A 401K is a qualified-retirement savings plan, sponsored by employers in the US. Eligible employees contribute a part of their pre-tax paycheck towards this plan, while the employer funds the rest. This not only helps reduce the employee’s tax liability but also builds a retirement fund. The US Internal Revenue Service (IRS) authorizes contribution limits for 401(k) accounts.
However, there are some regulations regarding the withdrawal of fund from this account, such as:
- The investment is locked in till you hit the age of 59.5 years.
- Prior to this, you will be charged a 10% early withdrawal penalty.
- Withdrawals are taxed as ordinary income.
“I am moving back to India in a few months and I have quite a bit saved in my 401K. What should I do?” This is a question that many NRIs returning to India after a long spell in the US ask. Here are some options that could help.
Option #1: Withdraw the Money
You can cash out your 401K account once you have left or the employer has terminated your services. But, when you consider this option, it doesn’t favor your retirement plan. And, it will increase your tax liability, along with the 10% penalty for early withdrawal. So, this could be the last option.
Option #2: Leave it in the US
You could leave the 401K plan as it is till you hit the specified age for withdrawal. However, you cannot add to it in the meantime, although you can continue to invest in funds available with the plan. However, your contribution will not be tax exempt in this case.
There are two issues that you should be aware of while choosing this option:
- The plan has a restrictive structure. Your employer has sponsored this plan and allocated your money in various fixed classes that you cannot change to reduce your risk.
- If your employer decides at anytime to discontinue this plan, you will have only two choices left. Either you can withdraw the money and deal with the tax and penalty or you could rollover to an Individual Retirement Account (IRA).
Note: You always have this option, rollover the 401K to an IRA with a new employer.
Option #3: Rollover to a Traditional IRA
Rolling over your 401K account gives you several benefits. Firstly, it is an individual account, as opposed to an employer-sponsored account. Secondly, you get the freedom to choose your own fund options, depending on your risk-profile. Furthermore, you are not charged any tax on movement of your contribution from 401K to traditional IRA.
Option #4: Rollover to a Roth IRA
Roth IRA is a tax-efficient way to save for retirement. It is funded by your post-tax income, which means that you can withdraw money at any time, without having to pay tax or penalty on it. However, dividends or interest received on your Roth IRA investment are subject to income tax. You can contribute to Roth IRA till any age, as long as you are earning an income. This could even help you fund your grandchild’s education or marriage.
Each option has its own pros and cons. So, do your research well before making a choice.
Let’s start a company together a great one since I already have a plan laid out if you have people with you
Let’s say one keeps the money in the 401K as per option 2 or rolled over to an IRA per option 3. There will understandably not be any tax liability in the US as there is no withdrawal till one turns 59.5 years old.
However, year on year the money in the accounts will keep on growing. Is there tax liability in India on the growth? I would imagine this growth will have to be added to the taxable income in India.
I had the same question as Shyam Sunder. If money stays within a tax deferred IRA account, there is no tax payable in the USA until an actual withdrawal event occurs. But will the capital gains or dividends inside the IRA account be still taxable in India and has to be shown as regular income every year in Indian tax return (though it is not taxable in the US) ?
If it is be shown as income, I don’t know how double taxation will be handled. Since there will also be US tax payable for the amounts, when a withdrawal happens from the IRA account down the road in the future. And if the withdrawal were to be made like monthly pensions from the IRA accounts, it becomes even more complicated to apportion the dual tax offsets to get any refunds.
How about this plan.. When moving to India; move 401K to Rollover IRA. Subsequent year close the Rollover IRA. By that tax slab will be reduced and will pay lesser tax on top of the penalty..
401k accounts are differentiated into a few types and each one of these have different tax angles attached to them. Let’s cover all 401k taxation in India so we can have a better understanding of how the taxation will work once you withdraw your 401k return to India.