For American Expats: What to Do If Your Private Banker Tells You to Go AwaySubmitted by Creveling & Creveling Private Wealth Advisory on May 22nd, 2012
By Chad Creveling, CFA and Peggy Creveling, CFA
“I don’t open U.S. accounts, period,” said Su Shan Tan, head of private banking at Singapore-based DBS―Southeast Asia’s largest lender―in a recent Bloomberg article.
This attitude has largely been a reaction to the implementation of FATCA, the IRS’s Foreign Account Tax Compliance Act. Intended to stamp out tax evasion by resident and expatriate Americans holding accounts overseas, FATCA has effectively pushed U.S. tax compliance onto foreign banks by requiring them to identify and report on American account holders or be subjected to a 30% withholding tax on all U.S.-sourced income.
In the same article, Bank of Singapore CEO Renato Guzman said that his firm has turned away millions of dollars from Americans because it doesn’t want to deal with the regulatory hassles. According to Guzman, at industry meetings among the 18 private banks in Singapore not accepting Americans is “quite the prevailing sentiment.”
Marylouise Serrato, executive director of American Citizens Abroad, sees a similar trend. “Bank accounts, investment accounts, mortgages, and insurance policies are being refused to American citizens, and those with accounts are seeing them closed or have been threatened with closure.”
The fact is that given the cost of compliance, many overseas banks have simply decided to turn away Americans overseas and in some cases force those with existing accounts to close them. But unfortunately, that’s not the only problem facing U.S. expats with foreign accounts.
Can’t Invest Overseas, Can’t Invest at Home Either
In addition to being turned away from local banks in their country of residence, U.S. expats face difficulty in purchasing investments overseas as well. This is because they have to deal with increased enforcement of the IRS’s Passive Foreign Investment Corporation (PFIC) rules that impose a particularly punitive tax regime on non-U.S. pooled investment schemes. PFIC rules include foreign-domiciled mutual funds, hedge funds, cash management products, and foreign pension schemes, which pretty much prevents expat Americans buying any investment product available from a foreign bank even if the bank were to offer them.
If that wasn’t enough, U.S. expat investors can’t purchase many U.S.-based investment products either. Many U.S.- based investment custodians/brokerages, under pressure from compliance departments to conform with various aspects of the Patriot Act, anti-money laundering legislation, and mutual fund distribution agreements, are increasingly making a distinction between resident Americans and non-resident Americans. Opening accounts at U.S. custodians have become increasingly difficult for Americans overseas, and with a foreign address they are often shut out from buying the U.S.- domiciled mutual funds that resident Americans can purchase. In some cases, they are offered an offshore version of a domestic fund through their U.S. custodian, but the fees are usually twice as much as the domestic version and the number of funds available is severely limited.
Portfolio Construction for Expat Americans
Facing a bewildering array of regulatory complexities and stiffer penalties for non-compliance (unintentional or otherwise), in addition to being shut out of the products and services of foreign financial institutions (and in some cases the products and services of U.S.-domiciled institutions), life is clearly getting harder for Americans abroad. But all is not lost. While not addressing all the issues faced by expat Americans, some solutions for managing your investment portfolio in light of FATCA and other regulations are to:
- Hold Your Investment Portfolio with a Custodian in the United States. This eliminates the issue of being shut out by the foreign banks and gets around the PFIC problem. Additionally, you typically will be able to access investment products and it will be cheaper to construct a portfolio than through an offshore custodian.
- Use ETFs to Construct a Globally Diversified Portfolio. As a non-resident American, you may be prevented from purchasing U.S.-domiciled mutual funds from your U.S. custodian due to various mutual fund distribution agreements. In that case, use exchange traded funds (ETFs) to construct a globally diversified portfolio. Today, there are ETFs listed on U.S. exchanges and available through U.S. custodians for nearly all asset classes and investment exposures required. In addition, the fees on a portfolio constructed from ETFs will be significantly cheaper than a similar portfolio constructed from actively managed mutual funds.
- If Possible, Use a Local Bank for Cash Management and Currency Hedging. Regular bank deposits are not considered PFICs, but money market fund and other cash management funds generally are. Still, if you report them on IRS Form 8621 and use the mark-to-market election, you will pay no more tax on cash and fixed income earnings than a resident American. If you cannot use a local bank, there are now numerous cash and fixed income ETFs you can use instead.
- Split Assets with a Non-Resident Alien (NRA) Spouse. If you happen to have a spouse who is considered a non-resident alien by the U.S., considering filing taxes as Head of Household rather than Married Filing Jointly. Your NRA spouse can then legally hold assets outside of the U.S. tax regime. The NRA spouse can hold the local bank and investment accounts to augment the accounts held by the American citizen spouse. (Consult your tax/financial advisor before electing this option to ensure you understand all the rules and implications.)
- Carefully Weigh the Potential Benefits of Local Tax-Advantaged Accounts. Before investing in local tax-deferred or tax-exempt accounts, carefully run the numbers with the help of your tax or financial advisor. Most local tax-advantaged accounts and even many foreign pensions will be considered to be PFICs by the IRS, subjecting you to a particularly punitive tax regime. Still, in some cases, by making the mark-to-market election, it may be beneficial for some Americans to participate depending on the unique characteristics of their local and U.S. marginal tax rates and the specifics of any tax-advantaged scheme. Do not just invest without doing your homework. The penalties are not worth it.
- Work with Financial/Wealth Advisors Regulated by the U.S. SEC. Many advisors working in offshore markets are not familiar with the U.S. tax regime and the special rules that apply to expatriate Americans. As a result, American expats can unwittingly be guided into situations and products that put them afoul of the IRS and expose them to significant penalties. To be safe, work with advisors familiar with U.S. tax laws and who are regulated by the U.S. Securities and Exchange Commission.
The benefits of this approach are:
- Ability to construct and manage a globally diversified investment portfolio while overseas
- Fully compliant with FATCA and PFIC rules, thus avoiding steep penalties and potential criminal charges
- Avoids restrictions on U.S.-domiciled mutual funds
- Minimizes portfolio fees―less than 0.5% in most cases
- Pay no more tax than a resident American
- Simple to implement and manage
- Peace of mind
By keeping it simple, you can avoid much of the regulatory complexity and pitfalls while achieving much the same, if not