Editor: Mary Van Leuven, J.D., LL.M.
Many Americans have little sense of how their Social Security retirement benefits are calculated. At the end of a long career, they apply for their pension and accept what is paid. Likewise, when it comes to tax planning, U.S. Federal Insurance Contributions Act, or FICA, tax, which includes Social Security tax, does not get much attention. A flat tax with no deductions, imposed on higher levels of earnings at a relatively low rate, FICA is generally an afterthought when tax planning is concerned.
However, when a worker moves across international borders, the cost can be significant, and there could be a substantial impact on the worker's future retirement benefits. For these reasons, it is important to understand the basics of U.S. Social Security coverage and benefits.
The Social Security component of FICA, formally known as Old-Age, Survivors, and Disability Insurance (OASDI), is withheld at the rate of 6.2% of wages with respect to employment and ceases to apply when taxable wages reach an annual limit of $147,000 (the inflation-adjusted 2022 amount). The employer pays the same amount as a payroll tax. The other component is Medicare tax, which has no upper limit. The withholding rate of 1.45% increases to 2.35% when wages exceed $200,000. (The increased withholding rate threshold of $200,000 applies to all employees, but a married couple filing jointly could be over- or underwithheld because their combined compensation over $250,000 is subject to the 2.35% rate. The difference is reconciled on their tax return.) The employer pays a corresponding payroll tax of 1.45% on all compensation paid to the employee.
FICA tax for international workers
In general, all compensation earned for employee services provided in the United States is subject to FICA. (A few statutory exceptions are not covered here.) In addition, compensation for services provided to a U.S. employer by an employee who is a U.S. citizen or resident is subject to FICA no matter where the services are provided. This simple rule, found in Sec. 3121(b), may have a major impact on mobility cost.
Example 1: L, a U.S. citizen who is employed by a U.S. employer, requests a remote-work arrangement for a year to care for her ailing parents in a foreign country. While living abroad, she will continue to be subject to FICA but may also be subject to the host country's social security tax. Many foreign countries' social security tax rates are much higher than those of the United States, so being subject to double social security tax may be a huge incremental cost. Even if L is held responsible for the employee-level foreign social security tax, the additional employer-level tax would also significantly increase the cost to her employer of her work abroad.
A similar problem can be imagined in the reverse scenario, when a foreign worker might find herself subject to FICA while temporarily working in the United States, while still subject to her home country's social security tax because that is her permanent base.
Social security 'totalization' agreements
The United States shares special social security agreements (often referred to as "totalization agreements") with 30 countries, which are intended to prevent the payment of double social security tax. However, issues can still arise. Most agreements the United States has entered into set forth a general rule that a worker should pay only the social security tax of the country where service is being provided. They also include a special "detached worker" rule: If a worker is sent by his or her current employer on an assignment of no more than five years, he or she can remain covered by his or her home country's social security system and avoid paying host country tax. (The agreement with Italy is the exception; in that agreement the determination of which country can impose its social security tax is generally based on the employee's country of citizenship.)
Example 2: R is a U.S. citizen with a U.S. employer. If R's employer sends him to Germany to work for a period of no more than five years, under the United States-Germany totalization agreement, he can continue his FICA coverage and will be exempt from German social security tax. It is a different story, however, if R initiated a remote-worker arrangement for his own purposes that his employer was simply accommodating. In that case, because he was not sent to Germany by his employer, the employment would be subject to the general rule of the U.S.-Germany totalization agreement, exempt from FICA but subject to German social security tax at a rate of 20.23% for the employee and 19.98% for the employer.
Even if R bears the incremental cost of the employee tax, his cost of employment has increased by more than 12 percentage points to his employer over the 7.65% U.S. FICA rate. In the current environment, then, with "work from anywhere" arrangements proliferating, U.S. employers may need to consider whether "anywhere" should be limited to "anywhere in the United States."
Social Security retirement benefits for mobile workers
Less often considered than the rate of home/host country social security tax is the impact of mobility on a worker's social security benefits. To address that consideration, it is important to have a basic understanding of how U.S. Social Security retirement benefits are calculated. In general, to qualify for U.S. retirement benefits, a person needs at least 40 "quarters" of coverage by FICA. These credits do not correspond to calendar quarters but rather to the amount earned: a person earns one credit for each $1,510 earned (2022 amount), up to a maximum of four credits per year. Thus, most workers will earn their 40 credits by working during 10 calendar years.
But the benefit calculation is more complicated, taking into account an average of the worker's top 35 years of inflation-adjusted earnings. (Any year that a worker is over the Social Security wage maximum is essentially equivalent for purposes of the calculation.) So, in the example above, if R works for a foreign employer abroad for a year or two and does not pay FICA, over the course of his career he will still likely have 40 or more years of earnings in the United States. Once a person exceeds 35 years, additional years may just replace earlier, lower-earning years in the calculation, which may not have a large impact on the amount of the benefit.
Example 3: B was born in 1965 and earned 10% of the Social Security wage maximum at age 22, 20% at age 23, and so forth. If he also earns more than the wage maximum in every year from ages 31 through 65, he will have 44 years of earnings in his U.S. Social Security record. None of those early, lower-income years will be included in his 35-year average, and his monthly benefit on reaching age 67 in 2032 should be $3,392 (in current dollars). (All retirement benefit projections in this article were performed using the U.S. Social Security Administration ANYPIA software, version 2022.1.)
If B took a position outside the United States with a foreign employer and did not pay FICA in 2022 or 2023, but the facts were otherwise the same, his benefit would be $3,372 — the loss of two high-income years from the 35-year average having a negligible impact on the amount of the benefit.
As noted above, the United States has entered into bilateral social security totalization agreements with 30 countries. In many cases, these agreements allow workers whose employer sends them to work abroad for no longer than five years to avoid the foreign tax and continue home country coverage. Thus, if, in this example, it had been B's U.S. employer that sent him to work in a totalization country for two years, there would have been no break in FICA coverage and no impact at all on his eventual retirement benefit.
Example 4: Now assume that B left the United States permanently after 2021 and did not contribute to FICA for the remainder of his career. His 35-year average would include nine lower-earning years, not just two, but his monthly retirement benefit upon reaching age 67 would be $3,140 — not as drastic a reduction as many workers might fear.
However, if B worked abroad without paying FICA for so many years that he had fewer than 35 years in his lifetime U.S. Social Security average, this could have a more significant impact on his retirement benefit. If he left the United States permanently after 2011, having only 25 years in his earnings record, his monthly benefit upon reaching age 67 would be $2,645. Clearly, when discussing work abroad with an employee who has concerns about the long-range consequences of not paying FICA, it may be worthwhile to quantify the potential impact.
Benefits for temporary US residents
A common concern of workers temporarily present in the United States is that the FICA tax they pay will result in no future benefit to them. For many workers, this is valid, given the 40-credit/10-year contribution threshold noted above. However, a second purpose of bilateral totalization agreements is to provide for social security benefits at a much lower threshold of participation. In the case of the United States, if a person has just six Social Security coverage credits but has at least 10 years of participation in the United States combined with that in a country that shares a totalization agreement with the United States, then the person will qualify for a U.S. retirement benefit.
Example 5: M works in the United States for three years, 2020-2022, accumulating 12 coverage credits. Assume that M was born in 1965 and paid FICA tax on the maximum amount of wages subject to FICA in each year 2020-2022. She has no other work history in the United States over the course of her career but worked in Spain and paid Spain's social security tax over those years. Because she has more than six U.S. coverage credits and more than 10 years of coverage in the United States and Spain combined, she will qualify for a U.S. Social Security retirement benefit. Under current law, her monthly benefit upon reaching age 67 would be $289, stated in current dollars.
M's life expectancy upon reaching age 67, according to the U.S. Social Security Administration's actuaries, is 87.6 years (247 months), meaning that she would collect a total of more than $71,000 if she lives to that age, an annuity with a present value of more than $44,000 at age 67 (using a discount rate of 5%). This is not a bad return on her investment of $26,505 (the maximum OASDI tax for years 2020-2022).
Many variables, not all consequential
The answer to the question "What impact will working abroad have on my U.S. Social Security retirement benefit?" is "It depends." Among the considerations are how many years the person has already paid FICA tax; how many years after the work abroad he or she expects to pay FICA; and, particularly for an inbound foreign worker, whether the other country shares a totalization agreement with the United States. Often, the answer to that same "What impact ..." question is — "Not as much as you might think."
Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C.
For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or email@example.com.
Contributors are members of or associated with KPMG LLP.
The information in these articles is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230 because the content is issued for general informational purposes only. The information is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. The articles represent the views of the author or authors only, and do not necessarily represent the views or professional advice of KPMG LLP.