“Should I contribute to social security?” You might think that is an odd question to ask. Afterall, most of the US citizens with earned income have no way to opt out of paying into social security system.

This is because US payroll tax, which funds social security trust fund, applies to all US employers and employees. If your earned income comes from foreign employer, it’s likely that you are subject to funding the foreign country’s public pension and welfare system through foreign taxes.

But what if you run a business and have a choice on where to incorporate?

Contribute to US social security as an expat business owner

If you are employed in a foreign business, you do not pay the self-employment tax to the US government that funds social security. While the US government presumes that you are now under another country’s coverage, not every country offers this type of public benefit. In such cases, you in effect get the tax savings to invest for your own retirement security.

Many people with the option to not pay taxes will jump on that opportunity without thinking twice. However, is that really the right way to think about this decision?

For those who do not want to return to the US full-time and eventually enjoy the other public infrastructure and services funded by income tax dollars, Social Security retirement benefit is one of the few benefits you are able to enjoy as a US citizen living overseas. (There are certain situations that prevent you from receiving social security from overseas, so do your research.)

Another way to ask the question becomes, does contributing to social security voluntarily give you more financial benefits than investing the money in the markets?

In this context, Social Security is similar to an annuity. You pay into the contract with the US government, expecting a stream of payments in the future. When you die the payment will stop. You do not get any upside from investing the market, but it is a guaranteed income stream. You don’t have to worry about managing the investments yourself.

(Of course, the US government has unilateral authority to change the contract! If you don’t believe the benefit will last in its current form until you retire, you probably are more likely to choose to take the tax savings and invest yourself.)

Income, Benefit, and Reinvestment

In this post, I’m going to explore three factors that may make incorporating overseas to get out of paying into social security more attractive. They are income level, benefit level, and reinvestment rate.

Those three factors are all intuitive. The lower the income, the less you pay into social security to get the same basic benefit. The higher the benefit you are eligible for with the same contribution, the more likely you want to join the system. The more tax savings you are able to reinvest into the market, the more likely you’ll grow the portfolio large enough to support monthly withdrawal for longer timeframe.

First, conclusion.

You may want to contribute to social security as an expat business owner if:

  • Your business profit is less than 50% of the maximum taxable earning,
  • You are married to someone who does not pay into social security but would be eligible for benefits based on your record, and
  • It’s relatively expensive to incorporate your business outside of the US.

That’s all you need to know if you don’t care about how the analysis supports this conclusion with numbers. However, if you follow my thought process below, it might help you analyze your specific situation.

Here are the assumptions.

Before I go into these factors, I want to note two things to keep in mind through this analysis:

  1. Your social security lifetime retirement benefits depend on your earnings, how long you work, how long you live, marriage status, foreign pension, and claiming strategy. There is simply no way for me to explore all the potential scenarios. If you want to know what you should do in your specific circumstance, you need to do your own calculation with your set of facts.
  2. Similarly, I also need to apply market return assumptions to compare the two strategies. Changing the capital markets assumption will drastically alter the conclusion. I’m using a set of assumptions that I’m comfortable with on a forward-looking basis. You are welcome to repeat my analysis with your own assumptions.

Social Security Assumptions

Below are the set of assumptions I used to simplify the analysis and get data from the Quick Calculator from Social Security Online.

  • Taxpayer has not accumulated 40 necessary credits yet to claim retirement benefits. Therefore, there is more incentive to figure out the future contribution strategy.
  • Taxpayer will own a business overseas until retirement.
  • In real dollars, taxable profit stays flat for the next 35 years.
  • Social security full retirement age stays at age 67. Taxpayer will work until age 66 and begin claiming benefits at age 67.
  • Taxpayer will live for 30 years after retirement, or until age 96.
  • Taxpayer is not eligible for foreign pension.
  • Ignore the taxes paid into fund Medicare – only 12.4% of profit goes into social security.

Investment Assumptions

Below are the set of assumptions I used to calculate potential investment account balance overtime if taxpayer takes the tax savings to invest in the market instead.

  • Taxpayer invests up to 95% of the tax savings in the markets to account for cost of incorporating overseas.
  • Assume fixed 4% after-tax, after-cost return annually from the investment accounts in taxpayer’s lifetime.
  • All dividends are reinvested unless there is a withdrawal greater than dividend yield.
  • In retirement, taxpayer withdraws from portfolio the same amount as social security benefit that taxpayer may otherwise be eligible for.

Factor 1: Income Level

Social security in essence is an income replacement scheme. At the lower income level, social security replaces a higher percentage. We can expect that the more profit you make, the less return each dollar of tax you pay at the higher income level generates.

Self-employment tax only applies to the first $132,900 (2019) of business profit. Having a cap makes it easier to compare how different income level plays into the decision of avoiding self-employment tax.

The chart below shows how your social security benefit and investment account balance may look like at max, 50% of the max, and 25% of the max taxable social security earnings.

Contributing to Social Security vs. Investing in the Markets Factor 1: Income Level


At the max social security taxable earnings level, by incorporating overseas and investing the tax savings, the portfolio is likely to be able to provide the same income as social security benefits while the balance continues to grow.

At the 50% level, the portfolio will still sustain the withdrawal with some wealth left at the end of life. However, we are ignoring sequence of return risk in our projection. Since it’s necessary to dip into the principal to sustain the withdraw in this scenario, it’s possible that in some market conditions, the portfolio may not sustain for 30 years. If you are severely averse to market risk, at this income level you may also want to choose to pay into social security.

At the 25% level, the portfolio is even less likely to sustain the same withdraw to match the social security benefit that you’d have been eligible for. Of course, it also depends on how long you think you will live. If you have lower income and care about longevity risk, contributing to social security likely makes sense.

S-Corp Election

As a side note, you can also adjust your contribution level into social security if you incorporate your business in the US but elect S-Corp taxation. I will not discuss it here, but it allows you to “hedge your bet” with social security system without incorporating overseas.

Factor 2: Benefit Level

Another feature of social security is that your spouse is eligible to receive 50% of your benefits in addition to your own. It came from an era when one income household was common. For dual income couples who both paid into social security, often the benefit may be higher if both spouses claim based on their own earning records.

The chart below compares the benefit for single vs. married couple at the maximum taxable earning.

Contributing to Social Security vs. Investing in the Markets Factor 2: Benefit Level


As you can see, the portfolio grows at the same rate since the contribution level is the same. Nevertheless, in order to distribute more from the portfolio for a married couple, you’ll need to dip into the principal. This effect will be even more pronounced if income level is lower.

Factor 3: Reinvestment Rate

Incorporating outside of the US comes with costs, although it may not be as high as you think. Some countries make it easy for foreigners to register the company without having actual operation cash flow from that country. Normally these countries adopt a territorial tax system, so any revenue generated outside of the country is tax free.

As I mentioned in the assumptions section, all the previous scenarios assume the business only needs to spend 5% of the tax savings on foreign registration cost. 95% of the tax saving is reinvested into the market.

Depending on your personal circumstance, it may not make sense to incorporate outside of your resident country. For example, your mere presence in the country may trigger tax on your business profit, so incorporating in a third country may not make any difference. It is still possible that the incorporating cost in your resident country is less than the tax savings from incorporating in the US.

The chart below shows three different reinvestment rates – 95% (equal to previous scenarios), 75% and 50%.

Contributing to Social Security vs. Investing in the Markets Factor 3: Reinvestment Rate


Under these 3 scenarios, the social security benefit you would have been eligible for is the same. However, the less tax saving you reinvest into the market, the slower the portfolio grows. Even if the cost of incorporating overseas is only 50% of the tax savings, the portfolio cannot sustain the same withdrawal for 30 years. You may feel like you saved a lot in the short-term, but you might be losing out in the long-term.

This is also a good reminder that reinvesting the whole tax savings is not easy. If the default is cash never goes to tax authority, business owners often will not think about setting some aside and simply use available cash toward future operation. Sometimes being forced to contribute to something for our long-term financial security is a good thing.

Run your numbers

In the end, it’s likely that your situation is more complicated than my assumptions. If this exercise actually applies to you, you may want to plug in your own numbers.

As business owners, we always hope our profits will grow every year while paying minimal tax every year. Those two believes that make us prudent business owners may also blind us on decisions that only play out in the long-term, such as social security.


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