As many of us know, the typical advice for Americans in Japan is to stay away from iDeCo accounts because the investment options, other than low-yield term deposits, are all non-US-domiciled funds and presumably passive foreign investment companies. However, I was running some numbers recently and found some interesting results. The upshot is that iDeCo contributions *might* be advantageous for certain high-income Americans living in Japan.
First, a disclaimer: **This is an extremely complicated issue and you need to carefully consider what’s right for your financial and tax situation. You should also consult a tax professional, which I am** **NOT.** **Finally, my calculations might simply be wrong.**
The arguments for an iDeCo might go something like this:
* For Americans subject to a 55% marginal tax rate, one could think of a contribution to an iDeCo as essentially a 55% boost to the initial savings amount.
* Most people planning for retirement keep *some* portion of their retirement funds in low-volatility, low-growth instruments such as cash or bonds.
* The tax regime in Japan applied to iDeCo withdrawals is extremely favorable to the taxpayer.
* There is a possibility, although perhaps not likely, that at some point there will be an official clarification that an iDeCo is a “qualified pension” under the US-Japan tax treaty. See discussion [here](https://www.reddit.com/r/JapanFinance/comments/14xjws8/us_citizens_and_ideco/). In this case, a US taxpayer with a funded iDeCo account might be able to invest the funds with more freedom from that point forward.
* A US taxpayer might wish, now or at some point in the future, to take the position that an iDeCo is indeed a “qualified pension,” even if there is no explicit guidance on this point. Having a funded iDeCo provides optionality to do this.
Considering the above, I ran a couple rough simulations of 20 years of iDeCo contributions. I’m not a financial professional so if anyone else has run the numbers and thinks my conclusions are wrong, please tell me!
* Below are some key assumptions. If you change any of these, you may get wildly different results.
* A bond fund will yield 4.5% per year, paid in annual dividends. These dividends are reinvested in the fund.
* The tax rate on dividends in the taxpayer’s taxable account is 20%. The US tax rate applicable to mark-to-market PFIC gain and dividends in the iDeCo is 37%.
* The taxpayer starts contributing to the iDeCo at age 40 and elects to withdraw all funds from the iDeCo at age 60. The taxpayer pays taxes on the withdrawal at applicable rates under the current tax regime in Japan.
* Money that the taxpayer contributes to the iDeCo would otherwise be subject to a 50% tax rate.
* Money used to pay taxes applicable to PFIC income would otherwise have been used for further investment in the bond fund in the taxpayer’s taxable account.
* Based on my rough calculations, over a 20-year period, if the taxpayer contributes ¥800,000 per year to their iDeCo and simply holds cash in their iDeCo that doesn’t grow at all, after paying taxes upon withdrawal, they will have about 25-30% more cash than the value of the bond fund they would hold if they invested ¥400,000/year in the bond fund in a taxable account. However, *the longer the money sits in the iDeCo, the less attractive the iDeCo is in this scenario*. That’s because the bond fund continues to compound while the cash held in the iDeCo does not.
* What if the taxpayer decides to put the iDeCo funds into a bond fund (also yielding 4.5% annually) and make a mark-to-market PFIC election every year? Furthermore, let’s assume the taxpayer redirects funds that would have been invested in a bond fund in a taxable account to pay the associated PFIC taxes. The issue here is that there is a compounding opportunity cost to paying the PFIC tax obligations. Nonetheless, in this case, after withdrawing the iDeCo funds and paying US and Japanese taxes, I roughly calculate that the taxpayer would have about 55-60% more in cash as compared to their taxable account bond fund holdings. Unlike the cash iDeCo option, the benefit of the iDeCo in this scenario *increases* over time because a larger portion of funds are compounding in the iDeCo account as compared to the taxable account.
Has anyone else run these numbers and reached a similar (or different) conclusion? Am I overlooking something important?
by stakes_are