When it comes to tax-advantaged retirement savings, the Roth IRA is a popular choice due to its tax-free growth and withdrawals. But what happens if your income is earned outside the United States? Can you still contribute to a Roth IRA? The answer depends on how you report your foreign income to the IRS.
Understanding Foreign Earned Income
Foreign earned income includes wages, salaries, fees, retainers, and self-employment income earned while living abroad. However, not all types of foreign income qualify, and passive income (such as dividends, rental income, or pensions) does not count.
If you’re working abroad, you have two main ways to handle your U.S. tax obligations:
- Foreign Earned Income Exclusion (FEIE) – This allows you to exclude up to a certain amount of your foreign income from U.S. taxation (e.g., $120,000+ depending on the year). To qualify, you must meet the Physical Presence Test or the Bona Fide Residence Test.
- Foreign Tax Credit (FTC) – Instead of excluding income, you can claim a credit for taxes paid to a foreign government, which helps offset your U.S. tax liability.
FEIE vs. FTC: How They Impact Roth Contributions
Your ability to contribute to a Roth IRA depends on whether you take the FEIE or FTC:
- If you claim FEIE → You CANNOT contribute to a Roth IRA. Since your income is excluded from U.S. taxation, it does not count as earned income for IRA contribution purposes.
- If you claim FTC → You CAN contribute to a Roth IRA. Since the income is still reported as taxable in the U.S. (even though you receive a credit for foreign taxes paid), it qualifies for Roth IRA contributions.
What This Means for U.S. Expats
If you’re living in a country with low or no income tax (e.g., the Middle East), you may be more likely to use FEIE, meaning you won’t qualify for Roth contributions. However, if you live in a country with higher tax rates (e.g., Canada or many European nations), FTC may be a better option, allowing you to contribute to a Roth IRA.
Final Thoughts
The decision between FEIE and FTC isn’t just about Roth contributions—it also affects your overall tax liability. If you’re an expat wondering whether you can contribute to a Roth IRA, you’ll need to carefully consider how you report your foreign income.
đź“Ś Need personalized tax advice? Every situation is unique! Contact Akif CPA to explore your best options for tax-efficient retirement planning while living abroad.
