One of my financial experiments for this year was was to use one of the lesser-known options for US citizens abroad to buy index funds – buying a non-US UCITS ETF inside a US IRA. Depending on exchange rates and my employer’s performance, I may also be within touching distance of the Roth IRA income phase out, so I’ll make this a backdoor Roth contribution for the first time.
Normally, non-US ETFs are toxic because they’re PFICs (Passive Foreign Investment Company) – an exotic-sounding instrument that just covers all non-US funds, even the most boring vanilla index funds, and results in punitive taxation and onerous filing requirements. However, within the shelter of an IRA, the main downsides of PFICs don’t apply – there’s no tax anyway, so the punitive tax doesn’t matter, and you also don’t have to deal with the headache of the tax filing typically associated with PFICs. At least, that’s how I interpret it – still not a tax lawyer!
Why bother with this when you could just use a US address to open an IRA and buy US ETFs directly? For one, not everybody has a US address they can use, and even if they do, I don’t want to rely on that forever. My main IRA remains with a big US brokerage using my parents’ address (where I lived for a decade, shows up on my credit report, etc. – strong links there, and it’s a zero income tax state), but it seems prudent to have a backup IRA where I can use my real US address.
And if you are lucky enough to have an existing broker that doesn’t mind you changing your address to the UK, they probably should restrict you from buying US ETFs, as a UK resident. Whether they do or not is a different story…
So one way through this catch-22 is buying UCITS (probably Irish) ETFs – which are perfectly accessible to UK residents – in an IRA – so the fact they’re PFICs doesn’t matter.
Now, just because this is something that’s allowed by US and UK tax and investment rules, doesn’t mean it’s in high demand. In fact, the only broker I know of that will a) allow you to open an IRA with a non-US address and b) allow you to buy UCITS ETFs within the IRA, is Interactive Brokers.1
Interactive Brokers Overview
Interactive Brokers (IBKR) is a huge, long established (since 1978) broker, but isn’t really focused on retail, buy-and-hold investors – more active traders and the like – so you may not have heard of them. But this isn’t some brand new fintech company, they’re an institution. And, they have one key feature for us: a willingness to extend their offerings to the full extent of what is permissible under the law, filling some narrow niches – like buying UCITS ETFs in an IRA.
As mentioned in my post on their ISA offering, what they are not known for is an intuitive interface or good customer service. That doesn’t mean they’re unusable – the interface is confusing but learnable, and I haven’t needed customer service yet – but just to set expectations, you will not get a polished, hand-holding experience. Not even Vanguard level.
There’s a much more detailed writeup of Interactive Brokers here – not from me, but I generally agree with the analysis.
Opening an IRA at IBKR
The account opening process is actually fairly straightforward – no different from most other financial institutions. Just click on the big link on their home page and go through the steps. One additional question will be what permissions you want for the account – margin, options, all kinds of exotic stuff can be traded through IBKR. But all we need is stocks/ETFs.
If you’re doing a backdoor Roth IRA, you’ll need to open both a Traditional and Roth IRA. If just a normal IRA contribution, open the IRA of your chosen flavor. I won’t go into the details here of the differences between Roth and Traditional, nor the pros and (minimal) cons of a backdoor Roth – I trust you know what you want, you’re following all rules on income, prorated Traditional holdings, etc., and are just trying to figure out how to do it as a US citizen living abroad.
Quick health warning – this information is current as of January 2022. Eliminating the Backdoor Roth was included in the draft Build Back Better bill in late 2021. This might still go through, eliminating the backdoor option. Worst case, it might be retroactive and require us to unwind previous backdoor contributions in 2022 – hopefully not!
Funding Your New IRA
Because an IRA is a US-specific account, it can only be funded in dollars. If you already have your IRA contribution in a US bank account, this is straightforward – just do an ACH transfer into IBKR. Easy to set up from IBKR’s Deposit page. Note that ACH deposits have a 4 business day hold time before you can trade with it, or do a Traditional to Roth conversion. There’s a 44(!) day hold before you can withdraw the money to a different account, but that’s not what we’re trying to do.
I’ve also heard of people using bill pay, sometimes being faster and with shorter hold times. However, my US bank sent a literal paper check for bill pay, which isn’t any faster. And when I tried to use our joint checking account to bill pay into my wife’s IRA, the check got rejected as “third party” – presumably because my name was on it too. So I’ll be sticking to ACH and just making sure I plan ahead.
If you don’t already have your deposit in USD, here’s a good writeup on how to use Interactive Brokers for currency conversions – it’s almost always the cheapest around, especially for the $6k you’re looking at for a full IRA contribution. This is a bit of a convoluted process to get to an IRA, since you can’t use the IRA itself for the conversion (you’ll want a separate IBKR brokerage account). High-level, the steps are:
- Move GBP from your UK bank account to IBKR
- Convert GBP to USD
- Wait the day or 3 holding period
- Withdraw USD from IBKR to your US bank account using ACH (takes another few days)
- Deposit USD from your US bank account to your IBKR IRA (another few days)
- Wait 4 day holding period
- (convert Traditional to Roth – only if doing a backdoor Roth)
- Finally buy your investment
Theoretically, you could skip steps 4 and 5 and just transfer from your IBKR brokerage account to IBKR IRA, but IBKR is notoriously fiddly about internal transfers, especially if the details on the accounts don’t match perfectly.
All told, for money that started in my UK current account until buying an ETF in my IRA, it took 20 calendar days. There were a couple of delays that might be avoided (like the whole paper check bill pay thing), but realistically it’s probably about 2 weeks minimum.
Traditional to Roth Conversion
Step 7 above can be a bit confusing to navigate, so I’ll go into a little more detail here. Nothing difficult, just the fun of the IBKR interface. This only matters for Backdoor Roth – if you’re just doing a plain Roth contribution, or a Traditional that you won’t convert to Roth, you can skip this part.
- Write down the account number of the Roth IRA you want to convert into – you have to type this in later, no drop down selection.
- Go to Account Settings
3. Find “IRA Conversion” on the right hand side:
4. From there, just follow the prompts. Type/paste in the account number of the Roth IRA that you wrote down earlier, then decide how much to convert (if you’re doing a backdoor, probably you want to convert everything – saves you hassle if you just do the full $6,000 all at once so you don’t repeat these steps multiple times). You shouldn’t need to do any federal withholding on the transfer, because a plain Roth IRA backdoor, without any existing Traditional IRA balance, isn’t taxable.
Investing in UCITS ETFs
Once you’ve jumped through all the hoops above, actually buying the ETF(s) is easy, just like any other trading on IBKR. There’s not a separate ETF trading area, it’s just like trading any stock. I won’t go into the details of market vs limit orders or anything like that – the options are basically the same as any other brokerage.
Picking your ETF(s) is up to you, of course. My personal criteria are below, but you may have different preferences:
- I wanted something where the expense ratio wasn’t dramatically different from the US option – not wanting to pay 0.22% for an all world fund where it’s 0.08% in a US version.
- Didn’t want US investments inside the ETF – no point paying 15% dividend withholding inside the Irish fund, when there’s no dividend tax actually due because it’s inside an IRA. That’s just a 15% drag on dividends for no purpose.
- Traded in USD, just to keep life a little simpler and avoid having to do any currency conversions within my IRA.
- Accumulating, so that I don’t have to pay for dividend reinvestment or remember to do it. Since a Roth IRA is tax advantaged in both the US and UK, no worries about reporting on the internal dividends and reinvestment – but if you’re reading this as a US citizen in a non-US country that doesn’t recognize the Roth IRA, you may want distributing to make you life easier.
- Ideally a one-for-one replacement for a fund I have elsewhere in my portfolio, just to make balancing easier.
- Expenses of 0.18% compared to 0.10% – higher, but still low cost and about the smallest delta I could find.
- On a $6,000 contribution, that’s $10.80 vs $6 a year, plus the $4 IBKR commission compared to $0 commission at other brokers. An extra $8.80 a year isn’t going to move the needle.
- Non-US emerging markets, no worries about paying unnecessary dividend withholding tax.
- Traded in USD on the London stock exchange
- Very nearly a one-for-one substitute for VWO. The key difference between the two is that VWO does not include South Korea, while EIMI does.
- South Korea is on the border between emerging and developed markets. The index VWO tracks (FTSE Emerging Markets All Cap China A Inclusion Index) counts South Korea as developed, the EIMI index (MSCI Emerging Markets Investable Market Index) counts it as emerging.
- Since I also hold VWO’s developed ex-US sister VEA which does include South Korea, I wind up with a small Korean overweighting – not enough to stress about.
- VWO also has more holdings (5,250 vs 3,001), but this is largely tiny small caps which are unlikely to make much difference. The major holdings of both funds are very similar, except for the Korean companies.
So I’ve bought $6,000 of EIMI in both my and my wife’s IBKR IRAs, and did a small rebalance away from VWO in my other IRA, for negligible net impact on the overall portfolio.
Now that I know how the process works, and know to be patient with all the steps, this is not a terribly difficult way for US citizens abroad to access good ETFs, even without a US address. Yes, it’s limited to $6k per year, assuming you’re eligible, so it hardly fixes the whole problem, but it’s a nice option to have. It also means that if my existing IRA ever decides they don’t want to deal with me, I could transfer to the IBKR one without any forced liquidations.
Personally, I haven’t decided if my 2023 IRA contribution will be with IBKR or my other brokerage, but I’m leaning towards IBKR just to keep some activity on the account.
1Maybe also Schwab International, but their website says you can only trade non-US ETFs over the phone, with a $50 transaction fee, and it’s not clear if you can do it in an IRA. Regardless, $50 transaction fees plus the hassle of calling to do them is not very attractive.