Whether it be work, family, a lifelong dream to live on the Côte d’Azur or even by accident, the number of Americans living in the UK, Europe and Israel has continued to grow. The increase in globalisation over the past two decades and the citizenship-based taxation system implemented by the US, has led to many “accidental Americans”, those who never intended to be, but are, within the US taxation system.
Whether the initial move was for a short-term secondment or a longer-term relocation, US families are impacted by the unique tax and compliance requirements set out by the US system. For these families, wealth management isn’t as simple as just managing an investment portfolio, they must consider a wide range of planning solutions to avoid the common pitfalls. Whilst there cannot be a one size fits all approach, each family has a different set of circumstances, there are some key commonalities that most US-connected families living in Europe should consider:
- Strategic financial planning
- Tax treaties, planning and reporting
- Currency management
- Estate planning
01. Strategic Financial Planning
There have been a raft of legislative changes around the world that have increased financial transparency between countries (CRS – Global, FATCA – US, IFI – France, Offshore Fund – UK). It is more important than ever that High Net Worth Families have a clear financial plan, taking into account their total assets across multiple jurisdictions.
As a starting point, families must review the different investment structures they hold internationally. On the face of it, individual accounts may be performing well from an investment perspective. However, these accounts must be reviewed considering the different tax regimes linked to the family. There are numerous examples where savings accounts offer tax benefits for nationals but are far from beneficial for US-linked families. In most instances, the US only recognises US-based plans, and products like ISAs in the UK and Assurance Vies in France typically do not qualify for US tax deferment. In some cases, these can still be used as part of an overall strategy, but families must be cautious about how they are invested and how they are utilised as part of the global management of the family’s affairs.
Having a clear understanding of the family’s long-term plans and building this around their international accounts, means that families can then start to set out a long-term strategy, thinking of cashflow planning, saving for college, retirement, and succession planning. This can be difficult for international clients as there are many items to consider. Families often struggle to match their needs and requirements and either end up solely having US accounts (using an old US address) and therefore being exposed to currency fluctuations, or having local accounts mismanaged from a US standpoint. Neither of these solutions are optimal and are more of a short-term fix. These families who do not have their affairs managed in a co-ordinated manner, can often find themselves with too much exposure to an asset class, an individual security or excessive levels of cash across their investment accounts.
A family’s international wealth should be managed as one, utilising the different international accounts as effectively as possible, maintaining the benefits of each of the accounts (401(k), and IRA in the US , SIPP in the UK, or ‘Plan d’épargne en actions’ in France, ‘Savings Plan for Every Child’ in Israel). Using the tax-exempt accounts to hold high income-producing assets is one way of creating an effective strategy; ensuring that you avoid investing in foreign mutual funds is another. These funds are known in the US as a Passive Foreign Investment Company (PFIC) and are to be avoided by US citizens. PFICs are subject to highly punitive tax treatment in the US, incurring a higher tax rate than a similar US-listed fund and also involving additional reporting requirements which can often be time-consuming and costly.
02. Tax treaties, planning and reporting
The US has tax treaties in place with over 65 countries globally. These treaties allow US citizens residing in foreign countries to be taxed at a reduced rate, or to be exempt from US taxes on certain items of income they receive from US sources. As part of the agreement, certain countries will not require tax to be paid on US sources of income. Each country has a different arrangement in place and some US states have their own set of rules in place, so it is important that families fully understand the relevant tax treaties when building their investment plans.
Different tax treaties offer a range of planning opportunities that families can use. Examples include the Franco-American tax treaty, whereby if you are an American living in France and invest in US situs assets, you are taxed in the US but are not required to pay the additional 17.2% CSG/CRDS. In Italy holding non-Euro currency can cause an issue, leading to calculations on FX gains even if it hasn’t been crystallised, therefore managing cash balances is very important.
Whilst local tax considerations must be taken into account, Americans planning on moving overseas must also consider their state of domicile within the US. If they elect a state where there is no income tax due, it will mean the family no longer has an obligation to pay state taxes as well as federal.
Many US families still use their old domestic US CPA to help with their planning and reporting. However, this can cause issues. The lack of familiarity with global tax matters can lead to more tax being owed or having to reorganise their affairs at a later date to become compliant.
From a planning point of view, families with advisers who understand cross border issues can look to utilise items such as foreign tax credits, making tax-efficient charitable donations and pension contributions, ensuring they are timed correctly to coincide with both the US and local tax year.
Any investments, in the US or in France, UK, Italy or Israel, will need to be fully reported to the US in USD on a calendar year basis, in addition to reporting them in the local currency of the country the family are residing in. US reporting requirements include providing details of all sources of income, gains and losses – something many domestic managers do not have the capability to do. This doesn’t mean that all assets must be based in the US, but it does mean that any investments must be made considering USD gains/losses, long-term versus short-term gains and how much income has arisen. Having advisers and investment managers in place who can review and report on all the family assets in USD and domestic currency means that it is possible to minimise the gains in both USD and the local currency. In addition, providing a simple 1099 in USD on the European portfolios will put you in the good books of your US CPA, as they no longer have to go line by line through a statement, translating all the figures into USD.
03. Currency management
Managing currency exposure is often one of the last things thought of by families. Some leave their assets in the US with old managers, which may be suitable if the family plan on moving back to the US in the short term. However, for families who plan on remaining outside the US for the long term or for an undecided period, this can entail exposure to exchange rate risk. If the dollar weakened, it would leave them with a significant shortfall in income if all their expenditure is in Sterling, Euro or Israeli Shekel.
The purpose of a portfolio of stocks and bonds is for the portfolio value to grow over time. These returns can be quickly eroded by movement in exchange rates. The dollar has moved by around 3% versus the Euro in the past year, and 4.5% against the Pound. In a low growth environment, these swings can significantly impact the level of returns for families.
With this in mind, it is important to build a long-term plan taking into account three separate buckets – short, medium and long term. Currency requirements need to be considered across each of these buckets. Whether it’s short-term cash for daily expenditure or long-term school or retirement costs, these need to be factored in and budgeted for. Having the ability to match your liabilities without the added concern of a shift in exchange rate is important.
An investment manager working with an international family must be able to build a portfolio which takes currency movement and reporting into account. The manager needs to review the portfolios in dollar and the local currency, matching losses versus gains and therefore effectively managing the accounts in both jurisdictions.
A parallel issue is opening a bank account as an American citizen. Many US institutions will no longer work with Americans living overseas and many European banks will not work with US citizens. It is important for families to be able to have access to a full suite of services including debit/cheque book facilities, minimal costs on transferring money from one currency to another or to a local bank and the option of margin loans against the portfolios. Due to the limited number of companies that are happy to work with Americans, clients often stumble across a solution that provides an element of the full service and try to make do. This inevitably unravels further down the line, especially when using a parent’s address on brokerage accounts, which can lead to portfolios being suspended or closed at difficult times.
04. Estate planning
As with any international family, estate planning needs to be kept up-to-date given the frequency of changes across countries. Similar to tax and reporting, each country has a different set of rules. Paying close attention to these changes is crucial.
Many families think that they can rely on any estate planning that was done prior to moving to Europe. However, this approach normally causes issues as the typical planning completed in the US is often disregarded in their new home country.
The changes brought in by the EU Succession Regulation in 2015 have allowed individuals to opt out of ‘forced heirship’ rules that are applied in some EU countries. This is an important consideration; if a prewritten US Will has not been updated accordingly and a family member passes away, their assets can still be considered under the original rules.
Similarly the way a pre-existing Trust is treated, can differ whilst living overseas. Trusts are a very common aspect of US planning. In countries where the forced heirship rules apply, the utilisation of a Trust can appear to go against these rules and can be challenged.
With each country applying different rules, estate planning requires detailed knowledge of the relevant structures and circumstances, including the underlying investments. Otherwise, families can get hit by an increase in tax in both the local jurisdiction and in the US.
Summary
On the face of it, managing your family investments can sometimes appear simple: pick the right manager with good performance, avoid market corrections, leaving you to focus on other matters. However, for international families with US ties, this has never been further from the truth.
In this article we have briefly covered some of the key considerations. However, each family and their new country of residence will have a range of specific circumstances that need to be analysed and considered when building a financial plan.
