Roth conversion oppertunities for US citizens in Germany

[USADe 0]

If you come to Germany with money in traditional 401k or IRA accounts, you may be able to convert money in these traditional accounts to Roth accounts without paying German or US taxes on the conversions. If you later move back to the US you could withdraw from the Roth accounts tax-free.

It has been discussed on this forum that the count case "Urteil vom 9.8.2018, Az. 11 K 2738/14" and the rejection of the appeal at the BFH means that withdrawals of contributions from traditional 401k and IRA accounts are not taxable by Germany. Only once you start withdrawing more than you contributed the gains are taxable as capital income.

I think this opens two possibilities for US citizens who still have to pay tax on their world-wide income to the IRS.

1)If they have mostly earned income and their income falls below the foreign-earned-income exclusion amount, they can use their standard deduction to offset roth conversions. This strategy is discussed on various websites online as it seems to apply to US-expats in several countries.

2) The US-German tax treaty may open up another possibility if they are paying presumably much higher German income taxes on their earned income from jobs or freelancing in Germany. US retirement accounts are treated as Pensions in articles 18 and 18A of the treaty. Pension income is taxable in the resident country. Of course, through the savings clause the US reserves the right to tax these Roth conversions for US citizens anyways. However, US citizens can also resource this income and use tax credits on it. The question is to which foreign tax credit category does this belong? I think until recently resourced income went into the "resourced by treaty" category where it is not of much use. However since about 2018 there is language in the form 1116 instructions that this category does not apply to US citizens who are residents of the foreign treaty countries. So is pension income general category or passive?
The form 1116 instructions and US code don't explicitly define retirement account withdrawals or pension income belonging to any category. Since contributions are from wages/earned income I think at least the basis should be able to be classified as general category and the gains as passive. It is not clear to me if for US-purposes one can withdraw the general category part first or has to withdraw general/passive proportionally considering the ratio of contributions to gains in the account. Anyways, it seems possible that a substantial portion of the withdrawal could be put in the general category where one could use the foreign tax credits from earned income that tend to accumulate if one lives and works in Germany.

Path 1 seems relatively well established to me. I am not sure about path 2.

What do the tax experts think (@Straightpoop @PandaMunich)?

Do any US retirees in Germany resource withdrawals from their US retirement plans and use foreign tax credits in the general or passive categories?

 

[BethAnnBitt 2,906]

26 minutes ago, USADe said:

withdrawals of contributions from traditional 401k and IRA accounts are not taxable by Germany. Only once you start withdrawing more than you contributed the gains are taxable as capital income.

Don’t forget that Uncle Sam will still tax you on the withdrawals.  You will get a credit for the tax paid to Germany, but will still end up paying what you would have had to pay Uncle Sam if you were residing stateside. 

[PandaMunich 16,570]

Whyever would you want to do that?

 

A Roth IRA, to which you contribute after-tax money, only has the advantage that your money can grow in it undisturbed by German taxation until you start withdrawing.

 

While a traditional IRA or 401k has that adavantage (no German taxation along the way, the money grows undisturbed), plus you also get to contribute before-tax money in it, also in your German tax return. You will not pay German income tax on your contribution.

 

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If you have an eligible US pension plan, e.g. a traditional IRA, into which you had started paying into since before you had started working in Germany, which makes it "eligible" under the double taxation agreement, you should hold onto it and continue contributing to it!

 

These contributions to your traditional IRA (or to any of the other eligible US pension plans listed in the protocol to the double taxation agreement) lower your German taxable income, just like a Rürup-Rente contribution would, i.e. 94% for contributions made between 01.01.2022 and 31.12.2022 and starting with 2023, all, i.e. 100% of your contribution to the eligible US pension plan are tax-deductible in your German tax return.

 

This is the best pension plan you can get, use it. Much, much better than a German plan like a Rürup plan, which always comes with yearly fees and commissions: https://www.toytowngermany.com/forum/topic/370917-full-time-job-money-on-the-sidesavingsother-income-advice/?do=findComment&comment=3581838

 

"Eligible" US pension plans: all these plans (except the Roth-IRA!) but only if you had first paid into it before starting to work in Germany: http://pinkernell.de/dbausa.htm#Protocol

• a) For purposes of paragraph 4 of Article 18A, the term "pension plan" shall include the following and any identical or substantially similar plans established pursuant to legislation enacted after the date of signature of this Protocol:

  b.) For purposes of subparagraph b.) of paragraph 3 and subparagraph d) of paragraph 5 of Article 18A, it is understood that:

• aa) In the case of the United States, qualified plans under section 401(a) of the Internal Revenue Code, individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k), individual retirement accounts, individual retirement annuities, and section 408(p) accounts, and Roth IRAs under Section 408A), section 403(a) qualified annuity plans, section 403(b) plans, and section 457(b) governmental plans.

   

• bb) In the case of the Federal Republic of Germany, arrangements under section 1 of the German law on employment-related pensions (Betriebsrentengesetz).

  aa) The Federal Republic of Germany recognizes qualified plans specifically listed in clause aa) of subparagraph a), other than Roth IRAs

[USADe 0]

I agree @PandaMunich that coming to the Germany with a traditional IRA gives you the best retirement savings options available in Germany. My wife uses this and we have been able after several attempts (thanks to the great info gathered on this forum) to get the Finanzamt to approve the deduction.

 

But we also have 401ks that we can't contribute to any more and we plan to eventually move back to USA. So converting balances from the traditional sub-accounts of our 401ks to the Roth sub-accounts could be advantageous for people in our situation if US taxes can be avoided since withdrawals in the US would be tax-free for both contributions and gains. If we are wrong and we don't move back it may not be negative (other than doing a lot of paper work for nothing) because when we withdraw from the Roths this conversions should still count as the contribution/basis so again only the gains would be taxable in Germany.

@BethAnnBitt  you are right that it all depends on how the IRS will treat this. The conversions are definitely taxable income but the two paths I laid out either put that income in the standard deduction (path 1) or resource the income to foreign source general category income so that foreign taxes from self-employment or job income can be used against it (path 2).

[Straightpoop 676]

20 hours ago, USADe said:

Only once you start withdrawing more than you contributed the gains are taxable as capital income.

 

Nope.

 

Each withdrawal has a proportional amount of the tax-free contributions.  The difference will be taxable.

 

Basically, Germany applies the same principle used in US tax law for withdrawals from traditional IRA/401(k) accounts in which you have a (US) tax-free basis (see:  Form 8606). 

 

Also, keep in mind that the mere change of residence to Germany will not change the US source of IRA distributions allocable to contributions from US-sourced earnings.  For example:  If you contributed 25,000 to an IRA before coming to Germany and then proceeded to contribute another 25,000 from German sourced employment/self-employment income (not excluded under §911) and then took a distribution, 50% of that distribution would be considered US sourced and 50% would be German sourced. 

 

The treaty would not allow you to resource that US-sourced 50% because Germany would be taxing only the 50% of the distribution allocable to the contributions made since you began your German residence. That being the case, there would be no double taxation and hence, no resourcing to avoid same.  You would declare the entire distribution on your US return and claim a credit only for the allocable portion of German taxes paid on the 50% attributable to German sourced employment income.

 

For Form 1116 purposes, the entirety of IRA distributions - like all pension income (attributable to employment) - are items of general limit income.  Whatever passive character earnings on contributions may have had when earned within the IRA (interest, dividends, gain, rent, etc.) is lost when distributed; they together with the contributions are transmogrified into "pension" (general limit) income.

 

 

 

  

[BethAnnBitt 2,906]

4 hours ago, USADe said:

@BethAnnBitt  you are right that it all depends on how the IRS will treat this. The conversions are definitely taxable income but the two paths I laid out either put that income in the standard deduction (path 1) or resource the income to foreign source general category income so that foreign taxes from self-employment or job income can be used against it (path 2).

I can only speak to our situation, clearly not exactly the same as yours, which is US retirees living in Germany off of 401K/IRA withdrawals and SS as our source of income, and no contributions were made to those pension accounts while working in Germany.  Best of luck to you navigating all this and Happy 2023!

[USADe 0]

Thanks! This is all very helpful and interesting information. I see now that resourcing income under the treaty requires there to actually be a German tax liability on that income. So what I wrote as path 2 is not possible.

[Barticagyal 1]

I have searched the site and have not found an answer for this specific question so far, so apologies if it has been posted.

 

Contributions to SEP-IRA or 401K in the US.  If you receive a tax benefit on US taxes (reduce AGI for contributions to SEP-IRA or non-tax contribution to 401K) can you also receive a tax benefit in Germany for these contributions?  Or is it the case that you can only claim a benefit in one country?   

 

Assuming tax resident for Germany and claiming FTC for US.  

 

Also, looking for a knowledgeable Steuerberater in Germany that has experience & patience with expats from US. 

[Gold and a Pager 17]

On 12/30/2022, 11:14:50, PandaMunich said:

A Roth IRA, to which you contribute after-tax money, only has the advantage that your money can grow in it undisturbed by German taxation until you start withdrawing.

 

If you have an eligible US pension plan, e.g. a traditional IRA, into which you had started paying into since before you had started working in Germany, which makes it "eligible" under the double taxation agreement, you should hold onto it and continue contributing to it!

 

 

If you create a Roth IRA after starting to work/reside in Germany, I understand that there are no advantages with regard to deducting the contributions, but the growth would still be undisturbed by German taxation, right?

[PandaMunich 16,570]

1 hour ago, Gold and a Pager said:

If you create a Roth IRA after starting to work/reside in Germany, I understand that there are no advantages with regard to deducting the contributions, 

Contributions to a Roth-IRA are never tax-deductible, the Roth-IRA its nature it is a pension plan to which after-tax money gets contributed: https://www.investopedia.com/terms/r/rothira.asp

 

1 hour ago, Gold and a Pager said:

the growth would still be undisturbed by German taxation, right?

Yes, since that is laid down in article 18A (1) of the DTA, which doesn't have as its pre-condition that the plan needs to have been paid into before starting to work in Germany.