I am working in the US what should I do with my 401k plan before moving back to India? This is a very common question considering the number of non-resident Indians that are working in the USA.
NRIs working in the USA participate in one of the retirement plans commonly known as 401k plans. The 401(k) is a qualified retirement plan with deferred tax benefits under US tax laws. NRI employees can invest a part of their salary in the 401(k) account, however, the employer may or may not match your contribution.
In This Article :
- Types of 401(k) Retirement Accounts
- What is 401k in India
- 401k withdrawal from India
- What is Traditional IRA
- NRI Should Know 401k before moving to India
Types of 401k Retirement Accounts
Among the six different 401(k) retirement plans and a 403(b) plan, NRIs can opt among the following three types –401(k), Traditional IRA, and Roth IRA/401(k).
401k in India
If your employer offers the defined contribution 401(k) plan, then they are matching your contributions to your corpus. Contributions are made before taxes and therefore the entire sum is taxable at withdrawal at prevailing rates.
Because of the matching contribution from the employer, a 401k in India is offering the best way to quickly save for your retirement. The investment options are also limited to those offered by the employer.
A self-sustained retirement plan, an IRA has only your contributions. You can open a new IRA account or when you leave your job then you can rollover your 401(k) Plan into one. You can decide your investment options – aggressive or conservative. Here also, contributions are made from pre-tax income, and the tax is deferred until withdrawals.
Roth IRA/401k Plans
Investments in Roth IRA are made from post-tax income, making withdrawals (of principal) tax-free. Any earnings, however, are taxable at prevailing rates. Early withdrawals do not attract taxes or penalties as investments were made post-tax. Earnings also become tax-free if you hold the account for more than five years or have turned 59½.
Which plan should you opt for?
As the 401(k) plans significant tax benefits and a matching contribution from the employer, if you are eligible, they do go for it.
For others, if post-retirement you expect to be in a lower tax bracket, then opt Traditional IRA otherwise Roth IRA is a better choice. Usually, salaried people would be in the lower tax bracket at the time of their retirement, thus we suggest opting for Traditional IRA for them. For businesspersons, and high-flying professionals like physicians, attorneys, Roth IRA is suitable.
Similarly, if you don’t think that you will be in the USA till the time you retire and would come back to India then again Roth IRA is a better choice.
Check – Why NRI Invest In India?
What to do with the 401k plan before moving back to India?
If you have invested in the 401(k) India or the Traditional IRA, then moving back to India before you turn 59½ may attract penalties and tax liabilities on the entire corpus.
You must opt between if you are going to cash out, leave the fund as it is, or rollover to another account.
Let’s discuss each of them here one by one.
Leave your 401(k) Plan as it is
If you choose to not do anything your employer will continue to manage it without any contributions. You would be able to defer taxes and earn tax-free growth till you turn 59½.
One downside is that if your employer decides to pull out of the fund, you will have no option but to either cash out or rollover to an IRA. It means you will have to keep in touch with your employer, even after you are back in India, which can be an issue for many.
Rollover to an IRA
By rolling over your 401k plan to an IRA you can lower your tax liability and need not pay the 10% penalty as you are still invested in a qualified account and not withdrawing.
A penalty of 10% will apply if you withdraw from this account before 59½ years of age. But certain exceptions apply for emergency and big-ticket expenses. These include out-of-pocket medical expenses, buying your first home, permanent disability, and qualified higher-education expenses (including tuition, books, supplies, room, and board) at eligible institutions.
One problem with opening an IRA is that many companies do not cater to non-US addresses, so get clarity on this aspect before opening the IRA. Another concern is that when you turn 70, you must compulsorily start withdrawing under the Required Minimum Distributions requirements.
You can also transfer your IRA fund to a retirement fund in your home country, but you will have to pay taxes in the USA on the withdrawal. As India has DTAA with the USA, you can claim tax credit here while filing IT return based on the taxes paid in the US. India US tax treaty 401k is part of it.
Rollover to a Roth IRA
The investment made in the Roth IRA account is from post-tax dollars, so it is less complicated. At the time of withdrawal, contributions are tax-free, only the earnings are taxed at the prevailing rates.
While moving back to India, if you fall are in a lower tax slab, then you can consider a roll-over to Roth IRA. You will pay taxes on the amount you are rolling over, but all subsequent withdrawals would be tax-free in the USA. As RMD does not apply to Roth IRA, you can continue to save even after you turn 70 for purposes like children’s higher education, or their seed money.
401k Withdrawal from India
If you cash out your 401(k) before you are 59½ or permanently disabled, then a 10% early withdrawal penalty is applicable over and above the appliable tax, in the case of 401(k) and Traditional IRA.
If your children are staying longer in the USA, then making them designated beneficiaries would make later withdrawals tax-free.
If there is a need to cash out, then wait for the next tax year, if you can. As you would have no US income in that year and fall in a lower tax bracket. The 10% penalty would still apply if you were younger than 59½.
In general, if you plan to come back to India sooner than later, then Roth IRA accounts are the best bet considering lesser tax hassles and offering liquidity.
Budget 2021-22 Return to India 401k Issue
Budget 2021 promised to address the double taxation issue by taking into account the specific needs of NRIs. An example of this is income from retirement accounts opened outside of India. It is common for NRIs working in the US to invest in 401(k) accounts to take advantage of tax benefits. (Or people working in Singapore investing in CPF or in UK Qrops)
Workers working temporarily in the US and later returning to India faced different tax laws in both countries. Returning home as residents of India, they paid taxes on their worldwide income, which is on an accrual basis. And since the source of such income (in this case, the retirement account) comes from the US, it also became taxable in the US under US tax laws, regardless of whether or not residing in the US.
In addition, there is the issue of different tax periods for the respective countries. NRIs usually pay taxes on the same retirement income with no tax credits in India and the US, albeit in different years. Personal taxes, Payable on a calendar year basis in the USA, Germany or Singapore, and on a fiscal year basis in India.
First of all, check if your country of residence has a DTAA with India. Earlier there were doubts as to whether such recurring NRIs would receive tax relief for such taxes paid in India under the Double Taxation Agreement (DTAA). This will likely be resolved soon by the government.
India US Tax Treaty 401k India Double taxation and the fight for it is clear for NRIs and the Ministry of Finance of India has made commendable efforts to improve this in the 2021-22 Union budget. Earlier, there were several tax-related issues in India that plagued NRIs and caused problems.
Some of these were: Non-compliance in the taxability period in India and the USA.
“To address this, the Union Budget 2021-22 proposed adding a new Section 89A to the Act to ensure that the income a particular person derives from a particular account is taxed in the manner and yearly prescribed by the crediting of the Central Government Challenge.
Funds for taxes paid abroad in India are taxed on a receipt basis in the USA and on an accrual basis in India”
Now you know what are the options that you have before moving back to India 401k. If you have any questions regarding 401k moving to India add them in the comments. If you have experience related to how to withdraw from 401k in India – must share it in the comment section.