Common geo-arbitrage setups
Geo-arbitrage in simple terms is using your geographic mobility to take advantage of lower tax rates, lower cost of living, or even higher incomes. Some people may do domestic geo-arbitrage but for the purposes of this blog, we're going to focus on international geo-arbitrage. Here are a few sample setups, leave a comment of others you want me to cover.
Social security basics: how benefits are calculated
Most international travelers I speak to have no idea how US social security works for their situation. It's hard to find answers and it's so far off that people just basically don't think about it. They hope they will get some magic money when they hit the governement benefits age. I was that person once too.
Disclaimer before we get started: I don't make residence or financial planning decisions based on the discussion we are about to have about social security. I live where I want to live and I hope you do to. I am also not a financial planner. This blog is a collection of knowledge I've learned along the way from doing research and talking to the social security administration.
What I hope you get from this information: knowledge in order to make slightly better and more informed choices when presented with two or more alternatives. One small little adjustment could mean the difference between "free money" in retirement or zero free money. I put free money in quotes there to appease the people that believe that social security will be totally gone when they hit government retirement age and therefore plan their financial future around getting nothing.
Here we go...
Who is eligible (also called: entitled) to receive a US social security benefit in retirement?
Assuming you earn more than $6,040 per year, you need to have lawfully worked 10 years to become eligible. I have over simplified this for purposes of the discussion and you can find further depths of eligibility on the SSA.gov website.
What does "lawfully worked" mean?
In simple terms, it means that your income was reported in your US Form 1040 individual tax return and you paid social security taxes on it. As an employee, that usually comes out of your paycheck as what is referred to as "payroll taxes". If you're an entrepreneur, then you would have paid this through the Schedule SE attached to your US Form 1040 which calculates your self-employment earnings and self-employment tax (the payroll tax equivalent for self-employed). If you've been working under the table then you have not been building credits.
How do you know how many credits you have so far?
You will annually receive a statement from the Social Security Administration (SSA) but I prefer to make an account on the SSA.gov website and simply login to see my credits.
When you retire, how is the amount you get paid each month calculated?
I am over simplifying for purposes of this discussion but the amount you get paid in retirement is based on a formula that is derived from the average of your 35 highest earning years. Like above, your annual earnings needed to either hit the SSA records through 1) employment payroll taxes or 2) through Schedule SE self-employment tax. You can find further depths of the calculation on the SSA.gov website.
To illustrate what this means for the rest of our discussion, I ran the following information through the SSA.gov simple online benefits calculator. I used a person born in 1970, who will retire at 65 years old, and who earns $75,000 per year for 35 years. I did not increase the wage for inflation just for the sake of being able to copy/paste the same number into the calculator. I then ran the calculation again but for only 15 years. This will matter later in the discussion. Here are the results in today's dollars.
The main take away here is that for all of those 20 years with 0's (zeros) in the SSA records, your monthly benefit will drop in retirement. Here are a few reasons/ways that someone might have 20 years of zeros in their SSA records:
We are here today regarding those last two.
Enter: the dreaded WEP.
WEP stands for Windfall Elimination Provision which was created to provide fairness to the system due to people that might have low credits or income in the system, and therefore artifically appear as "low income" when in reality they were receiving social insurance payments from other sources. This is due to the calculation of benefits being weighted in favor of lifetime low income earners. Legislatively, it makes sense. Mathematically, it creates a double dip hit to foreign earners (i.e. international migrants).
I took the example above and I added in what happens with the WEP adjustment into the 3rd column. I ran the calculation, in today's dollars, to see what would the monthly Netherlands social insurance benefit be paid the US migrant who moved to the Netherlands to work their remaining 20 years. This amounts to USD $524 at today's exchange rate (30 April 2022). This was already adjusted for the fact that the amount would have been $1,311 with 50 years of service/residence in the Netherlands. The SSA factors in this $524 benefit in their online advanced WEP adjusted benefits calculator with the following output:
Isn't that a double-dip?? You would be right to ask...
In my personal opinion? Absolutely it is. But we aren't going to dive into the merits here of how the calculation works, we just want to use this blog to become more knowledgable about these outcomes. This is mathematically a double dip since in the middle column with no WEP adjustment, the US SSA monthly benefit was already reduced dramatically by the presence of 20 years of zeros, which brings down the average of the 35 highest incomes. Those 20 years are instead reflected in the foreign benefit calculation. But then the $1,840 gets adjusted again because this individual is in receipt of the $524 monthly benefit. You can see in the right hand column that this person would receive a social insurance benefit of $2,137 between the payment from the US and the payment from the Netherlands, for 50 years of service. If that same person had worked the same 50 years all inside the borders of the US, then they would receive what we see in the far left column of $2,642.
There are 3 primary ways that your SSA benefits will not be WEP adjusted (in 95%+ of cases):
Planning and pitfalls for international migrants and nomads
Totalization agreements for migrants without enough credits in any country
The US government has entered into agreements with a number of countries called totalization agreements. These agreements dictate which country gets to collect/tax the worker and collect social insurance taxes so that the worker does not get taxed twice (once by the country of citizenship and again by the country of residence). These agreements also ensure that an individual is "made whole" when moving between a lot of different countries in the their lifetime. For example, if you work in the US for 8 years and Ireland for 8 years, you may not be eligible for social security benefits in either country because you didn't work 10 years in each. With a totalization agreement between the US and Ireland, both countries will recognize the credits from the other country which then makes the worker eligible for benefits in retirement from both countries systems (8+8=16).
The totalization agreements also work in cases where you have enough credits in 1 country but not the other(s), to ensure that they count towards eachother. So if I have 15 years in the US system but only 2 in the Irish system, then I would be eligible to receive a social security benefit in the US without the need for the totalization agreement but would need to use the totalization agreement to become eligible for a payment (though quite small) from the Irish government when I reach retirement. This is an important distinction I illustrate with this example:
Totalization agreements and the WEP good news.
If you do a search for the word "totalization" on this SSA.gov WEP history page you will find that certain foreign pensions paid as a result of "accessing the totalization agreement" will not be WEP adjusted. This is further confirmed in the WEP screening tool on the SSA website. "Pensions" in this context means the government social insurance benefits of a foreign country.
Residence based social insurance benefits and the WEP good news.
In the case that a country pays its government social insurance benefits based on your residence in that country, and not based on your working/income, then in most cases there will be no WEP adjustment on that payment. An example is the Netherlands which pays a monthly benefit based on your presence in the country. This is very beneficial for stay at home parents that would receive quite low (or no) benefits in a country that bases its social insurance benefits on income you paid into the system (like the US).
Planning opportunities: examples
As was mentioned earlier - social security is going to be such a small amount of a FIRE journey that location / residence decisions should not be based around it. But you could have some small wins for "free government money" later by being a little bit more knowledgable. Here are some examples:
Social security pitfalls: examples
The following can cause some real headaches so keep an eye out:
TLDR: in summary
Paying social insurance taxes provides security to you both for income replacement in case of disability and income replacement in retirement / old age. You should evaluate your circumstances to find the most optimal solution for you given 3 possible outcomes:
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Unfinished human, currently v.5.0. Expecting at least 10 more versions. Aspiring adult.