It sounds counterintuitive, but you can actually earn a fortune by quitting your job, retiring to Europe and spending the next few years of your life traveling throughout the continent drinking wine and staying at expensive hotels. I’ve created an expat retirement planning tool that will help you calculate whether and how you can take advantage of the various life hacks and tax planning opportunities that make this outcome possible. You will find a link to this tool at the end of the article.
What do you need first?
Step one: right now, you live in a high cost area with high state property and income taxes.
Step two: you have developed (or are working to develop) sufficient sources of passive income to support your lifestyle. Those passive income sources could include a pension, social security, income from a liquid portfolio of assets, rental income, or some combination of all of these. You can also add in income that you earn from working remotely.
The amount of income you think you need may be a much lower number than you’d guess – which is where the expat retiree planning tool will come in, later. As you’ll see, a high-earning family that is barely getting by in a high cost area like San Francisco or Boston can quit their jobs and earn MORE net cashflow by retiring abroad.
Step three: you have identified a low cost foreign jurisdiction where you can reside full-time with little to no local income tax exposure and very low medical expenses. There are many possibilities to explore, but here are a few to get started:
A. Portugal. My family and I moved from Washington DC to Portugal nearly three years ago. There is tax program in Portugal called the “non-habitual resident” regime. Persons who haven’t resided in Portugal before can move here and reside full-time for up to ten years free of Portuguese taxes on most of their non-Portugal source income. Living expenses in Portugal are about 25% less than living expenses in cities like Los Angeles, Boston, New York, or the Washington DC area, and the cost of healthcare insurance is a tiny fraction of what comparable US health insurance rates are.
B. Ireland. Living expenses in Ireland can be low, and residents who qualify as non-domiciliaries are subject to tax on foreign source income based on how much (if any) income they bring into the country. It may be possible to limit tax exposure by using a US credit card to defray living expenses, which would leave less need to bring foreign source income into the country. Irish tax rules are complex and require the expertise of a local accountant.
C. Andorra, Malta, Gibraltar, Montenegro, the Czech Republic – these are all relatively low cost areas in Europe with either very low income tax rates or, potentially, income tax rates of zero. Living expenses vary, although it appears costs for health insurance can be low relative to what you find in the USA. You can find excellent summaries of the tax rules for each of these (and other countries) if you do an online search for publications by any of the large international accounting firms such as Price Waterhouse or KPMG.
These are only some possible options, and a full discussion of each jurisdiction is beyond the scope of this article (and beyond the expertise of the author).
Step four: you need to reinvest the cost savings you earn each year.
Now that you’ve completed these four initial steps, let’s get into the guts of what you do next. I’m going to demonstrate a few tax gambits and cost arbitrages using an example that walks through how you can use the expat retiree planning tool. Once you download the tool, you can input your own data and also change the equations and assumptions of the tool to make it more accurate to your situation (for example, you might want to change the tax computations to include RMDs from your IRA, or lower the assumed average marginal income tax rate, or change the standard deduction assumption from married filing jointly to single or to head of household). In its current, generic form, the expat retiree planning tool is designed to be a general starting point – but it is flexible enough for readers to adapt and customize it to their own needs.
Take Sarah and Edward. Sarah and Edward are a married couple who live in the Washington DC area. They are each 48 years old. They have no children, and receive no pension income or social security. They recently purchased a home for $750,000 and carry a mortgage of $400,000 on the property. They also own a portfolio of stocks and funds worth $600,000, and have just received a windfall of $100,000 in the form of a cash inheritance from Sarah’s great aunt. Their combined net worth is $1,050,000.
Sarah and Edward input their housing information into the expat retiree tool, along with the interest rate on their mortgage and their annual property tax.
They also enter in their portfolio information, broken out by asset category, tax treatment for income from the various asset types, and yield. (You can put in additional categories for other asset categories that match your portfolio or a portfolio that you’re considering building). The tool will automatically determine the total qualified and non-qualified dividend income, and feed that through a back-of-the-envelope tax calculation.
Sarah currently does not work, but she has worked for many years and is fed up with the rat race. Edward works in recruiting and earns a salary of $80,000 a year, but he has recently been giving some thought to trying to work remotely. He believes that he can earn up to $20,000 a year working online for a legal recruiting newsletter that he’s already started and that’s already bringing in some cash. The problem is that he just doesn’t have enough free time to devote to the project to make it commercially viable. Edward would definitely have the time to develop his online career if he quit his job as a recruiter, but trading an $80,000 a year salary for the mere possibility of earning $20,000 doesn’t make any financial sense to him… and certainly as long as he and Sarah remain in the DC area. As it stands, they are getting by on a very thin margin of safety. It strikes them as crazy that a couple with a high five figure salary and a net worth of just over $1,000,000 should only be able to save $5,000 a year, but living expenses in the DC area have been rising unrelentingly. The other issue is that Sarah and Edward have started to travel more – partly because they are interested in going out into the world to find another way.
Gambit Number One: The Foreign Earned Income Exclusion
It’s possible that if Edward worked and earned income abroad, he might be eligible for the foreign earned income exclusion. Expats who earn income (such as a salary) while working abroad may be eligible to exclude the first $104,000 of earned income from Federal income tax. This exclusion presents a huge planning opportunity for someone like Edward, because possibly his $20,000 could escape US income tax (and maybe even Portuguese tax as well).
Edward inputs all of this salary and earning information into the planning tool. The tool obviously cannot tell him the tax consequences of his idea, but if the numbers work out, Edward knows that this will be an area that he can explore with his accountant.
Edward and Sarah are interested in moving to a beach town on the coast of Portugal. They found a very charming house with a view of the ocean that costs $350,000 at today’s exchange rates. They don’t have the cash to buy the house outright, and obtaining a mortgage in Europe seems like it’s next to impossible.
They’ve decided that they could take out a home equity loan on their DC property, and use the proceeds of that loan and their $100,000 in cash to purchase the beach house in Portugal. This presents another planning opportunity, and Sarah and Edward are exploring two options for what to do next.
Gambit Number Two: enhance cash flow by turning a home into an income producing asset, and use depreciation deductions to reduce tax liability.
One option is that they will rent out their DC home, and use the rental payments to offset the mortgage and the home equity loan. This approach might accomplish two major benefits. First, it could boost their net cash flow modestly, because the rental rates in DC are fairly high relative to the cost of an added loan on their DC residence. Second, Sarah and Edward can claim depreciation deductions on their DC rental property, shielding not only the rental payments but also potentially shielding some of their investment income as well.
Alternatively, Sarah and Edward might decide to go completely debt-free, sell their DC home and reinvest the proceeds into the Portugal beach house and also into liquid securities. That approach would also impact their overall cash flow as well as their tax posture, but the moving parts are too complicated to visualize without the aid of a computer.
Sarah and Edward aren’t sure which approach would make the most financial sense – but the expat retirement tool should help them visualize all the moving pieces. They enter the rental information for their DC house, along with the applicable interest rate on the home equity loan, into the planning tool. The tool automatically calculates what the rough interest expenses would be if they keep their DC house and use a home equity loan to help purchase the house in Portugal. The tool assumes a depreciation basis on the DC property as well. Since only buildings and structures (and not underlying real estate) are depreciable, the tool assumes that Sarah and Edward will only be able to claim 75% of the value of their DC home for depreciation purposes (you can change this assumption to suit depreciation rules that are applicable to your own situation).
The expat retiree tool automatically calculates what the additional dividend income would be if Sarah and Edward sell the DC house and reinvest the net proceeds into a portfolio of blue chip dividend stocks or stock funds. In this way, the tool will help Sarah and Edward do a side-by-side comparison of both approaches, and help them see which would be optimal.
Gambit Number Three: lower healthcare costs and living expenses to fuel out of pocket savings.
Sarah and David have priced out some health insurance policies in Portugal. They figure that their basic living expenses will be 25% lower in Portugal than the USA. They also realize that they will incur additional legal and accounting fees in Portugal for things like their Portuguese tax returns and residency permit applications. All of this information goes into the planning tool.
Gambit Number Four: reduce net travel expenses by renting out the beach home in Portugal whenever Sarah and Edward are away, and use cheap airfare to get around Europe.
Sarah and Edward would like to travel around Europe as much as possible. By living in Europe, airfare is going to be far lower than airfare from the USA to Europe. Not only that, they realize that since their house in Portugal is located in a prime tourist area, they can rent it out as a short-term vacation rental whenever they aren’t at home. By doing so, they will be able to substantially offset the cost of hotels if they take a trip to, let’s say, Munich or Barcelona. Who knows? They might even upgrade themselves to fancier hotels. They definitely want to take more trips per year if they move to Portugal.
They input this data into the planning tool.
At this point, the planning tool takes care of all the rest. The tool gives a very rough calculation of the travel savings, health insurance cost savings, cost of living savings, savings from having to pay state and local income taxes, tax savings from the foreign earned income tax exclusion. The tool also calculates the added rental income, and possible added dividend income if they sell their DC house and reinvest the net proceeds. Finally, the tool provides a rough guess as to the Federal income tax impact of each option: stay in DC and work, expatriate and rent the DC house, or expatriate and sell the DC house.
The expat planning tool digests all this data and determines Sarah’s and Edward’s total savings and the total impact on their cash flow for each of the three different options that they face. It turns out that their after-tax net cash flow is substantially higher if they move to Portugal – even if Edward takes an $80,000 pay cut to pursue his new online venture. If they keep their DC home and rent it out, their net cash flow jumps to $38,339, and if they sell the DC home and reinvest the net proceeds, their net cash flow goes to $33,714.
Gambit Number Five: harness the “stealth dividend tax exclusion.”
You might not have realized it, but the first $70,000 of your long-term capital gains and qualified dividend income is taxed at a rate of zero percent. If you have no income besides $70,000 of qualified dividends, your Federal tax rate is zero, but the more other income you have, the more of this “stealth” dividend tax exclusion gets crowded out.
Since Edward and Sarah can use depreciation deductions to shield their taxable income, more of their qualified dividends now escape federal income tax.
Gambit Number Six: use the power of compounding to transform savings on taxes and living expenses into a larger pool of investment capital.
Last of all, the expat planning tool determines that if Sarah and Edward stay in Portugal for 10 years and reinvest all of their annual savings, their decision to retire early and live abroad will earn them over $500,000 if they earn 6% on their reinvested savings (the tool enables you to assume any future rate of return you wish, for as many years as you care to enter).
At the end of the exercise, the tool demonstrates a result that is, in fact, equivalent to getting paid over half a million dollars… on an after tax basis… to quit an $80,000 a year job, and retire ten years early to go live on the seashore and travel around Europe in high style. It doesn’t seem like this should be possible – but I can tell from personal experience that it absolutely IS. That’s all thanks to the six planning techniques I’ve described.
Could you pursue similar opportunities yourself? Go ahead and try out the tool for yourself and find out. Stress test different outcomes based on how much of your portfolio is invested in REITs and MLPs, or based on your mortgage borrowing costs. Add additional factors to the tool that I haven’t considered. Make the income tax calculations more precise. In short, use the spreadsheet as a launchpad to help you start thinking about opportunities you might have to not only step off the treadmill early… but to actually get paid for doing so.
Here is the link to the spreadsheet.
Click the link, hit “file” and “make copy.” Then, go ahead and enter whatever data you wish into the spreadsheet, or make modifications to adapt the spreadsheet to your own uses.
Most importantly of all, feel free to comment with practical questions or to point out mistakes or oversights that I have made. I’m always happy to share whatever practical wisdom I’ve picked up along the way with readers, and as we all know, the comment streams on Seeking Alpha are sometimes more informative than the articles themselves!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article, and the spreadsheet tool attached to it, are not investment or tax advice and cannot be relied upon for any reason whatsoever besides entertainment value. The calculations and tax rules in particular may be incorrect, incomplete, and non-applicable to a reader, and should only be viewed through a “I might want to look into this further” type of lense.