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US Expat Investor? Here's What You Should Know About New PRIIPS Regulations
Our guest is Tom Zachystal from International Asset Management. He’s here to explain what the new regulation means, and highlight some other investment issues that Americans living abroad should be aware of.
Carlie: Welcome to another episode of the Expat Focus podcast. I’m your host, Carlie, and today’s topic is one that you may have read about on expatfocus.com. It concerns US expat investors, who are living in Europe, and new regulations known as PRIIPS. I’m not a financial planning expert, but my guest is. Tom Zachystal from International Asset Management. He’s here to explain what the new regulation means, and highlight some other investment issues that Americans living abroad should be aware of. Tom, it’s been a while since we’ve had you on the Expat Focus podcast. Thanks for joining me!
Tom: My pleasure, Carlie, yeah, I guess it’s been about a year, and, it just seems like the regulations keep giving us things to talk about!
Carlie: They are changing all the time, and I know even myself as an Australian in France, there is so much for me to get my head around. So, how has investing become just that bit more difficult for Americans living abroad over the past year?
Tom: Well, basically, especially in Europe, there are a number of new regulations that have come up, and sometimes these regulations clash with, with the US regulations. Sometimes they just add a layer, a regulatory layer that firms, especially US firms, don’t want to jump through. And so just over the last, say, 5, 6 years, 10 years, we’ve had FATCA come out, which was I guess started about 6 or 7 years ago, and then GDPR, a data protection standard started last year in May, that’s a European standard, and now there’s the PRIIPS regulations which also started at the beginning of 2018.
Carlie: Tell me about these PRIIPS regulations, and what they mean for American expats.
Tom: So, PRIIPS is an acronym that stands for Packaged Retail and Insurance-based Investment Products. And already anything that’s that long should give pause for concern, I would say! But, essentially it’s an EU initiative which mandates a certain type of disclosure document for anything that they consider these packaged products. And so, what that includes are things like mutual funds, also exchange traded funds, certain types of insurance products like variable annuities, certain types of structured products.
Basically, anything where you don’t have individual shares or bonds, you know, where something is packaged. And the type of disclosure document that’s mandated is called a KID. It’s called a Key Information Document. And so, it’s a document that each of these funds or whatever they are need to provide to new investors. And in Europe, so this is a European mandate, in Europe many of the funds already have these KIDs, they’re used to using them, they conform to the regulations in each EU country.
But in the US, we’re not used to these KIDs, and a lot of the US, well, the vast majority of the US mutual funds and exchange traded funds just do not have documents in that format, and in some cases they even contravene some of the US laws pertaining to, say, disclosure of performance data and that kind of a thing, so it’s hard for the funds to even issue these documents.
So the problem, then, is that for EU investors, that are invested in US funds, if there’s no KID, if there’s no disclosure document, these funds shouldn’t be made available to them, and in fact a lot of the US brokerage firms, custodians, mutual fund companies, have started banning the sale of these products to EU investors.
Carlie: This KID on the face of it, this disclosure document, doesn’t sound like a bad thing to need, of course, but as you said it’s just not so simple when you’re dealing with EU to US, and compatibility by the sounds of it.
Tom: Yeah, that’s right, so the idea behind the KID is that it sort of creates a common framework for where investors can compare these different types of products. With, without a common framework, then you know, one mutual fund might disclose performance data net of fees, and one might disclose it gross of fees. One might calculate the fees in a different, in a different manner, or give the performance over a different timeframe, or, or versus a different benchmark. So this standardises it, and the intent behind it is fine, but it’ll, I think it’ll take especially the US fund companies and ETFs a while to conform to this, and you know, they’re really set up with dealing with US investors, not with investors elsewhere, so, it could be a while before we see these funds.
And so, I should mention, this creates a special problem for Americans living in Europe, or anybody who qualifies as a US tax subject, is subject to US tax, or green card holders as well, living in Europe, because if you file US tax forms, then you probably don’t wanna have non-US funds in your investment account, if it’s a taxable account, because these create a US tax reporting issue, because they’re considered passive foreign investment corps, PFICs, under US tax law, and there’s a form for each fund, and so most US tax payers want to avoid this PFIC issue, and they want to buy these US, US funds rather than European ones, but now they may not be able to do that any more.
Carlie: It sounds like such a headache, Tom, and as you said, funds are basically putting this in the too hard basket, and blocking I suppose US investors that aren’t resident in the USA, instead of trying to deal with it.
Tom: Yeah, well, that’s right in a sense. And I should mention that this is an issue for new funds, when they’re offered. So for example, somebody living in Europe might have a brokerage account in the US, they might have mutual funds in it, they’re not gonna get kicked out of those funds, or there’s kind of a grandfathering. But the issue will be, they may not be able to buy new funds, so when you want to rebalance that account, or if you just wanna change the investments and you wanna use funds, you may not be able to do that any more. You may also not be able to reinvest dividends any more. So there is some kind of a grandfathering aspect to it, but, but eventually it’s, yeah, it’s gonna be a problem for these people living in the EU.
Carlie: So what is the solution, short of moving back home?
Tom: Well, the solution, so what we’re doing is, we’re an investment management firm, but we don’t hold our clients’ money, we just manage the money in what we call custodial accounts, the custodial accounts are with various brokerage firms, for our US clients, or US firms.
And, so what’s the solution? Well, it depends first of all on what type of account it is. So the big issue for many people is US retirement accounts, because you can’t move those overseas. If you have something like an IRA, or 401K, or [unclear 00:07:42], or US retirement accounts, you probably don’t want to distribute those accounts, because you’d pay tax, or maybe early withdrawal penalties. But you also can’t move them overseas, if it’s a regular taxable brokerage account possibly you could move that overseas, reinvest it in your country of residency. So, that’s, so there’s a specific issue with US retirement accounts.
Now, in the retirement accounts, we can use European funds, even for our US taxpayer clients, because these, these accounts are considered pension funds under, under the tax laws, so, so there’s no PFIC issue in there. So there we could use, if we want to use funds, we can use European funds, or, typically we don’t use mutual funds, but we use exchange traded funds. So we can use the European equivalents. And, just because it’s, European funds also have for example access to US, like the SNP500 Index, or various US investments, so it doesn’t just have to be a European investment, but the fund is a European fund.
But, the other solution we use in taxable accounts, in non-retirement accounts, and also in, in the larger retirement accounts we manage, is, we just use what trades on an exchange. So, things like shares, individual shares of companies, bonds, real estate investment trusts, other non-packaged investments, we can create a portfolio of these, and those are not subject to the PRIIPS regulation, because they’re not packaged products.
Carlie: And are these basically the solutions that US expats have been taking up since the regulation began a year ago?
Tom: Well, so the thing is, that various brokerage firms implement these regulations at various times, so, for example, one of the firms we deal with didn’t even implement the PRIIPS rules until November, even though, November of ‘18, even though they came out January 1st. So it takes a while for the brokerage firms to figure that out. Some of them haven’t even figured it out yet, or, maybe are ignoring it, so, so there may not be issue.
The other thing is, if some Americans at least, living abroad, use US addresses on their accounts, even though they don’t live in the US any more, and so if a US address is used on the account then the brokerage firm doesn’t know they live outside the US, and so, so there’s no issue that way, but it’s becoming increasingly difficult to, to do that. Most, I mean under FATCA, the brokerage firms have an obligation to figure out where, where a person lives, because they have to report to the tax authority in the country of residency, so, more and more of these brokerage firms are, are finding out, finding ways to, you know, find out where their clients actually live, even if they try to use a US address, so that, that is maybe a relative’s or a mailing address or something like that.
Carlie: So PRIIPS is one that, as you said, did enter into force a year ago, but, firms are slow on the uptake, and, it does take a while for these regulations to trickle down and actually be enforced, and companies to take action as a result. What other regulatory changes are in the landscape at the moment that US expats may not be aware they’re facing?
Tom: Well, I would say that the biggest thing is that other countries are now implementing certain types of regulations that correspond to this as well. And, and the past regulations, they’ve, they’ve kinda been slow to implement. I mean the big three are FATCA, which is the cross-border tax reporting regulation, which basically mandates that US brokerage firms have to report to the tax authority in a person’s country of residency on their US accounts, and vice versa, so that’s why it makes it difficult for US citizens living abroad to open a local brokerage account or bank account sometimes, because that bank or brokerage firm has to report to the IRS on that account. So that’s FATCA. And, that’s pretty much been implemented now.
And then last year there was GDPR in Europe, which is the data protection standard. That doesn’t really affect clients directly, but, because these firms now have to, especially US firms now have to conform to this European data protection standard, some of them have chosen not to deal with Americans living in Europe any more, so, it’s affected people that way. And now they have the PRIIPS regulation slowly making its way through the system.
But I think, maybe what’s going to affect people in the future is, not so much the fact that there might be another new regulation, but the fact that the US firms are getting better at figuring out where people actually live, so it’s becoming more and more difficult for Americans living abroad to use a US address, where they don’t own the property, where it’s, you know, a mailing address.
I mean, to give you an example, I heard from somebody in Singapore a while back, who had an account with one of the US brokerage firms, and he had used some US address on it. But he had been logging into his account online from Singapore, and the firm was monitoring where he logged in from, and so after about a year of this they sent him a note saying, you’ve been logging in from Singapore for the last year, unless you can prove to us that you actually live in the States we’re gonna have to close your account. So I think that might be the thing that catches people in the future as these firms become better and better at sussing out where they actually live, because they’re obliged to do so.
Carlie: Is it making it less, I’m not sure if lucrative is the right word, less lucrative or less beneficial to have investments when you’re an expat, or does it just mean that you really need to make sure you’re getting the right advice, and adapting as the rules change?
Tom: Yeah, I think ultimately you don’t really have that much of a choice in the matter. To the extent that you want to have an investment account, to the extent that you have to have a bank account, you just need to be aware of the regulations, and once you get things set up, then, then it works pretty well, it’s just dealing with the right firms, dealing with the brokerage firms that will deal with US expats, or dealing in, in Europe or your country of residency with a firm that will deal with US citizens. You know, just finding the right firms to deal with.
And it also extends to other things like money transfers for example, so there are certain firms that will convert funds from one currency to another and transfer it between international bank accounts, and, you know, those, those firms are typically a much better deal than, than going bank to bank, where you could lose maybe 7% on the exchange rate, so, just finding out who is best to deal with for an expat or somebody with cross-border financial concerns, that’s really the way to do it. And once you’re set up it all works, it all works seamlessly.
Carlie: And it goes without saying that the worst thing you can probably do is ignore this and stick your head in the sand and hope it goes away.
Tom: Well, you, you can do that, and I’m hoping that at least some of it will go away, there are organisations for example like American Citizens Abroad, ACA, which are trying to push the US tax regulators, or Congressmen I guess, to change the tax laws so that US citizens are taxed on the basis of residency rather than citizenship. But that’s a process that’s been going on for years and years, so I don’t know if it’s ever gonna happen.
At some point, probably, I would hope that countries would get together to have sort of a common standard, and, and certainly there have been efforts on the tax side to create a common tax reporting standard and information exchange standard.
Quite often the US is the country that wants to do their own thing and wants everybody to conform to their laws! But I’m hoping that things will get easier, not, not worse, but so far, so far we haven’t seen that.
And I should mention one other thing then is that there’s also a lot of bad advice out there. And a lot of that bad advice comes from either advisors who are not fiduciaries under the law, which is typical outside the US, there aren’t many fiduciary-type advisors outside the US. Or else sometimes it just comes in the form of chatrooms, advice from friends or other people who think they know what they’re doing. And, really it’s, it can make a big difference, getting good advice, or bad advice from somebody.
Carlie: I was reminded of that just today actually, of course we have Expat Focus forums and Facebook groups, and there are so many out there for the expat community. At the end of the day you are just listening to a random person on the internet in these chat threads! And it’s really not as beneficial as seeking out the right qualified people to get the answers from.
Tom: Well that’s right, and on the tax side it’s very important, on the investment side as well. On the investment side there are very few firms that deal with cross-border individuals. I mean, we specialise in people who have sort of a US angle to them, whether they’re expats living in the US, or US citizens that have moved abroad, that’s, that’s 90% of our client base, but, very few firms specialise in that. And on the tax side as well, you have people who can give tax advice in one country or another country.
There are for example many people and many tax advisors in the US who can do US tax forms for Americans living abroad, but they don’t understand the tax rules in their country of residency. And that’s, and the tax, and they don’t understand the tax treaty maybe, and that’s the key to the whole thing for these people, so, if you are getting tax advice and you live, you’re a US citizen living abroad, it’s wise to deal with somebody who understands the tax treaty between your country of residency and the US.
Carlie: Tom, I believe you mentioned before a lobby sort of group and the work they’ve been doing, and I’m curious, since President Donald Trump has been in office, he’s, obviously there’s a lot of talk about how much he’s strengthened the US economy. Have we seen any benefits for US expats?
Tom: I don’t know that we’ve seen, I can’t think of any specific benefits for US expats. People have pretty strong opinions on President Trump, but I also think they kind of dissociate those opinions from Americans in general [laughs]. I don’t think the situation is getting better or worse for US expats. Except possibly in the sense of, you know for example, he’s initiated these, these bargaining agreements, these trade bargaining agreements with various countries, so, most notably China I suppose. And I wonder whether these trade barriers that are put up, they might affect the ability of US persons to have jobs in those other countries. That could possibly affect them. And certainly vice versa.
The idea that a foreign national can work in the, in the US, I think President Trump hasn’t made that easier, although I’m not sure to what extent President Obama made it easier either. So, it’s kind of a neutral thing. It, I don’t know to what extent it’s gotten worse, I don’t think it’s gotten better.
Carlie: Not especially high on government agendas.
Tom: Yeah, I don’t think it’s big on the agenda, you know, there’s other things, especially these days, there’s other things President Trump is worrying about, I think.
Carlie: Just like investments, another one just to keep on your radar when you’re living abroad.
Tom: Yeah, exactly, and be careful who you, who you deal with, and, and a lot of people, so, Americans when they move overseas, there’s various reasons why they move overseas. Sometimes they’ll move to a place that’s, say, less expensive, so, a lot of the emerging market countries. There’s big US expat communities in Mexico and Ecuador and Costa Rica. A lot of those people are, have retired over there, some because they can live off their US social security there. But other people have moved overseas for, you know, to pursue careers, or for whatever other reason, just because they like it, and, and so it, it also depends on the, on the situation you’re in, and you know, why you’ve moved there.
For example, I’m surprised that it’s still relatively for an American to establish permanent residency in Mexico, when we’re making it so difficult for Mexicans to come over the border, but, but that could change as a, as a result of US policy, for example. So it’s hard to say what’s, what’s down the road for this.
Carlie: Unfortunately, nobody has a crystal ball, but luckily we have experts like yourself on the podcast to keep US expats up to speed.
Tom: Yeah, and let me mention one issue that, that we’ve seen increasingly actually, which is on the investment side, and specifically to do with US retirement accounts. So, as I mentioned earlier, you can’t move a US retirement account overseas without distributing it subject to tax and penalties. So, a lot of people want to, want to leave those accounts in the US. They’re intended for retirement, maybe they have many years to retirement so it’s nice to build up that money tax-deferred, and under many treaties, tax treaties, it can stay tax-deferred even in the country of residency.
But the issue becomes that many of the US brokerage firms no longer want to deal with non-residents, and so they threaten to close these retirement accounts. And, we’ve had, we’ve come across situations where, let’s say it’s a US citizen, or, doesn’t have to be a US citizen, but somebody with a US retirement account, living overseas, outside the US. All of a sudden they get a letter from their brokerage firm saying, you know, we’re not dealing with people in your country any more, and you need to move your account, or we’re gonna close it.
And in some cases people have ignored this, and they just figure, well, they’re not gonna close it, they’re not gonna close it, I’ve done business with them for years. And then all of a sudden they get a cheque in the mail and their account’s been distributed, and this is a big deal. So, don’t ignore those letters. There’s things you can do, there are still US firms that will deal with Americans living abroad, and, and you need to take action if you’ve, if you’ve received that kind of a notification. Just to mention one more thing on the retirement accounts side, because this is a, a pretty big deal.
So for somebody who’s a non-resident alien of the US, they’re neither a US citizen nor a green card holder nor a resident of the US. But maybe they worked in the US at some point and they have one of these 401K or IRA accounts. For them it is especially difficult to find a US brokerage firm that will deal with them. A couple, you know, maybe I’ll mention a couple of names, I mean, Pershing will deal with them, but they only deal through investment advisors. In some cases [unclear name 00:23:33] might deal with them. In certain countries a company like TD Ameritrade might deal with them, but for most of these countries, for most of these companies it’s country-specific, it depends where you live, so that is especially a problem.
But we can find a solution for these, so don’t just distribute the account, because, you know, it’s best to keep that money tax-deferred, especially if it’s a larger sum. Let me touch on this fiduciary thing I briefly mentioned. So a fiduciary is a legal term, and legally it means somebody who by law has to have the client’s interests, who has to put the client’s interests ahead of their own. And that may sound obvious. But in most of the world, amongst investment advisors, if they have a standard at all, they have what’s called a suitability standard, which means that they just have to put a client’s money into suitable investments.
And so for example, there may be two funds that are suitable for a client based on their risk profile. But one of those funds has a higher expense ratio, because it pays a larger kickback to the financial advisor, to the broker. Well, if they have a suitability standard, they can put their client’s money into either of those investments, so they’re both suitable. But in one event there’s gonna be a higher fee. So if a client, if a, if an advisor has a fiduciary standard, then they can’t do that. So, we as registered investment advisors have a fiduciary standard. If somebody is a certified financial planner, CFP, they also have to have a fiduciary standard. And you should ask anyone you’re dealing with, especially on the investment side, whether they are a fiduciary, because it’s potentially quite important and something that’s little understood.
Carlie: What’s the easiest way for people to get in touch with you, Tom, if they’d like to know more about fiduciary standards, PRIIPS regulations, or anything else you’ve touched on today?
Tom: Well they can go to the Expat Focus website, of course, which is a great place to go, and they can find us on there in the financial section. We also have a website of course, which is just www.iamadvisors.com and they can have a look at our site, and we have a contact form on that. But, Expat Focus is a great place to find us, and also many other advisors, advice that might be beneficial to you as an expat.
Carlie: I wholeheartedly agree! Thanks a lot, Tom!
Tom: My pleasure!
Carlie: That’s it for this episode. Expatfocus.com is the place to go if you have any questions or want to discuss expat investment issues. You’ll find all the links there to our articles, forums and facebook groups. Also on the website, and on iTunes, our previous chats with Tom and other experts, not just limited to finance of course. The Expat Focus podcast covers all aspects of life abroad. If you like what we do, please leave us a review. And I’ll catch you next time!
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