Retirement Planning for Self-employed Trailing Spouses Overseas

For many of us, moving abroad for our spouse’s career presents a unique opportunity. Some find the time to pursue what they love and turn it into a business venture; some stay in their original professional field and take the challenge to become their own bosses; and some continue to work with previous employers remotely on a contracting basis. No matter what type of professional path you pursue, I want to congratulate your success, and applaud your dedication for making this career transition work for you.

But the transition of your professional life doesn’t end there. Now that you are making money again, what’s next? Saving for retirement may be the last thing that would cross your mind, especially if, like me, your professional life is still in its first decade. Many of us in our previous professional lives worked for a company with automatic deductions from salary (even with matching!) that went toward retirement plan accounts, so we rarely think about saving for retirement from our income stream. Now that you are on your own, what can you do to continue saving for the future other than stashing cash under your mattress?

1. Open a SEP IRA or Individual 401(k) account

SEP stands for “Simplified Employee Pension Plan.” It provides small business owners an easy way to contribute to the employees’ as well as his or her own retirement utilizing Traditional IRA accounts. It allows you to save at a tax-deferred basis, which means you can deduct the whole or part of the contributions from taxable income, like your old 401(k). (For IRS rules and regulations on SEP, see here.)

You may be thinking, “But I don’t own a small business!” Actually, as long as you report self-employment income on your tax return, you are able to contribute to a SEP IRA, whether you receive such income from teaching yoga at home, taking projects as an independent contractor, or starting a consulting business.

Alternatively, you can also establish an individual 401(k) plan for yourself if you are a sole proprietor. This is beneficial because you can contribute to your retirement both as an employer and as an employee! Depending on your earnings, you may be able to contribute more to a 401(k) on a tax-deferred basis than to SEP IRA. However, 401(k) plans are subject to more stringent IRS regulations when you have employees. (That is why SEP is ”Simplified.”) If you do have employees or are in a partnership, establishing a SEP or 401(k) would be more complicated since the plan is for your employees and partners as well. I strongly suggest that you consult with a tax professional in this case.)

For a simple explanation of how much you can contribute to SEP vs 401(k), read this.

Another thing to note is that self-employment income reported on the tax return is actually “net profit” (usually on Schedule C.) Therefore, if you do not report a profit on your tax return, you cannot contribute to SEP IRA or individual 401(k) account that year.

Once you have determined that you should open and contribute to SEP IRA or 401(k) account, the actual implementation is quite straight forward. Many banks, brokerage service firms or mutual fund companies allow you to open an account online. Simply contact them to follow their procedure. You may want to understand their fee structure and investment options available before you open an account, or work with an investment advisor to determine suitable investments (Some account custodians allow you to keep savings in cash or Certificate of Deposit if you are wary of riskier investments).

Lastly, remember that SEP IRA is meant for retirement savings, so you would be subject to penalty if you were to withdraw funds prior to turning 59 and a half, with some exceptions. Prepare to see your money locked away at some place you can’t touch until later, for your benefit!

2. Social Security

If you are like me and have heard since your twenties that Social Security will not be there for us, then you might be secretly happy that you are working for yourself overseas now so Uncle Sam won’t be able to tax you. Wrong! As a matter of fact, since you are self-employed, you will need to pay both the employer and employee portion of the payroll tax, which amounts to 15.3% of your self-employment income.

Regardless of the viability of Social Security when you retire, self-employment allows you to continue paying into the system, so you are eligible for the benefit when you need it, (such as the disability benefit, which you could potentially need much earlier than when you retire). If your spouse’s job overseas does not allow him/her to continue paying into Social Security, you may be the source of Social Security benefits when you eventually move back to the U.S., depending on how many quarterly credits he/she already earned.

3. Traditional or Roth IRA

In addition to SEP IRA, you can also utilize the Traditional IRA to save on a tax-deferred basis, or Roth IRA to enjoy tax free capital gain. You can only contribute up to the lesser of $5,500 in 2014 or your earned income (with an additional catch-up contribution of $1,000 if you are over age 50.) However, half of your spouse’s earned income is considered yours, so most likely you are able to contribute even before your self-employment earnings. As the name suggests, IRAs are for individuals so you and your spouse may each open one and contribute up to the individual limit, if your joint income is below the income limitation.

There are many rules and regulations related to IRAs which are covered extensively by many publications, so I will not go into details here. IRS summarizes the differences between the two types of accounts here.

You might be wondering which type of account is better for you. Well, it depends on your personal situation. You need to consider your current income, current tax rate, potential future tax rate, timing of distribution, your current cash flow need, to list a few.  You may want to consult with tax advisor or financial planner before you determine what type of saving plan works for you.

4. Rollover your old 401 (k) into an IRA

It’s also worth noting that you should consider rolling over 401 (k) accounts from past employers into a Traditional IRA account. Doing so would give you the benefit of having more investment options and a lower cost of investing (from embedded 401 (k) administration fees), plus you could continue to contribute to the rolled over account without opening a new one (although the contribution may not be tax deductible). You will need to contact the financial institution that currently holds your 401 (k) account to discuss a rollover to another institution.

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