US Roth IRA (Account Options)

Number 2 in the series on account options – full list is at Account Options.

Synopsis

As long as you’re eligible and you have a Roth IRA established before moving to the UK, this is a great option with tax benefits in both countries and no tax-related limits on what you can invest in.

Priority

Filling your annual Roth IRA allowance should come right after maxing out the employer match in your UK employer pension – or maybe after maxing out the employer pension as a whole, kind of a tossup there, depending on the options and fees in the pension.

There’s an argument for considering a Traditional IRA instead of a Roth, but it hinges on the question of whether Traditional IRA contributions are UK tax deductible, which isn’t entirely clear. More on that in the Traditional IRA article to come.

Eligibility

You must have earned income to contribute to a Roth IRA. Not gifts, not interest, not capital gains, not unemployment, not welfare, not stimulus payments – earned income. But the good news is that foreign earned income is completely fine, as long as you haven’t excluded it using the Foreign Earned Income Exclusion (FEIE). For most Americans in the UK, the Foreign Tax Credit (FTC) is more beneficial anyway – I’ll post more on that in the future.

There are income limits as well – for 2021, the amount you’re allowed to contribute starts to phase out at $125k (single filing), $198k (married filing jointly), and a very low $10k (married filing separately). For those people with a non-US spouse they want to keep out of the US tax system, that’s a big drawback.

If you’re above the income thresholds, there is a completely legitimate loophole, called the Backdoor Roth. I’ll post more on that in the future, but the short version is that you make a non-deductible contribution to a Traditional IRA and then immediately convert it to a Roth IRA. There’s no income limit this way, and it’s just a little bit more paperwork/mouse clicks.

The big challenge is that you may find it challenging to manage an account without a US address. Many people use a US address (a friend, family member, etc.) – that’s not ideal, since they’ll get your mail and might get sick of it, and it’s of somewhat dubious legitimacy. This is something I’d like to do some more research on and find a good way around. For the moment, Charles Schwab and Interactive Brokers are known to work with people, and I’ve seen some mixed reports as to whether Vanguard won’t freeze your account if you’re already an established customer. Worst case, you won’t lose your money, but you might get your account shut down and only have 60 days to find another IRA provider or get hit with some ugly US taxes on an early distribution.

Another challenge is that you should really try to have the Roth IRA open, with some contributions in it before moving to the UK. Based on the US/UK tax treaty, if you’re already living in the UK, you’re probably not eligible to open a first Roth IRA if you don’t already have one (moving providers is fine), and you’d lose the UK tax advantages. If you’re in this situation and want to try to start a Roth IRA, you should get professional advice.

One more caveat – I have seen some interpretations that even if a Roth IRA is already open, once you move to the UK any new contributions are not tax advantaged in the UK. This seems to be an unusual interpretation, possibly based on a clause in the US/Canada tax treaty (Article XVIII Paragraph 3b from the 2007 protocol, if you’re interested). That treaty is pretty clear, but there’s no similar language in the US/UK tax treaty. There’s obviously major drawbacks if this interpretation is true, and if you have any doubts, you should seek professional advice. For my own personal situation, I’m confident that this is an overly restrictive interpretation.

Investment Options

From a tax perspective, you can invest in whatever you like. It’s pretty clear that you can hold funds that don’t report to HMRC without any problem (although if you want to be extra safe, it’s not hard to have a good three or four fund portfolio using only HMRC reporting funds). You probably shouldn’t hold PFICs here, but there’s no real reason why you would want to when you can buy US-based funds anyway.

That makes a Roth IRA the perfect place for any weird, high-risk investments – YOLO on GME! If you make 1000x returns, it’s still tax free.

Big Caveat: There’s some lovely EU, and now UK, legislation called MiFID and PRIIP that requires funds to issue a Key Information Document (KID) to prospective investors. There are no US funds that I’m aware that issue such a document – supposedly, they’re caught in a Catch-22 around US vs EU/UK reporting requirements. If the fund doesn’t issue that document, the broker shouldn’t sell the funds to retail investors living in the UK/EU like you and me. A few ways around this:

  • Keep using a US address on your Roth IRA (although maybe a little dubious!)
  • Don’t be a retail investor – you’ll need a large portfolio (€500k+) and/or be a finance professional
  • Invest in individual stocks only, same solution as getting around PFIC, I’ll post more on how to do this later
  • Have an advisor invest for you – but you’ll pay them, of course

Risk & Return

Entirely depends what you invest in – capital at risk, no guarantees

Withdrawal Options

One nice thing about the Roth IRA is that you can access your contributions at any time, with no penalty. Of course you have to sell any investments, but as long as you don’t take out more than you’ve contributed, there’s no tax or penalties. Certainly not the first place for your emergency fund, but a better option than most investments.

For earnings, you can withdraw them at 59 1/2 or older, as long as you’ve held the account for 5 years. There are no taxes or penalties on withdrawal.

If you want to withdraw earnings before 59 1/2, you’ll pay tax on the gains plus penalties. There are some exceptions for first-time home purchases, education, medical expenses, disability, death, etc. You’d also want to check into UK tax implications – this gets a bit complicated, and ideally you want to avoid it anyway!

Contribution Limit

For 2021, you can contribute $6,000 per year, per person ($7,000 if you’re over age 50). This goes up with time. The contribution limit is shared with any Traditional IRAs. The UK doesn’t impose any additional limits over what the US does.

Fees

These will depend on the provider, but having the account open should be free or nearly free. Fees on the underlying investments will vary, but if you’re using index funds these should be low, usually under 0.1%.

UK Tax Treatment – Contributions

Roth IRA contributions always come from after-tax money, so there’s no tax impacts at the time of contributing.

UK Tax Treatment – Withdrawals

The UK recognizes the US tax advantages, so there is no tax on withdrawing contributions at any time, or on earnings after 59 1/2. Early withdrawals that are subject to US tax and penalties get complicated – try not to do this!

US Tax Treatment – Contributions

Same as with the UK, contributions are from after-tax money, so there’s no impact.

US Tax Treatment – Withdrawals

As long as you’re 59 1/2 and have had the account for 5 years, there’s no tax on your withdrawals of earnings. Contributions can be withdrawn tax and penalty free at any time.

Roth Conversions

I’ll write a focused post on this in the future, but the quick version is that you can convert a Traditional IRA (including any rollovers from a 401(k) or similar) to a Roth IRA, and then that money will be tax-free on withdrawal after age 59 1/2. This is a taxable event in the US – you’re taking tax-deferred money and moving it to an after-tax account, so the IRS wants to get paid.

The good news is that this is very probably not a taxable event in the UK. So you can take money that you didn’t pay UK income tax on when you earned it (mostly because you didn’t live in the UK yet), and convert it so you don’t pay UK tax when you withdraw it, and not pay UK taxes in the process. Caveat is that there are a few different treaty interpretations, but this seems to be the prevailing one. You might also be able to use excess foreign tax credits to offset the US tax due – this gets a bit complicated and I’ll explore it more later, but it could be a very significant advantage.

2 thoughts on “US Roth IRA (Account Options)

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