Hidden Tax Traps: What Those with U.S. Ties Need to Know Before Moving Abroad

If you’ve lived and worked in the U.S., you will most likely have been automatically enrolled into a 401(k) plan by your employer. 

To many people, 401(k)s are like a mythical creature: You’ve no idea what’s going on with it. But if you move abroad, it pays to know. 

There are different types of 401(k), including ‘traditional’, ‘safe harbor’ and ‘SIMPLE’, but no matter what type you have, the general guidance would be to transfer it into an IRA to give you more freedom and flexibility when moving abroad. 

This is a common path for U.S. citizens to take whether or not they move abroad, especially as they begin to accumulate several 401(k) plans and want to consolidate their assets into one account. 

It is important to remember that this method will not be suitable for everyone. If you’re a U.S.-connected individual looking to move or having moved abroad, it is vital that you seek advice from an experienced financial adviser – preferably one with knowledge of both jurisdictions. 

Similar to 401(k)s, IRAs cannot be moved into a foreign retirement account. However, they give you greater flexibility in choosing investment providers and assets. You can, therefore, find a provider which is “foreign friendly”. 

But beware, because if you fail to plan properly, there is a risk you could be double taxed – by both the Internal Revenue Service (IRS) in the U.S., and by your local tax enforcement agency. 

The U.S. has tax treaties with a number of other countries. Under these treaties, people living in other countries (even if they aren’t citizens there) can pay lower taxes or sometimes no U.S. taxes at all on certain types of income they earn from the U.S. 

The exact tax breaks and rates depend on the country and the kind of income involved. 

And there is no guarantee that you won’t be double-taxed if you fail to plan properly. 

Withdrawals from both 401(k)s and IRAs are taxable in the U.S. as ordinary income, just as if you were still living there. 

But other countries will often treat IRA distributions as taxable pension income under their domestic laws and tax your withdrawals as well. 

Many people aren’t aware of the tax implications of accessing pre-tax money, which vary depending on your jurisdiction. 

Some countries are even more aggressive with taxation than the U.S., and it can come as a shock to discover you owe local tax even though the asset is held in the U.S. 

There are also ‘Roth’ versions of both types of retirement account. In the U.S., this means you make contributions with after-tax dollars – in other words, you’re putting in money that has already been taxed. The funds then grow tax-free, and when you withdraw them, you don’t pay tax again. 

However, if you move out of the U.S., most other countries don’t recognise Roth 401(k)s or Roth IRAs as tax-free. They treat them simply as pensions, and pensions are taxable. 

As a result, people who have saved into a non-taxable U.S. account with post-tax dollars may find they’re taxed again when withdrawing abroad. 

Again, this depends on the tax treaty in place with the country you’ve moved to. 

Once you retire and want to start drawing down your funds, you’re faced with another issue: Where will the money be paid? 

If you’ve closed your U.S. account after moving abroad, this becomes a problem because, for most people, it isn’t easy to withdraw directly into a local account. 

And if you’re spending in another currency, you could face foreign exchange (FX) fees when converting dollars, losing additional percentage points in the process. 

You are not allowed to access, for example, a UK pension early. 

With a U.S. pension, although you shouldn’t access it early because of the 10% tax penalty plus income tax, you can if you really need to – and you never know when that situation might come up. 

People might need to access their accounts before age 59½, and anyone who does knows about the 10% penalty. 

However, if the structure isn’t set up properly, with withholding tax, income tax, currency risk, and that additional 10% penalty, your account could diminish very quickly and might not last through your retirement. 

When you start withdrawing, another big problem you will face is withholding tax. 

As soon as you register with many custodians as living abroad, they apply a 30% withholding tax no matter what your tax rate is locally. You then need to claim it back. 

That’s a massive minefield, especially if you’ve inherited an account and never spent time in the U.S., so you don’t know anything about U.S. tax. Then suddenly you find you need to reclaim withholding tax on funds you’ve accessed. 

Depending on your jurisdiction, there may be tax treaties to avoid double taxation. But often institutions ignore that and apply a flat 10–30%. 

Then you receive the funds, pay tax locally, and have to balance it all out through foreign tax credits or reclaiming from the US. 

Even financial advisers find it challenging to navigate, despite their knowledge and training. Trying to manage it on your own is nearly impossible. 

Moving abroad should be an exciting experience. But if you don’t think carefully about where your retirement savings are held – and where they should be – you could end up losing thousands. 

In such a complex tax landscape, what works for one person won’t necessarily work for another, as it all depends on your location and personal circumstances. 

That’s why getting professional advice is so important. Hoxton’s trusted advisers can help you navigate this landscape and make the most of your move abroad.