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Puerto Rico is a commonwealth of the USA. Puertoricans are US Citizen, but while they live in the island they don't have to pay Federal Taxes.

My question is for someone that have lived in the US Mainland and accumulated retirement money through 401k, Traditional IRA and ROTH IRA. If this hypothetical person moves to Puerto Rico, were Federal taxes are not paid.

Would this person withdrawals from the deferred tax accounts owe any federal taxes?

  • 4
    It's more subtle than "Puerto Ricans don't pay federal taxes". According to irs.gov/taxtopics/tc901.html, the rule is that Puerto Ricans don't pay federal taxes on income from Puerto Rico sources. If they have income from, say, mainland US sources, that is taxable. So the question is what is the "source" of their IRA distributions. – Nate Eldredge Oct 25 '16 at 23:39
  • @NateEldredge so a naive retiree loses; a retiree who walks into the San Juan office of their home bank (or a PR-only institution), and opens an IRA, and conducts a rollover from a mainland IRA into the new account... wins? – user662852 Oct 26 '16 at 0:16
  • @user662852: I doubt it is that simple, but I just don't know. – Nate Eldredge Oct 26 '16 at 0:49
  • If you could do that, then lot's of people would be doing that, and we'd all know about it (and then the tax loophole would likely be closed). Ergo, you can't do it. :) – gaefan Oct 26 '16 at 12:20
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This is a fascinating question. I am posting here only a partial answer because I haven't found official sources. The upshot appears to be that a Puerto Rico IRA is a wholly different thing from a US IRA, and different rules apply. This is said most succinctly in this post on the Boglehead forums:

US federal tax code and Puerto Rican tax codes are separate. By contributing to a U.S. IRA, you defer US taxes. You need to pay these deferred US taxes, and take an early withdrawal penalty too, if you want to move the asset to PR.

Other web pages give similar information, for instance, this post from "Accountant Forums":

The Puerto Rico (PR) Internal Revenue Code (IRC) defines a Puerto Rico IRA (I am assuming that this taxpayer has a PR IRA.). It is unfortunate that they chose to use the same name as the US IRC uses. A PR IRA is not a US IRA. It has different tax rules. In addition, the US IRC defines an IRA as being "a trust created or organized in the United States." The US IRC (Sec. 7701) defines the United States as being the 50 states and the District of Columbia.

The Bogleheads thread also contains a link to a document from a Puerto Rican CPA school which appears to be a FAQ, and says (translated here from Spanish):

Thus, any distribution from an IRA established in Puerto Rico does not qualify to be transferred to an IRA established outside Puerto Rico without the imposition of penalty and/or payment of corresponding income tax. In the same way, the transfer of an IRA established outside Puerto Rico to one established in Puerto Rico also does not qualify as a transfer.

It is not clear whether the exact meaning of "transfer" (given as either "transferencia" or "traspaso" in the document) corresponds to the US usage of IRA transfers (i.e., nontaxable events); some information I found indicates that the end of the quote above might be translated as "does not qualify as a rollover". In any case, it seems that moving an IRA to or from Puerto Rico at least potentially has tax consequences. There is also a previous question on this site which likewise says "You cannot transfer or rollover an IRA that was established in PR to USA and vice versa".

These are not exactly authoritative sources, but they all seem to point towards the same conclusion, namely that you won't be able to avoid taxation on your IRA by moving to Puerto Rico. Of course, I am no expert. To be sure, you would have to talk to an accountant versed in the tax laws of both Puerto Rico and the incorporated US (and probably also whatever state you'd be moving from, to be on the safe side.)

  • your answer is fantastic. Thanks for consolidating all of these sources. My question was more along the lines of valid retirement distribution from a US IRA rather than a transfer. As an example, today if you work on a US company, like for example GE, and you live in Puerto Rico, you pay local income taxes but you don't pay federal taxes. So following that same line of thinking, if you get a distribution from a US Traditional IRA while living in Puerto Rico, who do you pay the deferred taxes, US IRS or PR IRS equivalent. – Geo Oct 28 '16 at 18:44
  • @Geo: Like I said, these sources don't directly answer your question, but together with Nate Eldredge's comment I think they let you make a strong guess about the answer. Given that the Puerto Rico financial system, IRAs, and related laws are totally separate from those of the incorporated USA, it seems highly likely that distribution from a US IRA would not be considered "Puerto Rico sourced income" in the sense Nate mentioned, and hence would be taxable. Put another way, taking a distribution is still "moving an asset" to Puerto Rico; you're just moving the money after you withdraw it. – BrenBarn Oct 29 '16 at 5:37
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A bit of our background. We are Puerto Ricans but we lived in the US mainland for many years hence our retirement accounts were saved in the US mainland.

The bottom line. If you withdraw money from your tax deferred accounts while living in Puerto Rico, you have to pay Federal and Puerto Rico taxes. You do get a credit in Puerto Rico for taxes paid to the Federal Government and at the end you pay the highest of both, which may or may not be higher than what you pay in state and federal in a given US state.

The stickler is with Roth 401k/IRA. Even though you paid federal and state taxes in a Roth and are considered "tax free" in the US when withdrawn, they are not tax free in Puerto Rico, you have to pay Puerto Rico taxes from your Roth withdrawals which can be sizable being that you do not get the tax credit.

This is what we discovered.

  1. There are really not tax advantages of converting Roth if your ultimate goal is to move to Puerto Rico, you end up paying taxes in three jurisdictions.
  2. Social security is not taxed in Puerto Rico, but pensions do with a exception up to 11,000 before the age of 65 and 15,000 after the age of 65 per pension plan (if you wife and you have a pension, then each pension gets the exception).
  3. You will pay federal taxes on your tax deferred accounts, pension and social security within IRS rules even if you live in Puerto Rico.

You have to look at your own personal situation, of course, but if there's any consolation, nursing homes and assisted living homes in Puerto Rico are far cheaper than in the US Mainland on average.

Best of lucks.

PS. The following comes from a website which explains this being that many retirees want to take advantage of Act 20/22, but in fact, they cannot. Source is listed at the bottom.


A NOTE ON RETIREMENT INCOME

Withdrawals from an IRA, 401(k), or other US tax-deferred retirement account would not be covered by Act 22. So moving to the island won’t lessen the tax on withdrawals. The situation is the same with Social Security and other pension income.

Puerto Rico has its own IRA system, with both traditional and Roth plans, but it is distinct from the US IRA system. Income from employment in Puerto Rico cannot be contributed to a US IRA and vice versa.

For a resident of Puerto Rico, a distribution from a US Roth IRA would be taxable by the Puerto Rican government. That is, unless the US Roth IRA is liquidated and the proceeds are used to contribute to a Puerto Rican Roth IRA (subject to contribution limits, which are similar to the US). The opposite is true as well.

A distribution from a US traditional IRA to a Puerto Rico resident would be taxable by both the US and the Puerto Rican government, unless it is liquidated and the proceeds are used to contribute (subject to contribution limits) to a Puerto Rican traditional IRA, in which case the distribution would only be taxable by the Puerto Rican government. Again, the opposite scenario is true as well. For taxable distributions, the availability of a credit from either government for tax paid to the other prevents double taxation, and you end up effectively only paying the higher rate.

Despite the many similarities to a US IRA (more details here), a critical difference makes a Puerto Rican IRA considerably less useful: Puerto Rican IRAs allow very little investment freedom-they must invest at least 34% of contributions into obligations of the Commonwealth of Puerto Rico.

Assuming that your investments are covered by Act 22 and that your business is covered by Act 20, there would be little current advantage in funding a Puerto Rican IRA.

We see no advantage to pouring your US IRA into a Puerto Rican IRA.

https://taxcreditsint-puertorico.com/act-22/

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You should ask your account broker since taxes in your IRA may or may not have paid taxes ahead of disbursement. And yes you can not roll over to a PR IRÁ, 401K etc without paying the US mainland tax. But your buck will go much further than in the main land if you consider expenses of retirement living in one of the states.

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IRS publication 970 clearly states that for IRAs the source of contributions is based upon where you worked when contributing to the fund, so it will be US sourced. The source of investment earnings in the account is based upon where the account is located, so that is likely to be US source as well if you stay with current provider

  • The last sentence ["if you stay with your current provider"] misses the depth of answer already provided and accepted, which indicates that transferring IRA's to a PR provider is simply not possible without tax consequences. – Grade 'Eh' Bacon Apr 3 '18 at 13:18

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