Soon to be non-resident alien with 401k and Roth IRA

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discpretzels
Posts: 2
Joined: Tue Jul 06, 2021 8:19 pm

Soon to be non-resident alien with 401k and Roth IRA

Post by discpretzels »

Hi,

I know similar questions have been asked my times, but no other thread has given me a clear idea on the questions I am about to ask.

I have been working in the US on a temporary visa for the past years and planning to go back to my home country soon.
Contributed to:
- 401(k) to get the company match
- Roth IRA, but I am not sure the benefits of the Roth IRA are applicable in my country (tax treaty)
I want to exit my positions over here as I am planning to retire early (and the estate tax also spooks me, no estate treaty and the default $60k is silly.)

401(k): I am thinking doing a conversion to Roth IRA, then pull the money out after 5 years, but can't figure out the timing when to do the conversion.
If I do the conversion in the year which I will be a NRA, will I be taxed the at the 10% treaty rate or at US tax rates?
How should I optimize the conversions to have the least tax burden?

Roth IRA: I am considering pulling out contributions and leaving the earnings in place as there doesn't seem to be a way to avoid the 10% penalty. Is there any other possibility I am missing?
Also, same question as above: If I withdraw Roth contributions while being a NRA, will I be taxed the at the 10% treaty rate or at US tax rates?

Thanks!
TedSwippet
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Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Soon to be non-resident alien with 401k and Roth IRA

Post by TedSwippet »

Welcome.
discpretzels wrote: Tue Jul 06, 2021 9:09 pm 401(k): I am thinking doing a conversion to Roth IRA, then pull the money out after 5 years, but can't figure out the timing when to do the conversion.
If I do the conversion in the year which I will be a NRA, will I be taxed the at the 10% treaty rate or at US tax rates?
How should I optimize the conversions to have the least tax burden?
Looking at the US/Romania treaty, there is this:
ARTICLE 16
Private Pensions and Annuities
(1) Except as provided in Article 18 (Governmental Functions), pensions and other similar remuneration paid to an individual in consideration of past employment shall be taxable only in the Contracting State of which he is a resident.
What this says is that for an NRA who is resident in Romania, only Romania may tax IRA, 401k and similar withdrawals. The implication is that there is no US tax whatsoever to consider here.

(By the way, the 10% treaty rate you quote is specific only to dividends paid by US corporations, treaty article 10 paragraph 2, and doesn't apply to pension withdrawals, or anything else paid by the US. These will, or will not, be handled by other treaty clauses. Pension withdrawals and Roth conversions are not "dividends".)

The main problem with this treaty -- in fact with most treaties -- is that it pre-dates the invention of the Roth IRA/401k, and never really anticipated such a thing. So threading a Roth through the treaty to find the right outcome can be tricky. In particular, a Roth conversion is not always viewable as a withdrawal.

How will Romanian tax treat a Roth conversion? An IRA/401k withdrawal? Knowing this might help you. Google tells me that Romania has a flat 16% tax on income; if (IF) that would apply here, it seems unlikely that you would do better than this with most US tax rates, particularly when you include early withdrawal penalties (the current thinking is that the treaty negates these, for NRAs), and perhaps also US state tax and state early withdrawal penalties on top; though of course I don't know your full circumstances.
discpretzels wrote: Tue Jul 06, 2021 9:09 pm Roth IRA: I am considering pulling out contributions and leaving the earnings in place as there doesn't seem to be a way to avoid the 10% penalty. Is there any other possibility I am missing?
Also, same question as above: If I withdraw Roth contributions while being a NRA, will I be taxed the at the 10% treaty rate or at US tax rates?
Really just the same answer as above. If (IF) the treaty means no US tax involvement in all of this, then it comes down to how Romania will treat these actions under it's normal domestic tax regime.
Topic Author
discpretzels
Posts: 2
Joined: Tue Jul 06, 2021 8:19 pm

Re: Soon to be non-resident alien with 401k and Roth IRA

Post by discpretzels »

Thanks for the reply!
(By the way, the 10% treaty rate you quote is specific only to dividends paid by US corporations, treaty article 10 paragraph 2, and doesn't apply to pension withdrawals, or anything else paid by the US. These will, or will not, be handled by other treaty clauses. Pension withdrawals and Roth conversions are not "dividends".)
Pardon my bad wording, what I meant is Romania is taxing most income at 10% including pensions and capital gains from brokerage accounts (were they to consider 401k a taxable brokerage account). Just unclassified income is taxed at 16%.
it seems unlikely that you would do better than this with most US tax rates, particularly when you include early withdrawal penalties (the current thinking is that the treaty negates these, for NRAs)
If the treaty would negate penalties, that would be amazing -- though I would have to double check with a tax attorney, I am still testing the waters at this moment.
SeaScape
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Joined: Sun Jul 11, 2021 5:16 pm
Location: Norway

Re: Soon to be non-resident alien with 401k and Roth IRA

Post by SeaScape »

TedSwippet wrote: Wed Jul 07, 2021 2:51 am What this says is that for an NRA who is resident in Romania, only Romania may tax IRA, 401k and similar withdrawals. The implication is that there is no US tax whatsoever to consider here.
For what it is worth, the Norwegian tax authorities treat IRAs and 401(k)s are normal taxable brokerage accounts. In a binding opinion (https://www.skatteetaten.no/rettskilder ... ra-konto2/) (Norwegian) they reference a letter from the IRS, where the IRS does not classify IRAs as pensions and retains US right to tax withdrawals. It seems even the IRS limits the definition of pensions to periodic payments from pension plans. Which almost no one has anymore.
TedSwippet
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Location: UK

Re: Soon to be non-resident alien with 401k and Roth IRA

Post by TedSwippet »

Welcome to the forum.
SeaScape wrote: Mon Jul 12, 2021 3:03 am
TedSwippet wrote: Wed Jul 07, 2021 2:51 am What this says is that for an NRA who is resident in Romania, only Romania may tax IRA, 401k and similar withdrawals. The implication is that there is no US tax whatsoever to consider here.
For what it is worth, the Norwegian tax authorities treat IRAs and 401(k)s are normal taxable brokerage accounts. In a binding opinion (https://www.skatteetaten.no/rettskilder ... ra-konto2/) (Norwegian) they reference a letter from the IRS, where the IRS does not classify IRAs as pensions and retains US right to tax withdrawals. It seems even the IRS limits the definition of pensions to periodic payments from pension plans. Which almost no one has anymore.
Hmm. Interesting. My guess is that this is an artefact of the age of the US/Norway treaty. It was last revised in 1971. Newer treaties can be clear that IRAs, 401ks and the like are pensions for treaty purposes. For example, from the US/UK treaty Exchange of Notes:
With reference to sub-paragraph o) of paragraph 1 of Article 3 (General Definitions):
it is understood that pension schemes shall include the following and any identical or substantially similar schemes which are established pursuant to legislation introduced after the date of signature of the Convention:
a) under the law of the United Kingdom, employment-related arrangements (other than a social security scheme) approved as retirement benefit schemes for the purposes of Chapter I of Part XIV of the Income and Corporation Taxes Act 1988, and personal pension schemes approved under Chapter IV of Part XIV of that Act; and
b) under the law of the United States, qualified plans under section 401(a) of the Internal Revenue Code, individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k), individual retirement accounts, individual retirement annuities, section 408(p) accounts, and Roth IRAs under section 408A), section 403(a) qualified annuity plans, and section 403(b) plans.
(For clarity, 401k plans qualify as pension schemes under the US/UK treaty because a 401k plan is a type of 401(a) plan. Assuming of course one can rely on the 'Exchange of Notes' in the first place.)

The problem for the topic author may be that the US/Romania tax treaty is nearly as old as the US/Norway one, and probably largely pre-dates the shift from employer-provided defined benefits pensions to self-managed personal pensions.

Thanks for posting this link. With most things, the more you study them, the clearer they become. With US tax, the reverse seems to be the usual case. Sigh.
TedSwippet
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Location: UK

Re: Soon to be non-resident alien with 401k and Roth IRA

Post by TedSwippet »

SeaScape wrote: Mon Jul 12, 2021 3:03 am In a binding opinion (https://www.skatteetaten.no/rettskilder ... ra-konto2/) (Norwegian) they reference a letter from the IRS, where the IRS does not classify IRAs as pensions and retains US right to tax withdrawals. ...
The case you cite is from 2016. To add further confusion, here is a PLR from 2002 in which the iRS determines that an IRA account is treated as a pension within the terms of a tax treaty that does not otherwise define IRAs or 401ks as pensions. My guess is that "Country" here is Israel:

https://www.irs.gov/pub/irs-wd/0209026.pdf
In order to constitute “pensions and other similar remuneration” within the meaning of paragraph 4, the payments must be made by reason of retirement or death and “in consideration for services rendered”. In this case, we conclude that it would be appropriate to treat distributions from the TDA and the IRA as pension distributions for purposes of the Treaty.

The payments in this case are being made in lump sums rather than a series of periodic payments. However, although the definition of “pensions and other similar remuneration” in paragraph 4 refers to “periodic payments,” the fact that a pension distribution may be in the form of a lump sum will not, by itself, disqualify the distribution for treaty benefits unless the treaty partner interprets the term “periodic” to exclude lump-sum distributions.

Therefore, based solely on the facts and representations submitted, we conclude that the distributions from Decedent’s TDA and IRA accounts to the Estate, which are then treated as distributed to beneficiaries A, B, C, and D, who are residents of Country, are not subject to U.S. withholding and are taxable only in Country pursuant to Article 20(1) of Treaty.
The message here seems to be, never underestimate the ability of the IRS to reinterpret reality to its own potentially unlimited advantage.
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Hyperborea
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Re: Soon to be non-resident alien with 401k and Roth IRA

Post by Hyperborea »

There's another IRS PLR from 2004 this time for an Australian citizen.

https://www.irs.gov/pub/irs-wd/0416008.pdf
Paragraph 1 of Article 18 (Pensions, Annuities, Alimony and Child Support) of the
Treaty provides that, subject to the provisions of Article 19 (Governmental
Remuneration), “pensions and other similar remuneration paid to an individual who is a
resident of one of the Contracting States in consideration of past employment” are
taxable only in that Contracting State. Paragraph 4 of Article 18 defines “pensions and
other similar remuneration” to mean “periodic payments made by reason of retirement
or death, in consideration for services rendered, or by way of compensation paid after
retirement for injuries received in connection with past employment”. The word
“periodic” in Article 18(4) does not preclude the application of Article 18(1) to lump sum
distributions.


Based solely on the information submitted and the representations made by the
taxpayer, and provided that Participant is a resident of Australia within the meaning of
Article 4 (Residence) of the Treaty at the time of a distribution from the Plan, we
conclude that the distribution will be exempt from U.S. income tax under Article 18 of
the Treaty.
Also, if you read the OECD notes on the model treaties which the US treaties seem to follow, the discussion is that most individual retirement savings accounts (i.e. IRAs, 401ks, etc in the US) are "pensions" under the terms of the treaties. They also discuss lump sum versus periodic payments.

https://www.oecd.org/berlin/publikationen/43324465.pdf

pg. 276
5. While the word “pension”, under the ordinary meaning of the word, covers only
periodic payments, the words “other similar remuneration” are broad enough to cover
non-periodic payments. For instance, a lump-sum payment in lieu of periodic pension
payments that is made on or after cessation of employment may fall within the Article
pg. 277
6. Whether a particular payment is to be considered as other remuneration similar
to a pension or as final remuneration for work performed falling under Article 15 is a
question of fact. For example, if it is shown that the consideration for the payment is
the commutation of the pension or the compensation for a reduced pension then the
payment may be characterised as “other similar remuneration” falling under the
Article. This would be the case where a person was entitled to elect upon retirement
between the payment of a pension or a lump-sum computed either by reference to the
total amount of the contributions or to the amount of pension to which that person
would otherwise be entitled under the rules in force for the pension scheme. The
source of the payment is an important factor; payments made from a pension scheme
would normally be covered by the Article.
Last edited by Hyperborea on Tue Jul 13, 2021 4:02 am, edited 1 time in total.
It’s not just that facts don’t seem to matter anymore. It’s that it doesn’t seem to matter that facts don’t matter.
wineandplaya
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Joined: Fri Sep 14, 2018 9:42 am

Re: Soon to be non-resident alien with 401k and Roth IRA

Post by wineandplaya »

If you are planning to buy a house in Romania when you move back, and currently aren't leaving a house, you might be able to use the first-time homebuyer rule to withdraw $10k of earnings from your Roth IRA tax free, in addition to your contributions.

For your 401k, it's probably a complex question and the best action depends on your investment options (including fees) in Romania, future taxes, Romanian treatment of Roth withdrawals etc. If the amount is big enough, estate taxes enter into play.
SeaScape
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Joined: Sun Jul 11, 2021 5:16 pm
Location: Norway

Re: Soon to be non-resident alien with 401k and Roth IRA

Post by SeaScape »

TedSwippet wrote: Mon Jul 12, 2021 10:09 am
SeaScape wrote: Mon Jul 12, 2021 3:03 am In a binding opinion (https://www.skatteetaten.no/rettskilder ... ra-konto2/) (Norwegian) they reference a letter from the IRS, where the IRS does not classify IRAs as pensions and retains US right to tax withdrawals. ...
The case you cite is from 2016. To add further confusion, here is a PLR from 2002 in which the iRS determines that an IRA account is treated as a pension within the terms of a tax treaty that does not otherwise define IRAs or 401ks as pensions...
To be fair, the crux of the Norwegian argument was that Norway had sole right of taxation of the IRA under terms of the treaty. The IRS was arguing that the IRA was not a pension and therefore the US had right of taxation. It never went to the competent authority for decision.
TedSwippet
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Location: UK

Re: Soon to be non-resident alien with 401k and Roth IRA

Post by TedSwippet »

SeaScape wrote: Tue Jul 13, 2021 2:47 am
TedSwippet wrote: Mon Jul 12, 2021 10:09 am
SeaScape wrote: Mon Jul 12, 2021 3:03 am In a binding opinion (https://www.skatteetaten.no/rettskilder ... ra-konto2/) (Norwegian) they reference a letter from the IRS, where the IRS does not classify IRAs as pensions and retains US right to tax withdrawals. ...
The case you cite is from 2016. To add further confusion, here is a PLR from 2002 in which the iRS determines that an IRA account is treated as a pension within the terms of a tax treaty that does not otherwise define IRAs or 401ks as pensions...
To be fair, the crux of the Norwegian argument was that Norway had sole right of taxation of the IRA under terms of the treaty. The IRS was arguing that the IRA was not a pension and therefore the US had right of taxation. It never went to the competent authority for decision.
Understood. However, unless I am misreading something, it still seems that the IRS has made polar opposite determinations of the 'pension-ness' of an IRA across these cases.
  • In the PLR the IRS concludes "yes, for treaty purposes this IRA is a pension".
  • In the Norwegian case -- and admittedly, we are not given the IRS's analysis here -- the IRS concludes "no, for treaty purposes this IRA is not a pension".
In both cases the treaties provide sole taxing rights to the residence country on "pensions" but without defining what is and is not a "pension".

One possible way they could differ is in retirement status. The PLR seems to centre on payments "made by reason of retirement or death". Perhaps in the Norwegian case the individual was not retired (or dead!), but simply elected (early?) withdrawal. Maybe that's enough to swing the determination?

But really, it would be far better for the US to provide some actual clarity here, rather than hide behind cryptic and obscure interpretations. I won't be holding my breath waiting for that to happen.
wineandplaya
Posts: 306
Joined: Fri Sep 14, 2018 9:42 am

Re: Soon to be non-resident alien with 401k and Roth IRA

Post by wineandplaya »

TedSwippet wrote: Tue Jul 13, 2021 3:29 am
SeaScape wrote: Tue Jul 13, 2021 2:47 am
TedSwippet wrote: Mon Jul 12, 2021 10:09 am
SeaScape wrote: Mon Jul 12, 2021 3:03 am In a binding opinion (https://www.skatteetaten.no/rettskilder ... ra-konto2/) (Norwegian) they reference a letter from the IRS, where the IRS does not classify IRAs as pensions and retains US right to tax withdrawals. ...
The case you cite is from 2016. To add further confusion, here is a PLR from 2002 in which the iRS determines that an IRA account is treated as a pension within the terms of a tax treaty that does not otherwise define IRAs or 401ks as pensions...
To be fair, the crux of the Norwegian argument was that Norway had sole right of taxation of the IRA under terms of the treaty. The IRS was arguing that the IRA was not a pension and therefore the US had right of taxation. It never went to the competent authority for decision.
Understood. However, unless I am misreading something, it still seems that the IRS has made polar opposite determinations of the 'pension-ness' of an IRA across these cases.
  • In the PLR the IRS concludes "yes, for treaty purposes this IRA is a pension".
  • In the Norwegian case -- and admittedly, we are not given the IRS's analysis here -- the IRS concludes "no, for treaty purposes this IRA is not a pension".
In both cases the treaties provide sole taxing rights to the residence country on "pensions" but without defining what is and is not a "pension".

One possible way they could differ is in retirement status. The PLR seems to centre on payments "made by reason of retirement or death". Perhaps in the Norwegian case the individual was not retired (or dead!), but simply elected (early?) withdrawal. Maybe that's enough to swing the determination?

But really, it would be far better for the US to provide some actual clarity here, rather than hide behind cryptic and obscure interpretations. I won't be holding my breath waiting for that to happen.
I'm interested in the Norwegian treatment of IRA and 401(k). To avoid derailing the conversation here, I made a separate post about it viewtopic.php?f=22&t=353535&p=6118568#p6118568. I would appreciate any comments/clarifications.
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