Employers that operate globally must often set up offshore locations and find employees to staff them. It follows that employers who sponsor retirement savings plans for their eligible U.S. employees likely will want a similar benefit for their employees outside the country. Many are taking steps to find the best way to make that happen, with plan sponsors increasingly seeking information related to vehicles designed for non-U.S. employees’ retirement savings.
Like Social Security in the United States, some countries have a government pension system that will provide retirement income to residents in retirement. And as with U.S. employer-sponsored retirement plans, it may be prudent in many countries to supplement workplace retirement savings through private retirement savings efforts.
This column highlights a few considerations that require attention ahead of establishing and funding a retirement plan for employees working outside the United States.
Who Can Participate?
When U.S. employees travel overseas to work and experience extended stays to complete assignments and special projects, they may continue to participate in U.S.-based retirement savings plans. Offshore employees are likely to become aware of the U.S. plan and its benefits, such as employer matches. In an effort to maintain fairness for local employees working with the U.S. transplant, some plan sponsors may allow employees not domiciled in the States to participate in the U.S. retirement plan. But it’s safe to say that the U.S. plan sponsor is not likely to be making tax-effective contributions for such employees.
It’s also important to become familiar with mandatory, state-run provident funds that exist in several countries, especially in Asia. With these, the U.S.-based employer is required to ensure that all local employees, or those foreign nationals compensated on local terms, are having a substantial withholding made each pay period for retirement, as required by law.
By the same token, non-American employees of a foreign subsidiary may be on extended assignment in the U.S., working on a resident-alien visa. In some cases, the resident-alien employees are permitted to participate and begin making contributions to the U.S. 401(k) plan. While a resident alien can benefit from pretax deductions that will lower his or her taxable income on the deferral side of 401(k) plan participation, it is advisable to give special consideration to the tax consequences that will apply upon distribution of plan assets.
Those tax consequences may be imposed by the Internal Revenue Service (IRS) or by the taxing authority in the country to which the employee plans to return. For example, consider whether the employee plans to stay in the United States, or where the participant will likely be at the time of distribution and whether a tax treaty is in effect for his home country. A participant who resides offshore when the 401(k) distribution is made may be subject to an additional U.S. withholding tax, which may be significant.
It’s important to note that, where available, the ability to roll over the plan assets to an individual retirement account (IRA) allows U.S. participants to delay income taxes on the contributions and any investment gains.
Understand Applicable Law
Another consideration is determining the applicable law for any proposed employee benefit offering outside the U.S. While U.S. plans are subject to the Internal Revenue Code and the Employee Retirement Income Security Act (ERISA), a separate set of established local tax rules likely applies to the plans providing benefits to offshore employees.
As an illustration, employees in Puerto Rico, in addition to being subject to ERISA, are governed by the Puerto Rico Internal Revenue Code. In Canada, instead of a broad federal law like ERISA, each province may establish required legislation, such as the Pension Benefits Act and regulations thereunder that govern plans sponsored by employers in Ontario.
Employers with foreign affiliates that sponsor non-U.S. retirement plans may be subject to U.S. withholding and reporting requirements under the Foreign Account Tax Compliance Act (FATCA), which is designed to combat tax evasion and recoup tax revenue. Certain steps may be taken by the employer or the third-party administrator to avoid these requirements, and in some instances the plan may qualify for an exemption or be covered by an intergovernmental agreement between the United States and another country. Because the treaty rules and related requirements vary by country, it is important to examine the requirements on an individual basis.
A registration and review process, much like the IRS’ recently eliminated determination letter program, may be required in certain non-U.S. jurisdictions. In addition to plans that are designed and prepared by legal counsel, it is not uncommon to have pre-approved plans that may be mildly or overtly customized to the needs of the adopting employer.
Similarly, the tax laws in the country of the sponsoring employer also come into play when ensuring that any contributions made to a retirement plan by employees and employer are tax-effective. It is prudent to engage legal, tax, and related counsel during the planning process.
A final consideration lies in Section 414 of the U.S. federal tax Code, the controlled-group rules. A controlled group is a related group of businesses that have common ownership and perform services with or for each other. If a controlled group exists, as defined by the applicable Code sections and associated regulations, the employees of those businesses are considered together for certain qualified plan requirements. The rules exist to prevent employers from setting up multiple entities to avoid paying some employees benefits they normally would have to pay to meet qualified plan requirements.
The IRS has stated that a foreign company can be part of a controlled group, primarily because the foreign affiliate may be under the common control of the U.S. parent company. Generally, certain foreign corporations are excluded from the controlled-group rules under Section 1563 of the Code; however, the Section 414 Regulations permit that the exclusion be disregarded when determining whether a controlled-group relationship exists.
The distinction of resident aliens and nonresident aliens is an important one, and though the identifying term and requirements may vary, this point may have similar importance when designing the offshore plan. Nonresident aliens are generally excluded from participation in U.S. plans and need not be included when performing coverage testing, but other eligible employees who are part of the controlled group would need to be counted.
Although many U.S. plans probably will exclude nonresident aliens, an IRS private letter ruling (PLR) confirmed that a 401(k), or other qualified plan, could cover a nonresident-alien employee. This scenario might be more likely in the event of a foreign parent company with U.S. affiliates that sponsor a 401(k) plan. Without regard to the circumstance, it is advisable to be clear about any exclusion in the terms of the plan, specifically the definition of an eligible employee.
As offshore retirement savings plans become more common for U.S. employers to manage, the differences among U.S. plans and the norm in the satellite business’s home country—as well as the underlying complexity—will become clearer.
Additional plan administration considerations include identifying service providers and available investments, as well as monitoring the overseas plan to maintain compliance and determine the appropriate currency for the plan’s designated investments. When embarking in uncharted waters, it is prudent to engage legal, tax, and related counsel during the planning process.
|Arris Reddick Murphy is an attorney with experience in the employee benefits and executive compensation practice area, and she is senior counsel with FedEx Corp.’s Tax & Employee Benefits Law group. Before joining FedEx, she held the position of associate with the law firm of Potter Anderson & Corroon, LLP, and worked in-house with The Vanguard Group and the City of Philadelphia as counsel to its Board of Pensions and Retirement. She is contributing editor of The 401(k) Handbook.|