What to do with your 401(k) if you move back to India

A 401(k) plan is an employer-sponsored defined-contribution pension account. It is called so as it is defined under the subsection 401(k) of the Internal Revenue Code in the United States of America. Funding comes directly from the employee paycheck and it can be matched by the employer. So, if you are an NRI, and have a 401(k) enrolled in the USA, this article is for you.

Latest Update (Budget 2021-22): Withdrawing 401k from India and the associated tax implications

As we can establish here that the 401(k) is a great way to save up for your retirement. But what happens when it clashes with your plans of returning home? In this article, we will explore the aspects of 401(k) and understand about the options that you have if you decide to return to India. What can you do and what are the tax implications of your choices? Let’s understand.

What to do with your 401(k) if you move back to India

The contributions that you make towards your 401(k) can 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)]. Now, what happens when you decide to move back to India? There are multiple options you can choose from. Let’s discuss them here.

• Leave your 401(k) where it is: Now, you can choose to let your 401(k) be as it is with your employer till you turn 59½ . This will help you to defer taxes [traditional 401(k)] till withdrawal or have a tax-free growth [Roth 401(k)]. Some employers might insist on maintaining a minimum balance of $1000. You get 60 days to decide if you want to change your 401(k) into an Individual Retirement Account (IRA).

There can be some downsides to it as well. If your employer decides to pull out of the fund, you’ll have to either withdraw the amount or roll over to an IRA. So, make sure to be updated with all the communication through email or mail. It can be hard to keep a track of your 401(k) sponsors and logins if you’ve had several employers.

• Rollover to an IRA: An IRA is an Individual Retirement Account. Therefore, it is not sponsored by your employer. You can do a rollover once you leave your employer and can choose between a Traditional IRA or a Roth IRA.

Now, Traditional and Roth are different in terms of tax implications. Let’s understand them. For a pre-tax 401(k), it is simpler and preferable to roll over to a traditional IRA as it will have no tax consequences. Your assets will have a tax deferred growth and will only be taxed once you retire. There is a required minimum distribution when you reach 70½ in case of traditional 401(k)s and IRAs.

Alternatively, you can roll over to a Roth IRA which will have no tax consequences except for any employer match amount as it is always pre-tax. But, if you had a pre-tax 401(k), rolling into a Roth IRA will have large tax consequences as you will owe immediate tax on contributions and growth. The main advantage of a Roth IRA is that you won’t have to pay taxes on qualified distributions while retiring as the funds have already been taxed and are grown tax-free. Sometimes, when you have a low income, it makes sense to rollover to a Roth IRA in a year because the potential gain in tax-free growth on the assets may be greater than the one-time tax hit.

Another aspect to keep in mind especially for immigrants is to check whether the company caters to non-US addresses or not. While it’s possible to change your address, you may be unable to open a new IRA account with a non-US address. It’s advised that you consult the firm you are maintaining an IRA with to get a clearer picture of the options available and the alternatives.

• Cash out your 401(k): While returning to India, you can also cash out your 401(k) if you’re above 59½. If not, then the withdrawal will be subject to taxes along with a possible chance of 10% early withdrawal penalty on the distribution.

It is therefore advised that you either leave your 401(k) as it is with your employer or take a rollover to an IRA.

Taxation on Retirement: How Will My Withdrawal Be Taxed If I Live In My Home Country?

There are 2 options that you have after reaching the age of 59½. You can take your 401(k) and IRA Distributions either as a lump sum distribution or as monthly pension. Now, both of these mediums have different tax implications. Let’s understand them one by one.

• Lump Sum Distribution: For a non-resident alien, the brokerage will withhold 30% from the proceeds. You can however be eligible for a reduced rate if your home country has a treaty with the USA (eg: Canada has a 15% rate). This withheld tax will be used to settle your actual tax due in the US. Now, simply put, if the tax amount is greater than the amount withheld, you’ll have to pay the balance or you can file form 1040-NR to claim a refund vice versa (if you are no longer a US Tax Resident) 

Note: In the case of the USA, 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%. Also, if your worldwide income is taxed in your home country then this amount must be added to your gross income (less any exemptions/credits). The DTAA (Double Tax Avoidance Agreement) also comes into play here.

• Monthly Pension: Now, primarily the brokerage has to withhold 30% from the monthly distributions if there’s no taxation treaty signed between the home country and USA. However, in case of India, there is a DTAA signed with the USA that dictates that you’ll only pay the taxes on your 401(k) pension in India (where you will be a resident after moving back). However, you are still required to file the tax returns in the USA.

Taxation is a very complex subject and often requires expert advisory before moving ahead. Now, Ask our expert directly on WhatsApp using the button below and clear your queries on taxation regarding 401(k) instantly. Also, visit our blog and youtube channel for more details.

Ask SBNRI Expert Now

401(k): FAQs