialist and senior financial adviser advising clients worldwide.