If you are a foreigner working in the US, it is a good idea to contribute to a 401(k) plan if your employer offers one. A 401(k) is a great way to save for retirement and your contributions may be tax deductible and grow tax-deferred (in a traditional 401(k) or taxable now but able to grow tax-free (in a Roth 401(k)). But what happens to your 401(k) when you decide to permanently move back to your home country?
Here’s a primer on what you can and should do with those 401(k) contributions once you leave the US and the tax consequences of each choice.
What to Do with Your 401(k) When You Leave
Option 1: Leave Your 401(k) Where It Is
Even if you are returning to your home country, you can choose to leave your 401(k) with your employer in the US until you reach the age of 59 ½. This will help you defer taxes until withdrawal or accumulate tax-free growth if you selected a Roth 401(k). Some employers won’t allow you to leave your 401(k) behind especially if your balance is less than $1,000. From the day you leave your job, you have 60 days to decide if you want to roll over your 401(k) to IRA.
Leaving your 401(k) as is can have some downsides. Within a 401(k) plan, your investment options may be limited. In addition, if your employer decides to terminate the plan, you’ll have either withdraw the funds or rollover the funds to an individual retirement account (IRA). Make sure that your 401(k) plan can communicate with you by email or mail once you have returned to your home country so that you get adequate notice of any changes. And keep track of your 401(k)s over your lifetime, as you may have several employers and it can be hard to keep track of all the plan sponsors and logins.
Option 2: Do a Rollover To an IRA and Take Control of It
An IRA is an account you can set up on your own as opposed to a 401(k) which is sponsored by your employer. As noted above, you can rollover your 401(k) to an IRA once you leave your employer. If you decide to pursue this route, you can opt to rollover your funds to either a traditional IRA or Roth IRA.
If your contributions to your 401(k) were pre-tax, rolling over to a traditional IRA may be the simpler and preferred option because it will have no tax consequences. Your assets will continue to grow tax-deferred and be taxed on the distributions when you retire. See tax details further down in the article. Traditional 401(k)s and IRAs also have Required Minimum Distributions when you reach 70 ½.
Another option is to rollover to a Roth IRA. If you opted for a Roth 401(k), again this will have no tax consequence except for any employer match amount, which is always pre-tax. But if you opted for a pre-tax 401(k), rolling into a Roth IRA will cause a large tax consequence – you’ll owe immediate tax on the contributions and growth. The main advantage of a Roth IRA is that you won’t have to pay taxes on qualified distributions when you retire because the funds have already been taxed and grow tax-free. Sometimes it makes sense to rollover to a Roth IRA in a year when you have a low income because the potential gain in tax-free growth on the assets may be greater than the one-time tax hit.
As an immigrant, one major concern when you do a rollover is the fact that you need to look for companies that cater to clients with non-US addresses. Fidelity and TD Ameritrade are popular option because you can open an IRA account while in the US and then change the address to a non-US address when you move. While it’s possible to change your address, you may be unable to open a new IRA account with a non-US address. However, TD Ameritrade does allow you to open accounts with non-US addresses. It’s better to consult the firm you are maintaining an IRA with to know your options and go over alternatives.
Option 3: Cash Out Your 401(k)
When you leave your employer and return to your home country, you can also cash out your 401(k). But if you do are not 59 ½, the withdrawal will be taxable and you may be subject to a 10% early withdrawal penalty on the distribution.
Between all three options, we recommend that individuals returning to their home countries pursue Options 1 or 2: leave their 401(k)s with their former employer or do a rollover to an IRA.
How Will My Withdrawal Be Taxed in Retirement If I Live In My Home Country?
When you reach the age of 59 ½, you can take 401(k) and IRA distributions. These distributions can either be a lump sum distribution or a monthly pension, each of which has a different tax procedure.
Scenario 1: Lump Sum Distribution
If you choose a lump sum distribution, the brokerage will withhold 30% from the proceeds if you are a non-resident alien. You may be eligible for a reduced rate if there is a treaty with your home country. Canadians, for instance, are only subject to a 15% withholding tax.
The tax withheld from your 401(k) proceeds will be applied to your actual tax due in the US. The tax you owe to the IRS may be more or less than the amount withheld. If your actual tax due is greater than the amount withheld, you have to pay the balance. If the amount withheld is more than your tax due, you have to file Form 1040-NR to claim a refund if you are no longer a US tax resident. As far as the US is concerned, once you have moved to your home country, you will only pay US taxes on US-Situs assets if you are a non-resident. Thus, if distributions are small, you could fall into the lowest US bracket and essentially pay 0%.
If your home country requires you to declare and pay taxes on worldwide income, you will have to declare the lump sum distribution as part of your gross Income in your home country, less any credits or exemptions. If there is a tax treaty between your country and the US, you may be eligible to claim actual tax payments in the US as a tax credit in your home country. An experienced tax advisor like Cuevas & Cuevas LLP can help you determine the taxes you can expect to owe in retirement.
Scenario 2: Monthly Pension
If you receive distributions as a monthly pension, you should check about the status of a tax treaty between the US and your home country. In most cases, you will only have to pay taxes in the country where you are a resident. If you have moved back to India, for instance, you only have to pay taxes in India when you receive your monthly 401(k) pension. However, you may still be required to file US tax returns. If there is no treaty between the US and your home country, the brokerage has to withhold 30% from the monthly distributions.
Since taxation rules and requirements differ from one country to another, it would be best to consult a tax advisor like Cuevas & Cuevas LLP prior to your move to help you create a strategy.
Why Planning 401(k) Distributions Matters
Your 401(k) from your US employer can be an asset and a source of income in your retirement, even if you have returned to your home country.
If you are leaving the US, it’s highly recommended that you that you make an informed decision about what to do with your 401(k). Take steps to examine your retirement cash flow requirements, pursue diversified investments in both international and US stocks, and be strategic about minimizing taxes in the future.
Taxes are usually the last thing on your mind when you find your life crossing borders, but they’re a critical consideration. This is an excellent time to take stock of the previous year and look at the one ahead to determine if your planning should include a discussion with an international tax professional.
This is just one article within our 2019 Year-End tax Guide. For more great insights, check out our 2019 Year-End Tax Guide or attend our individual or business year-end planning webinars.
For additional information, please contact our Our Affiliates Cuevas & Cuevas International Business Advisors.
THIS INFORMATION IS PROVIDED AS A COURTESY – NOT AS LEGAL ADVICE.
Please know that we are raising the above issues as a courtesy and for informational purposes only. It is not intended as a substitute for legal advice concerning a particular situation that may be affecting your business.
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