by Jarrad Morgan
As American JETs are aware, we get some pretty darned good tax benefits for working in Japan. Alas, while preparing my 2009 taxes, I discovered a dark side to these benefits: they make retirement investing more difficult. Therefore, I offer a cautionary tale to those of you thinking of diving into a Roth or Traditional IRA this upcoming year.
Who the Hell is Ira?
Understanding retirement account options can take some effort. To put it simply, IRA stands for Individual Retirement Account. These accounts are a handy dandy way to prepare for retirement and carry nifty tax benefits. For Traditional IRAs, the money that you put in is tax free. When you retire, you are taxed on the withdrawals based on your income bracket at that time. For Roth IRAs, you are taxed up front, but the money is tax free when you withdraw it. Given the arguably superior tax benefits, Roth IRAs are available only to those below a certain income bracket.
The process of investing through an IRA is straightforward. To put it simply, you put money into an IRA account (you can have one or hundreds) and use the money in that account (or those accounts) to invest in stocks, bonds, mutual funds, ETFs, and so on. Naturally, investment is far more complex than that, but explaining anything more is beyond the scope of this post.
Suckage
As I said, there is a major downside to our tax benefits, specifically our Foreign Earned Income Exemption (FEIE). For the past six months, I have dumped several thousand dollars into my IRA in order to take advantage of the cheap stock prices created by the current economic downturn in the United States. The downside is that I had failed to make an important connection during my research: our FEIE means that we have no earned income from a tax perspective.
“So, what?” you may ask. Well, normally, IRAs have a $5,000 per year limit to contributions. This prevents the obscenely wealthy from dodging taxes by dumping their excess cash into an IRA. Unfortunately, I missed an important caveat: the limit is $5,000 or your earned income, whichever is lower.
With a post-FEIE earned income of $0, our IRA contributions max out at—you guessed it—$0. So, what does that mean for someone like me? Well, it means that I have violated tax laws and must pay a 6% per year penalty on the amount that I deposited and any interest it earns until the overage is corrected. That is, my choices are to kill my investments or take a penalty that will wipe out a hefty portion of my gains in an average year.
Conclusion
So, for those of you tempted to start saving for retirement through an IRA, you will need to wait until you’re back in the U.S., making well in excess of the FEIE, waive your FEIE, or invest without the tax benefits of an IRA. To put it succinctly, your options blow, but now you know. And knowing is half the battle.
G.I. Joe!
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A third-year AET in Miyazu, Kyoto, Jarrad has megalomaniacal delusions of grandeur. He will take over the world because he is just that good.
Ahh, thanks much for the article, Jared! I was actually doing IRA research myself– good to know that it might be completely useless while I’m in Japan. Two questions, though . . . do you know if those restrictions on earned income still apply to those who are students? And what about those who have a US-based taxable income in addition to the FEI?
Any further research you wish to share regarding investments, etc would be welcome. Wading through official info is a headache and a half, but you’ve made it very easy to understand.
“Earned income” can occasionally be a somewhat complex concept in terms of taxes. Unfortunately, I’ve never researched the issue in terms of income earned as a student. With respect to the income we earn in Japan, there is a specific exemption that essentially makes our income non-existent. So, when it comes to student income, the best answer that I can give you is “it depends.”
With respect to U.S. based income, it does not fall under your foreign earned income exemption. If it does not fall under any other exemption, then the income that you are earning in the U.S. should count as “earned income.” However, keep in mind that the amount that you can contribute to an IRA cannot exceed your earned income for the year.
What other investment info did you have in mind? I’ve been researching it to death for over a year now, so I’d be glad to give you any input if I’m able.
Nice to know! Thanks for the information :-)
Thanks for answering my questions, tis much appreciated. :-) As for what other investment info I had in mind . . . well, that’s a difficult question to answer, since I don’t know what you’ve been researching. I guess anything that would be relevant to a first-time and fairly small-time investor who wants something fairly low-risk. Who basically wants to invest, then say “well, that’s done” and forget about said investment except when receiving papers that say things like “congratulations, you now have more money than you started with!”
So, err, information relevant to lazy poor people such as myself, would I guess be the gist of that.
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