The Art & Science of Determining how much of your Wealth to hold in the U.S. vs Australia

Navigating the complexities of managing wealth between the U.S. and Australia requires a thorough understanding of various life goals and financial factors. This post explores the key considerations in determining how much of your wealth to allocate to each country considering your timelines, goals, and desired financial outcomes.

Topics covered in this post will include currency allocation, tax implications, exchange rates, expected returns, restrictions on U.S. tax residents, estate planning, and investment administration. While this will be used to provide you with valuable insights, it is not a substitute for personalized financial advice.

Which Currencies Should My Assets Be Allocated To?

Golden Rule of Global Asset Allocation

When it comes to global asset allocation, the golden rule is to maintain the majority of your net worth in your country of domicile. This approach is guided by several practical and strategic considerations.

Why Hold the Majority in Your Country of Domicile?

1. Expenses Will Arrive in This Currency: Most of your living expenses, such as housing, utilities, groceries, and local services, will be billed in the currency of the country where you reside. Holding the majority of your net worth in this currency simplifies your financial transactions and ensures you are not constantly subjected to currency conversion fees.
2. Simplicity: Managing finances becomes less complicated when your assets are in the same currency as your expenses. It eliminates the need for frequent currency exchanges and reduces the administrative burden of handling multiple currencies. It may also simplify your tax situation if you are able to locate more of your investments in the same country.
3. Risk Management: One of the critical reasons for this strategy is to mitigate the volatility of exchange rates. Exchange rates can fluctuate significantly, especially during periods of economic or political instability. By holding assets in your local currency, you reduce the risk associated with these fluctuations.

Exceptions to the Rule

While the majority of your net worth should be in your country of domicile, there are exceptions to this rule. For instance, it may be prudent to diversify your assets internationally to safeguard your wealth in countries with political instability, risk of kidnapping, or a lack of a stable banking system.

Balanced Approach

It’s important to note that holding the majority of your net worth in one currency doesn’t mean all of your wealth should be in that currency, as diversification remains a key principle of sound financial management. You can still allocate a portion of your assets to other currencies and investment opportunities abroad to balance potential risks and returns.

Taxes

Tax Advantages

Understanding the tax advantages available in the U.S. and Australia is crucial for optimizing your wealth allocation strategy. Different tax treatments apply to various types of income, such as dividends, interest, and capital gains (sometimes depending on residency status).

Let’s take a detailed look at how these can impact your financial decisions.

Dividends

Dividends are a common source of investment income, and their tax treatment varies significantly between the U.S. and Australia:

• Australia: Australian tax residents benefit from the imputation system, which provides a tax credit for the tax paid by companies on profits distributed as dividends. This system can significantly reduce the overall tax burden on dividend income.
  • Fully franked dividends are especially advantageous as the tax paid by the company can be used to offset the shareholder's tax liability.
    • A U.S. tax resident shareholder of a fully-franked dividend, however, will not benefit from a franking credit.
  • Otherwise, unfranked dividends are fully taxable in the hands of the shareholder at their Australian marginal tax rate.
• U.S.: In the U.S., qualified dividends are taxed at 15% for married taxpayers with an income below $523,050 USD (or single filers with an income below $492,300 USD) in 2024, which are lower than ordinary income tax rates. This preferential tax treatment can provide substantial tax savings for U.S. residents.
  • Non-qualified dividends, however, are taxed at ordinary income tax rates.
• Source rules:  Dividend income is sourced to the place of incorporation of the company paying the dividend. The Australia/US Income tax treaty provides a 15% dividend withholding paid by U.S. corporations.

Interest

Interest income is another critical component of investment returns. Here’s how it’s taxed:

• Australia: Interest income earned by Australian residents is taxed at their marginal tax rate. There are no special concessions or tax credits for interest income, making it fully taxable at ordinary rates.
• U.S.: In the U.S., interest income is also taxed at the ordinary income tax rates. However, certain types of interest, such as that from municipal bonds, can be exempt from federal income tax and, in some cases, state and local taxes, offering a potential tax advantage.
  • This is typically only of benefit to U.S. taxpayers in the highest income tax brackets.
  • Muni bonds held by an Australian tax resident will be fully taxable Australian income.
• Sourcing Rules: Interest income is sourced to the country where the payor is resident. The Australia/US Income tax treaty provides for 10% interest withholding on income paid from the source country. This avoids double taxation and allows the country where the interest was paid from to tax a nominal amount while the remainder is taxed at the marginal rate of the interest receiver in their country of residence.

Capital Gains

Capital gains taxes can significantly impact the net returns on your investments, making it essential to understand the differences between the two countries:

• Australia: Australian residents benefit from a Capital Gains Tax (CGT) discount. If an asset is held for more than 12 months, individuals receive a 50% discount on the capital gain, effectively halving the tax payable.
  • However, this income is added to your total taxable income for the year. This substantial discount incentivizes long-term investment and can significantly reduce the tax burden on investment returns.
• U.S.: In the U.S., long-term capital gains (on assets held for more than one year) are taxed at preferential rates, which are lower than ordinary income tax rates.
  • In the U.S., long-term capital gains won’t push you into a higher ordinary tax bracket, but do increase your taxable income. This can potentially move you from a 0% tax bracket to a 15% or 20% bracket if your gains are sufficiently high.
  • Short-term capital gains, on the other hand, are taxed at ordinary income tax rates.
• Additionally, the U.S. has a Net Investment Income Tax (NIIT) of 3.8% that may apply to Single tax filers with AGI > $200K or Married Filing Joint taxpayers with AGI > $250K.
• Sourcing Rules: For capital gains realized on stocks/funds, the gain is sourced to the country of residence of the owner, with the exception of those that have a Effectively Connected Income (ECI) relationship to the US.

Strategic Tax Planning

Effective tax planning involves leveraging these tax advantages to minimize your overall tax liability. For example, Australian tax residents might focus on investments yielding franked dividends and holding assets long-term to benefit from the CGT discount.

Americans, meanwhile, can maximize the use of qualified dividends and long-term capital gains rates. If in a higher tax bracket, and a U.S. tax resident, they may also consider tax-exempt interest from municipal bonds.

Exchange Rates

Cash Needs

When determining how much of your wealth to hold in U.S. dollars versus Australian dollars, it's essential to first assess your immediate and future cash needs. For instance, if you're planning to move to another country in the near term, you'll need to account for initial expenses such as plane tickets, shipping, buying a car, insurance policies, and a few months of living expenses.

Ensuring that you have enough foreign currency to cover these costs is crucial, regardless of the current exchange rate.

Time Frame and Strength of Currency

The timing of your currency conversion plays a significant role in optimizing the value of your assets. Exchange rates fluctuate based on various economic factors, including interest rates, trade balances, and geopolitical events.

Historically, the Australian dollar has experienced significant volatility against the U.S. dollar. For example, in 2011, the AUD reached an intraday high of almost $1.11 USD in 2011 and fell below $0.55 in more recent times during the early days of the COVID-19 crisis.

As of 2024, the Australian dollar has been relatively stable in the mid to upper-60 cent range against the U.S. dollar. Economic forecasts, such as those from Westpac, suggest modest improvements in the exchange rate, potentially reaching $0.71 USD by the end of 2025.

Exchange rate predictions are inherently uncertain, however, and it's crucial to stay up-to-date on economic trends and forecasts.

Plan for Exchange

To manage currency exchange effectively, it's advisable to develop a strategic plan. Here are a few steps to consider:

1. Assess Immediate Cash Needs: Calculate your immediate expenses in local currency, ensuring you have sufficient funds to cover these costs without needing to exchange currency frequently.
2. Set Up a Transfer Schedule: For larger sums, consider spreading your currency exchanges over several transactions rather than a single large one. This approach can help mitigate the risk of unfavorable exchange rate movements.
   1. Setting up quarterly transfers or using limit orders to execute trades when the exchange rate reaches a preferred level can be beneficial.
3. Leverage Interest Rates: If you anticipate a favorable change in the exchange rate, you might choose to hold your funds in a high-interest savings account temporarily. This strategy allows you to earn interest while waiting for a better exchange rate.
4. Use Cost-Effective Services: Select foreign exchange providers that offer competitive rates and low spreads.
   1. Interactive Brokers, for instance, offers some of the lowest spreads in the market, although it comes with trade-offs in terms of customer service and usability.
   2. Other providers, such as Wise and the retail offering of OFX, offer reasonable rates with better customer service. Arete Wealth Strategists client benefit from an institutional rate we have with OFX which brings its’ spread below that of any other retail offering we’re aware of.
   3. Avoid using traditional banks for large exchanges, as they typically charge higher spreads.
5. Hedge Against Volatility: For those with significant exposure to currency risk, consider using hedging strategies to protect against unfavorable movements. Financial instruments like currency futures or options can provide a safeguard against exchange rate volatility.

By carefully planning your currency exchanges and taking into account your cash needs, the time frame of your financial goals, and the current and expected strength of the currencies involved, you can optimize your wealth allocation between the U.S. and Australia.

Expected Returns

ASX50 vs S&P500

When comparing investment returns between Australia and the U.S., historical performance provides valuable insights. Over the past 20 years, the S&P 500 has significantly outperformed the ASX 50.

Specifically, the S&P 500 delivered a return of 390% from June of 2004 to June of 2024, while the ASX 50 returned 128%. This disparity highlights the potential for higher returns in the U.S. stock market, driven by factors such as a broader diversification of industries, including high-growth sectors like technology.

Interest Rates

Interest rates are another critical factor influencing expected returns. In recent years, the U.S. Federal Reserve has raised interest rates aggressively, reaching around 5.25%. This rapid increase has impacted both stock and bond markets.

Conversely, the Reserve Bank of Australia (RBA) has kept rates lower, currently just below 4.5%, despite ongoing inflation concerns. The impact of higher rates is felt more acutely in Australia as the vast majority of mortgage holders are on variable-rate mortgages.

Higher interest rates in the U.S. can lead to better returns on fixed-income investments and savings accounts compared to Australia. For instance:

• A U.S. floating rate ETF, such as the State Street SPDR Bloomberg Investment Grade Floating Rate ETF (FLRN)^, currently offers a yield of around 5.8%.
• Similar Australian ETFs provide lower returns, approximately 4.75%.

This interest rate differential can influence the attractiveness of holding assets in the U.S. versus Australia.

^Arete Wealth Strategists is in no way affiliated with State Street Global Advisors and is not recommending this fund to the general public, this is simply being used to make a comparison.

MS Global Fund Investor Experience Study

The Morningstar Global Fund Investor Experience Study provides a comprehensive comparison of investment environments across countries. In terms of regulation and taxation, both the U.S. and Australia face challenges.

However, the U.S. excels in disclosure, offering detailed transparency on fund holdings and management. This level of detail is often lacking in Australian funds and superannuation accounts, where investors have limited visibility into their specific investments.

The study also highlights the higher number of available funds in the U.S., providing investors with a broader range of choices to tailor their portfolios. This diversity allows for more precise alignment with individual investment goals and risk tolerance.

Trading Fees

Trading fees can significantly impact net returns, especially for investors with higher portfolio turnover. In the U.S., trading fees are generally low or even zero for many online brokers trading in stocks or ETFs. This trend towards zero-commission trading has made it more cost-effective to manage and rebalance portfolios frequently.

In Australia, trading fees remain higher, often around $24 - $48 per trade. These costs can add up, particularly for investors looking to maintain a diversified portfolio across numerous securities. This higher cost structure in Australia makes it less attractive for active trading compared to the U.S.

Custodial Costs

Custodial costs, or the fees charged by financial institutions for holding assets, also differ between the U.S. and Australia. In the U.S., custodial fees are typically minimal or nonexistent at major institutions like Schwab and Fidelity. This low-cost custodial structure is another factor tilting in an investor's favor in the U.S.

In contrast, most Australian custodians will charge a fee ranging from 0.1% to 0.3% of the account value, just for the privilege of holding the assets. This higher cost can erode investment returns over time and makes the U.S. a more attractive option for custodial services.

Expected Returns Conclusion

In summary, while the U.S. offers potentially higher returns through its outperforming stock market, lower trading fees, minimal custodial costs, and higher interest rates, it is essential to weigh these benefits against individual financial goals and risk tolerance.

The broader range of investment options and superior transparency in the U.S. further enhance its appeal. However, diversifying assets and considering tax implications in both countries remains crucial for optimizing your overall wealth strategy.

Investment Management

Account Openings/Closures

Maintaining the authority to keep accounts open and invested across borders can present significant challenges, particularly given the regulatory pressures American banks are under to comply with FATCA regulations.

• U.S. Financial Institutions: Due to stringent compliance regulations like the Foreign Account Tax Compliance Act (FATCA) and the Bank Secrecy Act, many U.S. financial institutions are wary of maintaining accounts for clients living abroad. These regulations require extensive reporting and impose severe penalties for non-compliance.
  • As a result, many U.S. brokerage firms may simply close accounts when they become aware that the account holder resides outside the U.S. This can cause significant tax burdens and disrupt your investment strategy.
• Australian Financial Institutions: Due to the aforementioned FATCA regulations, it may be practically impossible to open an Australian bank account while abroad. Australian banks may apply more scrutiny to opening accounts for U.S. tax residents.
  • For reasons relating to PFIC regulations mentioned below, it wouldn’t make sense for a U.S. tax resident to open an Australian taxable investment account.

Rebalancing

Maintaining a well-balanced investment portfolio is essential for managing risk and achieving financial goals. However, rebalancing a portfolio across different countries adds layers of complexity.

• Visibility and Coordination: Rebalancing requires a clear view of your entire portfolio, including holdings in both the U.S. and Australia. This visibility is necessary to ensure you are not unintentionally overexposed to certain asset classes or sectors.
  • However, different financial systems and reporting standards can make it difficult to get a consolidated view of all your investments.
• Cost Considerations: Rebalancing typically involves buying and selling assets, which can incur significant costs. In the U.S., trading fees are generally low or even zero, making rebalancing less costly.
  • In Australia, trading fees are higher, which can make rebalancing more expensive. Additionally, custodial costs in Australia are typically higher, adding another layer of expense when managing a cross-border portfolio.
• Tax Implications: As mentioned earlier, each country has its own tax regulations regarding capital gains, dividends, and interest, which can impact the net benefit of rebalancing.
  • For example, selling assets to rebalance a portfolio could trigger capital gains taxes, which vary significantly between the U.S. and Australia. Understanding these tax implications is crucial to making informed rebalancing decisions.
• Currency Risk: Rebalancing across different currencies adds another level of complexity. Exchange rate fluctuations can impact the value of your investments and the cost-effectiveness of your rebalancing strategy.
  • Careful planning is required to manage currency risk and ensure that rebalancing actions do not inadvertently lead to unfavorable currency conversions.

Strategic Considerations

Effective investment administration for cross-border portfolios involves:

1. Choosing the Right Financial Institutions: Select financial institutions that support international clients and understand the complexities of cross-border investment. This can help avoid unexpected account closures and provide more seamless management of your investments.
2. Effective Cross-Border Investment Monitoring: Keep a close watch on your entire portfolio regardless of the country. Utilize financial software or work with a financial advisor who can provide a consolidated view of your assets and help identify when rebalancing is needed.
3. Cost Management: Be mindful of the costs associated with rebalancing and account management. Seek out low-cost trading platforms and consider the overall expense ratio of maintaining accounts in different countries.
4. Tax Planning: Work with tax professionals who are well-versed in both U.S. and Australian tax laws. They can help you navigate the tax implications of rebalancing and other investment actions to minimize your tax burden.
5. Currency Hedging: Consider using hedging strategies to manage currency risk. Financial instruments such as forward contracts or options can provide protection against adverse currency movements, ensuring that your rebalancing efforts are not undermined by exchange rate volatility.

Restrictions on U.S. Tax Residents

PFICs: A Complex Challenge for U.S. Tax Residents

For U.S. tax residents, navigating the investment landscape becomes particularly complex due to the Passive Foreign Investment Company (PFIC) rules. These regulations impose stringent reporting requirements and potentially punitive tax consequences on investments in foreign mutual funds, ETFs, and other pooled investment vehicles.

What is a PFIC?

A Passive Foreign Investment Company (PFIC) is any foreign corporation that meets one of the following tests:

1. Income Test: 75% or more of the corporation's gross income is passive income (such as dividends, interest, rents, and royalties).
2. Asset Test: At least 50% of the corporation's assets are produced or are held for the production of passive income.

If an investment falls under these criteria (even just once), it is classified as a PFIC, triggering complex tax and reporting requirements for U.S. taxpayers.

Tax Implications

Investing in a PFIC can result in highly unfavorable tax treatment:

• Excess Distribution Tax: Gains from PFICs are taxed as ordinary income and are subject to the highest marginal tax rates. Additionally, an interest charge is applied to the deferred tax, effectively penalizing the investor for holding the investment.
• Mark-to-Market Election: This election allows investors to annually mark the value of the PFIC to market, recognizing gains as ordinary income each year. While this avoids the excess distribution tax, it results in annual taxation on unrealized gains.
• Qualified Electing Fund (QEF) Election: If the PFIC provides the necessary information, investors can make a QEF election, which allows for capital gains treatment on earnings. However, obtaining this information can be challenging, and the compliance burden remains high.

Reporting Requirements

The compliance burden for PFICs is significant. U.S. tax residents must file Form 8621 for each PFIC they hold, detailing income, gains, distributions, and the elections made. The IRS estimates that it takes about 12 hours to complete this form for each PFIC holding, reflecting the complexity and time-consuming nature of these requirements.

Strategic Considerations

Given the adverse tax implications and compliance burdens, U.S. tax residents are generally advised to avoid PFICs. Instead, they should focus on U.S.-based investment options or carefully structured foreign investments that do not trigger PFIC rules.

Estate Planning

Estate planning is a critical consideration when managing wealth across borders. For individuals with assets in both the U.S. and Australia, understanding the nuances of estate administration, the step-up in basis, and transfer taxes is essential to ensure a smooth transition of wealth and to minimize tax liabilities.

Estate Administration

Estate administration involves the legal processes required to transfer assets from a deceased person to their beneficiaries. This process can be complex, especially when dealing with cross-border estates.

• U.S. Perspective: In the U.S., estate administration typically involves probate, a court-supervised process that validates the will and oversees the distribution of assets. The efficiency of probate can vary significantly by state, but it is generally time-consuming and costly given that both the executor and probate attorney are entitled to probate fees (fees vary by State).
• Australia Perspective: In Australia, the estate administration process also requires probate. However, one key difference is that assets must be settled to cash before being distributed to beneficiaries. This requirement can trigger significant tax liabilities, particularly if the estate includes appreciated assets.

Step-Up in Basis

The step-up in basis is a crucial tax benefit in estate planning, particularly in the U.S.

• U.S. Rules: When a person dies, the basis of their non-retirement assets is "stepped up" to the fair market value at the date of death. This means that beneficiaries inherit the assets at their current market value, effectively erasing any capital gains that occurred during the decedent's lifetime.
  • For example, if a stock was purchased for $10,000 and is worth $50,000 at the time of death, the beneficiary’s basis in the stock would be $50,000. This step-up in basis can significantly reduce the capital gains tax liability when the beneficiary eventually sells the asset.
  • The same treatment does not apply to tax-deductible retirement accounts such as 401(K)’s or Individual Retirement Accounts (IRAs) where a beneficiary typically must distribute the account within ten years following the year of the account holder’s passing (although this can sometimes be shorter).
• Australia Rules: Australia does not offer a step-up in basis. Instead, the beneficiary inherits the decedent’s original basis in the asset. This can lead to substantial capital gains taxes when the asset is sold, as the gain is calculated from the original purchase price.
  • Additionally, Australia requires that the asset be settled to cash upon the decedent’s death, potentially triggering immediate tax liabilities. Different treatment applies to a deceased’s primary place of residence and Superannuation accounts.

Transfer Taxes

Transfer taxes include estate taxes, gift taxes, and inheritance taxes, which can impact the value of the estate passed on to beneficiaries.

• U.S. Transfer Taxes: The U.S. imposes estate and gift taxes, but these are mitigated by a substantial unified lifetime exemption, which is $13.61 million per individual in 2024. This means that an individual can transfer up to $13.61 million through their estate or as gifts during their lifetime without incurring federal estate or gift taxes.
  • However, this exemption is scheduled to revert to approximately $6 million at the end of 2025 unless new legislation is enacted.
  • Beyond the exemption, the top estate tax rate is 40%.
• Australia Transfer Taxes: Australia does not have a formal estate or gift tax, but this does not mean there are no taxes on transfers. The requirement to settle assets to cash can lead to capital gains taxes at the time of the transfer.
  • Additionally, if the beneficiaries are non-residents, they may face higher tax rates on inherited assets, including the loss of the capital gains tax discount available to residents.

Strategic Considerations

Effective estate planning for individuals with assets in both the U.S. and Australia involves:

1. Utilizing Trusts: Establishing trusts can help bypass the probate process, allowing for a quicker and more private transfer of assets. Trusts can also provide ongoing management of assets for beneficiaries and potential tax advantages while minimizing probate fees.
   1. Dual citizens must be especially careful of assets held in trust, however, as there may be conflicting tax treatment with the trust in the non-resident country.
2. Coordinating Wills: For assets that aren’t or cannot be placed in a trust, having separate wills for assets located in different countries can streamline the estate administration process and reduce complications arising from differing legal systems.
   1. This also avoids the need for probate to be granted sequentially before foreign assets can be distributed, saving significant time and administrative inconvenience.
3. Professional Advice: Consulting with estate planning professionals who are knowledgeable about the laws in both the U.S. and Australia is essential. They can help structure the estate to minimize taxes and ensure compliance with all legal requirements.

Conclusion

Managing wealth between the U.S. and Australia requires a strategic approach. The factors that must be considered such as currency allocation, taxes, exchange rates, expected returns, legal restrictions, estate planning, and investment administration can all play a role in the outcome of your overall financial portfolio of assets.

By maintaining the majority of your net worth in your country of domicile, understanding the tax implications, leveraging favorable exchange rates, and optimizing expected returns, you can enhance your financial strategy and realize better financial outcomes in the long run.

Additionally, avoiding complex PFIC regulations, planning for estate transitions, and managing cross-border investment portfolios effectively will help you minimize risks and tax liabilities. With careful planning and professional advice, you can ensure that your wealth management aligns with your financial goals and maximizes returns across both countries.

At Areté Wealth Strategists, we have years of experience helping individuals and families successfully make the most of their global financial lives.

Visit our website to learn more about how we can help you. When you’re ready to reach out, get started with your free consultation