Tax Planning
It is never too soon to start worrying about these things...
There are now only two countries (Eritrea and the United States) that have a lifelong citizenship-based taxation system. Since I am not sure I have any readers from Eritrea I will write today from the perspective of the US, which taxes the worldwide income of its non-resident citizens.
Sticker Shock
The US tax rates are rather modest when compared to the rest of the world. (And if you are fortunate enough to be in the 1%, or claim to be like some former President, you can pay nothing.) NHR, the tax scheme that reduces one’s Portuguese tax obligation during the first 10 years of residency is a major draw for many expats. However, some seem unaware of “traditional” (i.e. non-NHR) Portuguese tax rates. Perhaps they intend to move back to the States after 10 years, or to another country. Perhaps they don’t plan that far ahead. If you are one of these people, prepare yourself for a bit of sticker shock. Below please find the Portuguese income tax table for 2023.
Now that you have picked yourself up from the floor, permit me to offer a few caveats.
This is a progressive system, so like the US, you pay 14.5% on the first €7,116, 23% on the next €3,619, etc. So on the first €75,010, you are effectively paying 37%…which by the way is the maximum rate for a single taxpayer making more than $578,125 this year in the US.
Interest, dividends, and capital gains are typically taxed at 28%.
Certain Federal pensions may be tax-exempt. NB: US Social Security is not considered a Federal pension.
Planning Ahead
So while it is not exactly 48%, it is still a lot more than most Americans are used to paying.1
If you are a long-term reader you know that when it comes to money, I think it is never too early to plan. So even though we still have 7.5 years left on NHR, I spent an hour meeting with the founder and Director of All Finance Matters (AFM) yesterday. As a tax preparation customer of theirs, we are entitled to a free consultation each year. It seemed a good time to start getting the answers to two questions:
Exactly how is income, including investment income, handled during NHR and after NHR?
Are there actions we should take before NHR runs out, that will minimize our taxes after NHR?
What to Take When
I can’t offer any advice to you relative to your retirement withdrawal strategy, but I will share a few items that surprised me. First, in the States, the traditional advice is to wait as long as possible to withdraw from your Roth. That’s because you have funded your Roth with after-tax dollars, hopefully it will grow, and you will not owe any taxes when the money is withdrawn. However, depending on your situation…you might want to take your Roth sooner. Under NHR you will owe nothing … but after NHR you will pay 28%.
Another surprise, which frankly I still am a bit confused by, relates to annuities. I am not a big fan of annuities, but Denise had 3 before we met. None had employer contributions…i.e. the initial investment was all her money. We have just let them ride for the past 27 years. We were advised to also divest them during NHR as 85% of the withdrawal is not taxed, and the remainder is taxed at 10%. After NHR the taxation is not as favorable.
Now I don’t mean to offend, but we have a good problem. Between pension, Social Security next year, and Required Minimum Distributions in 3 years…I am not exactly sure how we will spend the annuities. I’ve shared our monthly spending with you…we don’t have a mortgage or car payment and frankly live very well on less in Portugal. When I raised this issue, I was told we could invest in insurance products that were tax-exempt in Portugal. Since annuities are insurance products … I am confused!
Here’s the Point
So here is the point of this post. If, like us, you have a good problem, i.e. a variety of potential sources of income in retirement, consult a qualified professional. It may be the US way of withdrawing funds may need to be altered. You will have to weigh the tax implications in the US and Portugal.
In addition, it is likely that you need to increase your withdrawal rate after NHR so you can afford the same standard of living as you have enjoyed, once you start paying the higher tax rate. I actually have a spreadsheet that reflects this.2
Finally, I realize that not everyone is as fortunate as we are. However, after NHR Portuguese tax planning is important for everyone. Let’s assume your only source of income in retirement is the average Social Security check ($1704/month). In the US as a single tax filer, you would owe nothing. However, in Portugal at the current exchange rate, your annual income is €19,450…it is likely you will have to pay Portuguese income tax.
Algo em que pensar, Até à próxima vez, Fica bem
Nanc
NB: Next week breaking news on the end of NHR.
US tax rates have been on a downward trajectory since 1986 when the top rate was 50%. I found it interesting to learn that in 1944 the top rate was 94%. And you thought taxes were high in Portugal.
I know some of you are saying, “Of course you do”.
Another fast and fantastic post. I appreciate how you're able to get to the meat of things plainly and quickly. Of course, I also love your longer, more detailed posts. But a post is a post: any little or long bit of a read from you is better than none!
Nancy, your points are well made and pertinent: Start early, plan ahead, and get competent assistance. I did our Portuguese tax return myself this year - a multi-week project that nearly wore out my translation app! The shocker for me was that at the end, I had no idea how much tax I owed. Since all of our income is "foreign sourced" (from the US), the online tax submission system could not calculate it. We had to wait until we got a bill in early August. I had some sticker shock at that point, but also had AFM audit my return to ensure I'd done it correctly. They said I did, so I paid the bill and promised myself I'd let them do the whole thing for me next year!