Avoid cross-border investing mistakes
Just because you are investing abroad does not mean you will get a better deal or a higher return. In fact, keeping your money “close to your chest” in your home jurisdiction is very often the safest option.
Our Bermuda regulatory system includes many taxes — some of them just purely punitive in nature. But, Bermuda does not levy a corporate or personal income tax, leaving Bermuda residents who have never been exposed to another country’s income tax regime, immigration, insurance and legal infrastructure, ill-prepared for the quagmire of other country’s tax and regulatory structures.
Yet, when Bermuda residents venture abroad to other countries, physically or electronically, they are still attracted to sales pitches from financial advisers, who may not be qualified for the complexity, complications, and due diligence standards implicit in advising foreign nationals. This is true — in just about every case that I have seen or heard about, where Bermuda residents invested abroad.
Our hypothetical case follows Henry as he attempts to extricate himself, and his money), from another jurisdiction, the United States. Note that this is a composite of real life situations, all changed to protect confidentiality of persons kind enough to share their international investing woes with me. Further, it provides only a general overview of US annuity products, a very, very complex investment structure, loaded with US tax implications.
Henry is a Bermudian permanent resident. He has no citizenship or green card or tax resident connections to the US. On vacation there a decade ago, he was able to open an investment account at one of the local banks in a small US town.
His portfolio of US stocks and bonds had its ups and downs, but overall had performed reasonably well. Currently, Henry is close to retirement. Increasingly concerned about the volatility in investment markets, he decides to cash out the US portfolio and move on to something “safer and more guaranteed.”
A couple of weeks later, he meets the bank’s financial adviser who recommends a couple of non-qualified, tax-deferred annuity products, one with a guaranteed rate of return of 2.7 per cent, the other linked to the S&P performance in US capital markets. The adviser explains that these products will pay out monthly for a set term, or for his life expectancy, then gives Henry a large set of application forms to complete. There is little mention of tax considerations, how the adviser is paid and no discussion regarding Bermuda’s tax regime. Henry assumes these products are like mutual funds, and will provide his additional retirement income.
He returns home. The annuity payments commence, but are a lot less than quoted, because a 30 per cent US tax is being withheld on every distribution (US annuity distribution tax regulations). Further, if he passes prematurely, it appears to him that his spouse will also be taxed on the remaining proceeds, while having to cope with a US federal estate tax situation.
Henry is just appalled. This is not how he understood these annuities would work for him. He decides to terminate this completely unintelligible investment. A call to the adviser is disastrous. Yes, he can cash out — at a 9 per cent penalty on the whole amount invested. Henry is extremely upset, berating himself for being so stupid.
What just happened here?
First, Henry is not a stupid individual. No one crossing borders to another country can be expected to have a significant understanding of foreign tax, investment, and insurance laws and how those laws will relate to them. The job of the financial adviser is to understand the client’s financial profile and provide investment recommendations that are suitable for them.
US Tax Categories
There are three very different tax structures within the US tax law for individuals: income tax, gift tax, and estate tax, all taxed at different rates under different circumstances.
US income taxation is further broken down into:
• active (earned wages) income from services performed
• portfolio income derived from investments: interest, dividends, capital gains, and royalties, and
• passive income, ie from rental property.
Non-resident aliens with no ties to the US follow a different set of tax regulations than US persons, bringing additional complications (and often higher taxes) if the country where you reside does not have a tax treaty with the US. Bermuda does not have one.
Non-resident aliens are not subject to capital gains tax on their appreciated investment returns. Real property sales yes, investments — no. This meant that Henry was sitting on tax-free investment proceeds before he met the adviser.
Instead, Henry’s US tax-free portfolio has been turned into a US tax-driven product, fully contingent upon the continued solvency of an insurance company (rated BBB on the credit scale), and probably subject to US estate tax entanglement. What good is that?
To be very blunt, if the adviser had a fiduciary responsibility to Henry, he should have declined to sell any US annuity products to a non-US person.
The adviser earned commission of somewhere between 3 per cent and 6.5 per cent on this annuity sale.
So, what should Henry have done? One good answer: repatriated the cash to Bermuda where he could invest in products that are not subject to US taxation.
More on the annuity product topic in detail at another time. Remember, our Bermuda National Pension Scheme pays out in annuity structures, but no income tax.
For good resource reading, low investment management fees and licensed noncommissioned annuity specialists, go to the Vanguard Group. The link is:
Readers, I have written on this topic for years; still, the message needs to be reinforced again and again. The consequences of untangling from another country’s tax, financial, immigration and other service agencies are often tedious, expensive and very upsetting. Please, please get international tax and finance planning before you invest anything in another country.
Do not rely upon local financial advice in Bermuda or any other jurisdiction, US, UK, Canada, etc, unless the individuals (or firms such as KPMG and EY Bermuda) can demonstrate that they have extensive experience and verifiable credentials qualifying them in international tax and financial planning.
Full disclosure. Readers, this is not a “pitch for business.” Pondstraddler Life Consultancy limits to only specific cross border planning cases. The author does not sell or own annuity investment products.
Readers, if you have an issue (or a horror story) that you would like to share, please write to me. Once a month, cross border financial planning questions involving Bermuda residents will be answered — on a generic basis — so that all identities and circumstances will remain confidential.
Martha Harris Myron CPA CFP JSM: Masters of Law — international tax and financial services. Pondstraddler Life, financial perspectives for Bermuda islanders with multinational families and international connections on the Great Atlantic Pond. Contact: firstname.lastname@example.org
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