TOP TEN INVESTMENT MISTAKES MADE BY AMERICANS ABROAD

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1 TOP TEN INVESTMENT MISTAKES MADE BY AMERICANS ABROAD January ) Buying foreign mutual funds. Foreign mutual funds may seem attractive to an American living abroad. However, in the view of the IRS, a foreign mutual fund is considered a Passive Foreign Investment Company (PFIC) and is a tax nightmare for U.S. tax filers. If you are a U.S. citizen or a U.S. permanent resident who has been living and working outside the U.S. and investing your savings through a non-u.s. financial institution, you need to understand PFICs quickly. PFICs are subject to special, highly punitive tax treatment by the U.S. tax code. Not only will the tax rate applied to these investments be much higher than the tax rate applied to a similar or identical U.S. registered investments, but the cost of required accounting/record-keeping for reporting PFIC investments on IRS Form 8621 can easily run into the thousands of dollars per investment each year. 2) Doing Nothing. Many American expats find themselves so overwhelmed by the complex rules and many horror stories they have heard about investing while living abroad that they are cowered into taking no action at all. However, remaining in cash will not provide for a comfortable retirement for yourself or a college education for your kids. Investing efficiently and compliantly while living abroad can be daunting, but it does not have to be overwhelming. A little research can go a long way. Qualified advisors can be found. Do not give up. This is too important. Thun Financial Advisors, L.L.C. is a U.S.-based, fee-only, Registered Investment Advisor that provides investment management and financial planning services to Americans residing in the U.S. and overseas. We maximize long-term wealth accumulation for our clients by combining an index allocation investment model with strategic tax, currency, retirement and estate planning. We guard our clients wealth as though it was our own by emphasizing prudent diversification with a focus on wealth preservation and growth. Thun Financial Advisors 3310 University Ave Madison, WI Skype: thunfinancial thunfinancial.com 1

2 4) Overinvest in your country of current residence. Fortunes have been made in all corners of the Earth, 3) Not understanding the underlying currency exposures of their portfolio. Expat investors often mistake the currency in which their brokerage firm reports the value of their investment with the fundamental currency denomination of those same investments. For example, many foreign public companies list their shares in both their home country and in New York. The New York listed shares will trade in dollars, but that does not make them fundamentally U.S. dollar investments. The U.S. listed shares will simply track the performance of the shares on their primary exchange. Similarly, the performance of a U.S. listed mutual fund that invests in foreign currency bonds will be determined by the fate of those underlying currencies. It is irrelevant that the fund trades in New York in dollars. The corollary is that truly multi-currency investment portfolios can be constructed through a U.S. brokerage firm that lists all investment values in dollars. What matters is the currency denomination of the underlying investments, not the reference currency of the brokerage statement. and rapid growth and opportunities may seem limitless one day and disappear the next. It can be particularly easy to become intoxicated with change or progress when you are presently profiting from it and have the edge of living and breathing in the local market. The laws of diversification are universal, and the penalties of failing to obey those laws are equally universal. Take profits in the local market along the way and re-deploy them into other (i.e., stable, boring) markets just in case your bullish longterm thesis turns out to be too darn bullish! 5) Failure to properly report foreign financial assets on U.S. tax return. Following IRS reporting requirements is an important concern for Americans living and investing abroad. Virtually all foreign financial assets that are not being held in a domestic (U.S.) financial institution are subject to numerous reporting requirements. These reporting requirements include, but are not limited to, timely filling of a Fin- CEN Report 114 (FBAR), IRS Form 8938 (Statement of Specified Foreign Financial Assets), and IRS Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund). Cost of compliance with these regulations often makes otherwise attractive investments inefficient, if not outright unsuitable, for a U.S. investor. In light of FATCA, risk of non-compliance should only further steer any and all U.S. investors towards keeping their financial assets in a domestic institution, where none of these requirements apply. 2

3 6) Fail to properly report for U.S. tax purposes a foreign business entity. Americans with ownership stakes in foreign entities have complex IRS reporting requirements. Failure to properly report ownership interests in Controlled Foreign Corporations (CFCs), Foreign Partnerships, and Foreign Trusts can lead to substantial IRS penalties. For example, failure to file Form 5471 for a CFC typically results in penalties in excess of $10,000 per form and opens the taxpayer s entire return to an audit indefinitely. While in the past it has been difficult for the IRS to discover ownership information on foreign corporations, this is currently becoming much easier through FATCA and intergovernmental agreements. Enforcement for these violations will only increase in the future. Many American entrepreneurs starting companies abroad unknowingly dig themselves into a deep tax reporting and compliance hole by starting to deal with these issues many years after launching their businesses. 7) Pay high fees for a non-u.s. investment that could have been bought through a U.S. broker for much less. At the retail (individual or family) level, there is virtually no investment available anywhere in the world that cannot be purchased cheaper through a U.S. discount brokerage firm. Investment expenses (brokerage fees, trade commission, advisory fees, mutual fund fees, etc.) are substantially lower in the United States than they are anywhere else in the world for the same or very similar investments. Furthermore, the range and liquidity of investments available to retail investors through U.S. brokers is vastly greater than it is everywhere else in the world. 8) Buy non-u.s. tax compliant insurance. Any non- U.S. registered insurance products that hold cash value policies that can be redeemed for some amount of cash immediately almost never qualify under U.S. tax rules as insurance. Hence, they do not benefit from any of the tax advantages that can sometimes make insurance a good long-term investment primarily tax deferral. Without this protection, your insurance policy is nothing more than a foreign investment account in the eyes of the IRS. In addition, it is probably a foreign trust and loaded with Passive Foreign Investment Company (PFIC) investments. Such investments and their tax reporting requirements are absolutely tax toxic for U.S. taxpayers. 9) Contribute to non-qualified foreign pension plan. American citizens living abroad often participate in foreign pension plans sponsored by their employers. Foreign pension plans generally have beneficial tax treatment under local country of residence law and employers often make valuable pension contributions. However, even in light of all these benefits, American expats must remain aware that not all foreign pension plans receive favorable tax treatment under U.S. tax law. 3

4 Most foreign pension plans are not qualified under double taxation treaties and participation in a nonqualified foreign pension plan can have negative tax consequences. For example, local tax benefits may be nulled by U.S. tax treatment and double taxation could occur in the worst case scenario. A high risk of failing to report these assets further adds complexity to planning a retirement with a foreign pension. Americans living abroad should beware of the tax treatment of both contributions to, and distributions from, these foreign plans in order to avoid headaches in the future. 10) Rely on your legacy U.S. estate plan. Your U.S. estate plan may not travel well. Laws regarding wills, trusts, and who can lawfully inherit your wealth upon death may be different in your new country of residence, and, as a result, you may find that your legacy estate planning strategy either (1) is no longer legal valid, or (2) even worse, triggers taxes that render the strategy completely counter-productive. When you relocate to a new country, it makes sense to consult with an estate plan expert that understands U.S. estate planning, estate planning in your jurisdiction of relevance, and the potential interaction of tax treaties and foreign tax credits on the distribution of your wealth. 11) Sticking with your old U.S. tax preparer even after moving abroad. Many competent U.S. tax preparers will mistakenly believe that they can continue to prepare your tax returns even after you move abroad. But beware: quite often, even a very good domestic tax preparer may be out of their depth when preparing expat returns. Too often, the tax preparer with little or no expertise in expat tax preparation will fail to do even the most basic research on special reporting requirements, relevant income tax treaties, the application of foreign tax credits, etc. We re not telling you that your existing tax preparer is purposefully misleading you, but we are certainly suggesting that finding out years from now that your tax preparer confidently continued to prepare your returns without considering the requirements of X, Y, and Z can be hazardous to your financial health. 12) Not understanding U.S. retirement account contribution rules when you have foreign earned income. Many Americans who move abroad incorrectly assume they can no longer contribute to U.S. retirement accounts such as IRAs, Roth IRAs, or 401ks. Others make the mistake of continuing to contribute without understanding the special rules that affect the eligibility of Americans abroad to continue to contribute. Finally, those eligible, often contribute without making a full analysis of the local tax implications of a contribution and unwittingly set themselves up to be double taxed on the income contributed because they did not fully understand the complex interaction of their local tax obligations and their U.S. tax obligations. 4

5 Editor s Note: We realize that our top ten mistakes list twelve mistakes. At the risk of excluding a mistake of which readers should be aware, we re leaving twelve top-ten-worthy mistakes to avoid. Contact Us Thun Financial Advisors 3310 University Ave Madison, WI Visit us on the web at Copyright 2015 Thun Financial Advisors DISCLAIMER FOR THUN FINANCIAL ADVISORS, L.L.C., THE INVESTMENT ADVISOR Thun Financial Advisors L.L.C. (the Advisor ) is an investment adviser licensed with the State of Wisconsin, Department of Financial Institutions, Division of Securities. Such licensure does not imply that the State of Wisconsin has sponsored, recommended or approved of the Advisor. Information contained in this brochure is for informational purposes only, does not constitute investment advice, and is not an advertisement or an offer of investment advisory services or a solicitation to become a client of the Advisor. The information is obtained from sources believed to be reliable, however, accuracy and completeness are not guaranteed by the Advisor. The representations herein reflect model performance and are therefore not a record of any actual investment result. Past performance does not guarantee future performance will be similar. Future results may be affected by changing market circumstances, economic and business conditions, fees, taxes, and other factors. Investors should not make any investment decision based solely on this presentation. Actual investor results may vary. Similar investments may result in a loss of in investment capital. 5