I'd like to welcome Douglas Goldstein, Certified Financial Planner® to my blog. I (Yosefa) have been a guest on Doug's insightful podcast The Goldstein on Gelt Show a few times. And I've invited him here to share some valuable information from his forthcoming book - The Inheritance Book: What you need to know about receiving and investing an inheritance from the U.S. when you live in Israel. Doug is the founder, owner, and director of Profile Investment Services, Ltd., based in Jerusalem, helping Americans in Israel handle their U.S. retirement, brokerage, and investment accounts.
How to Deal with an IRA/401(k) and Avoid Needless Taxation When You Make Aliya
From time to time, I run into people who have paid needless taxation on their U.S. retirement plans when they moved to Israel. They could have avoided paying taxes when they made aliya had they known a few important facts.
If you have or inherit an IRA or 401(k)
The following information is critical for Americans who move to Israel and have individual retirement accounts (IRAs) or 401(k) plans. Anyone who inherits such an account should also read this article. While I am not a tax advisor, as an investment advisor, I often work with tax planners to help people choose investments which can minimize taxes and maximize growth.
What is an IRA?
Many folks working in America have set up retirement accounts that allowed them to squirrel away thousands of dollars each year and get a lot of tax benefits.
Current tax deduction
Example: If you worked in America, here’s how it might have looked for you: Let’s say you were 40 years old and earned $90,000 per year. You could have contributed $5,500 to an IRA account and gotten a current tax deduction, which means that as far as the IRS is concerned instead of you having to pay tax on $90,000 of earnings, you would only be paying tax on $84,500. That’s already a great savings.
Ongoing tax savings
Even better, though, is that you could invest that money in an IRA in most “normal” types of investments (stocks, bonds, mutual funds, ETF’s, bank deposits) and as long as those securities stayed inside of the IRA, you would not have to pay U.S. tax on any of the dividends, interest, and capital gains. In fact, you could keep the money in the IRA until you are 70 ½ and enjoy those tax benefits. At that point, you would have to start taking some withdrawals from the portfolio called “required minimum distributions” and pay taxes on that money.
There are a variety of different types of IRAs with names like “traditional IRA,” “Roth IRA,” and “inherited IRA.” Each of them has pros and cons depending on your situation, but all of them allow you to defer paying taxes on the income and profits from the investments as long as they remain inside the account.
What is a 401(k)?
Much like an IRA, a 401(k) also allows for tax-deferred savings. However, a 401(k) is a plan that is associated with an employer instead of being handled solely by an individual. Also, unlike an IRA, a 401(k) has a much higher limit for the amount of money that you can contribute pretax ($18,500 as of 2018). Another great benefit of a 401(k) is that many employers will match some or all of the employees’ contributions, which is basically like getting free money.
When you make aliya, remember these five important facts in handling your retirement plans
You can control your assets. There’s a reason why some IRAs are called “self-directed.” That means that you can have an account with a brokerage firm and you can direct all of the investments. You are in charge of your own money (with a financial advisor’s help, if you want). An IRA is a type of account, not a specific type of investment. Depending on what type of investment firm holds your IRA, there are different possibilities as to what type of investments you can own. Some companies allow you to buy only their own mutual funds, and some banks may only allow you to buy CDs (certificates of deposit). But in an IRA that is held by a brokerage firm, you can normally buy a full range of investments. If your current IRA is not set up through a brokerage firm, consider transferring your account.
Roll your 401(k) into an IRA. There are rarely any benefits to keeping your money in a 401(k) connected to your previous employer. Chances are, if you’re reading this, you are in Israel and no longer working for the firm that set up your 401(k). You are allowed, and in fact it is very easy, to simply transfer the assets from a 401(k) into an IRA, thus severing your ties with the bureaucracy of your old employer and taking complete control of your IRA.
Not all brokerage firms work with clients in Israel. Because the rules of handling clients who live outside the United States are complicated, many brokerage companies will not work with clients who live in Israel. However, it’s important to know that there are those that will. One of the main reasons a brokerage firm in America might choose not to work with someone in Israel is because the company is not able to properly fulfill its responsibility of the “know your client” rule. Since they don’t have an office or representative in Israel, they might simply prefer not to have you as a client. When you speak to your advisor in America, confirm that he will be able to continue to work with you when you are overseas. If not, choose a brokerage firm with a presence in Israel that can properly fulfill the “Know Your Client” regulations. (Click here to see how Profile Investment Services, Ltd. can get you set up with a U.S. IRA or brokerage account.)
Do not take the money out of the IRA and bring it to Israel. If you want to continue benefiting from the tax deferred status of your retirement account, you must not take the money out of the framework of an IRA or 401(k). One of the biggest mistakes that people make is they instruct the brokerage firm or bank to distribute the money from their IRA and then they come to Israel and deposit the money in a bank here. By doing that, they completely forfeit all of the benefits that the retirement accounts offered, and unless they reverse their action immediately, it cannot be fixed.
Invest the money in the IRA according to your financial plan. Your retirement account is the central part of your long-term retirement plan. Look at it along with your other savings plans, your stock and bond portfolios, your real estate, and any pension plans (both Israeli and American) or future inheritances that relate to you. Once you develop a financial plan, you can then select the appropriate investments to have in your IRA. For example, many people like to benefit from the fact that dividends and interest earned on investments in an IRA are not subject to tax in the United States on a current basis. Therefore, they select investments that pay high dividends or interest payments and place those investments in their IRA as opposed to in a regular brokerage account. Other tax-deferred products like annuities or municipal bonds normally aren’t held in IRAs.
If you have any questions or comments about handling your U.S. retirement accounts or brokerage accounts from Israel, feel free to contact me: firstname.lastname@example.org, 02-624-2788, or toll-free from USA 1-888-327-6179.
Doug Goldstein is accredited by the Israel Securities Authority (ISA) as a licensed Israeli advisor and is also a licensed U.S. advisor. He holds the designations of Certified Financial Planner™ in the United States, Registered Investment Advisor, and Trust and Estate Practitioner. He is a member of both the Financial Planning Association and of the Society of Trust and Estate Practitioners. His company, Profile Investment Services, Ltd., (02-624-2788) helps Americans who live in Israel handle their U.S. investment accounts. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.
© Douglas Goldstein, 2018. Reprinted with permission.