Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

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tinytortoise
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Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by tinytortoise »

Hello all,

I am Indian citizen and my company was not offering 401k till now. This year, company decided to start offering 401k and it has both Trad and Roth 401k option, but no company match. I have been investing in my personal taxable account. I have more than 30+ years to reach 59 1/2 years, so not sure I will still be in US by that time. I am in 24% tax bracket.

Trad 401k: I will pay less in taxes upfront, not sure beneficial or not (30+ years to see any benefits), both contributions and gains will have tax implications and penalty for premature withdrawal

Roth 401k: After tax contribution, money grows tax free, can withdraw contributions without tax and penalty after 5 years, only gain will incur 10% penalty and tax

Based on this, it looks like Roth 401k might be better suited for me if I decided to contribute. Is it really good idea to contribute to Roth 401k or should I stick to investing in my taxable account for foreseeable future? I am not inclined towards contributing to any form of 401k, because I don't like the idea of paying 10% extra in penalties. But, I may not be seeing the complete picture so decided to post here. Appreciate any insight from seasoned members
Last edited by tinytortoise on Sun Jan 23, 2022 9:54 pm, edited 1 time in total.
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LadyGeek
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by LadyGeek »

Welcome! I moved your thread to the Non-US Investing forum which has the experience to answer your questions. What is your home country?

I don't have the experience to answer your question, but the wiki has some background info:

- Investing from outside of the US
- Non-US investor's guide to navigating US tax traps

Additional information (content applies to US citizens):
- 401(k)
- Traditional IRA
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
Topic Author
tinytortoise
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by tinytortoise »

Thanks LadyGeek. Updated original post. I am Indian citizen working here in US
gougou
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by gougou »

Are you planning to stay in the US long term or are you going back to India? That’s going to matter a lot.

Also what’s you state income tax rate?
The sillier the market’s behavior, the greater the opportunity for the business like investor.
Topic Author
tinytortoise
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by tinytortoise »

1. That's tricky question to answer as I am so early in my career. So I am assuming I might retire in India looking at other things which are out of my control. I might stay in states for another 10 years or so
2. State income tax is 9+%
gougou
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by gougou »

With 24% federal plus 9% state I would recommend you to max out pre-tax 401k.

If you plan to go back to India, pre-tax 401k is a no-brainer. You are saving 33%+ tax right now to contribute. You’ll pay 15% withholding tax when you take it all out as an Indian resident. (Double check this with tax professionals)

Roth 401k is tricky when you might want to leave US eventually. You contribute after-tax dollars to Roth 401k, but it is still subject to withholding tax when you withdraw it as a non-resident. So it could be even worse than a taxable account. For example, if you saved $1M in your taxable account and you went back to India, you could sell all $1M tax-free when you are a non-resident of US. If you saved $1M in Roth, that $1M is subject to 15% withholding tax when you withdraw in India so you’ll only have $850K left.

If you are pretty sure you’ll stay in the US then you should max out Roth 401k and do the $6k backdoor Roth as well.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
TedSwippet
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by TedSwippet »

gougou wrote: Mon Jan 24, 2022 12:14 am If you plan to go back to India, pre-tax 401k is a no-brainer. You are saving 33%+ tax right now to contribute. You’ll pay 15% withholding tax when you take it all out as an Indian resident. (Double check this with tax professionals)
Not a tax professional, but ... on my reading of the US/India tax treaty, IRA and 401k withdrawals made by a resident of India who is not a US citizen are taxable only to India. Article 20 paragraph 1 and paragraph 3. See also the tax treaty withholding tables that the IRS publishes for use by payers. To the extent that there is any tax withheld on the US side then, it should be fully reclaimable by filing the appropriate 1040-NR tax return with the IRS.
gougou wrote: Mon Jan 24, 2022 12:14 am Roth 401k is tricky when you might want to leave US eventually. You contribute after-tax dollars to Roth 401k, but it is still subject to withholding tax when you withdraw it as a non-resident. So it could be even worse than a taxable account. For example, if you saved $1M in your taxable account and you went back to India, you could sell all $1M tax-free when you are a non-resident of US. If you saved $1M in Roth, that $1M is subject to 15% withholding tax when you withdraw in India so you’ll only have $850K left.
I am pretty sure this is also wrong. As a general rule, qualified Roth withdrawals are not US taxable to anybody, US 'taxable person' or not, and even if they were, Article 20 of the treaty would still protect them from US tax. So again, if a provider withholds any US tax on payments from a Roth made to an Indian resident, it should be reclaimable as above.

This is all the US side of things. I know nothing about how India would view or tax US IRA, 401k, and Roth accounts.
tinytortoise wrote: Sun Jan 23, 2022 8:33 pm Based on this, it looks like Roth 401k might be better suited for me if I decided to contribute. Is it really good idea to contribute to Roth 401k or should I stick to investing in my taxable account for foreseeable future? I am not inclined towards contributing to any form of 401k, because I don't like the idea of paying 10% extra in penalties. But, I may not be seeing the complete picture so decided to post here. Appreciate any insight from seasoned members
It's a tricky question, and the right answer can only be known with hindsight. All you can really do is try to weigh the probabilities of whether or not you will spend the rest of your life in the US, and if not, how much longer you will stay. If you have not already found it, this wiki page outlines a few more planning points for people who move to the US:

US tax pitfalls for a non-US person moving to the US - Bogleheads
international001
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by international001 »

I also didn't understand the 15% withholding. I think this may be applied if you decide to take a pre-tax 401k distribution, but not sure.

What you should investigate it's how Roth distributions are treated by India. Whether they have a clear policy or not, or whether it's even enforced. Note that the treaty date precedes the invention of Roths.
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tinytortoise
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by tinytortoise »

Thanks a lot for detailed reply. The other question I have is what should be my withdrawal strategy once I moved back to India?
Not a tax professional, but ... on my reading of the US/India tax treaty, IRA and 401k withdrawals made by a resident of India who is not a US citizen are taxable only to India. Article 20 paragraph 1 and paragraph 3. See also the tax treaty withholding tables that the IRS publishes for use by payers. To the extent that there is any tax withheld on the US side then, it should be fully reclaimable by filing the appropriate 1040-NR tax return with the IRS.
What happens to early withdrawal penalty in this case?
bogledogle
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by bogledogle »

tinytortoise wrote: Sun Jan 23, 2022 8:33 pm Hello all,

I am Indian citizen and my company was not offering 401k till now. This year, company decided to start offering 401k and it has both Trad and Roth 401k option, but no company match. I have been investing in my personal taxable account. I have more than 30+ years to reach 59 1/2 years, so not sure I will still be in US by that time. I am in 24% tax bracket.

Trad 401k: I will pay less in taxes upfront, not sure beneficial or not (30+ years to see any benefits), both contributions and gains will have tax implications and penalty for premature withdrawal

Roth 401k: After tax contribution, money grows tax free, can withdraw contributions without tax and penalty after 5 years, only gain will incur 10% penalty and tax

Based on this, it looks like Roth 401k might be better suited for me if I decided to contribute. Is it really good idea to contribute to Roth 401k or should I stick to investing in my taxable account for foreseeable future? I am not inclined towards contributing to any form of 401k, because I don't like the idea of paying 10% extra in penalties. But, I may not be seeing the complete picture so decided to post here. Appreciate any insight from seasoned members
401k is a no brainer for you, even if you plan to leave the US. You save federal + state taxes every on every paycheck - thats ~33% extra $$ working for you in your investments. If you leave in just a few years, you can leave that money behind to compound over time and serve as retirement vehicle. This will give you international diversification in the future and exposure to the US dollar. Worst case scenario, you can pay the 10% penalty but you may still come out ahead with that 33% extra $$ working in your account. There is the possible avenue to take SEPP (72t) payments on a regular basis without penalty.

If you skip 401k and use a ROTH 401k, you will only pay penalty on gains, but start out with less capital.

It is really hard to predict taxation between countries for decades, but under current tax laws India does not double tax you. You will pay what you owe to the US and India will only tax you if you tax rates are higher in India. Assuming you are living in India in retirement, you might be in a lower tax bracket in the US and a higher bracket in India - so you will owe India some money too.

There has been talk that India will allow 401k rollovers to an equivalent retirement account sometime in the future.
TedSwippet
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by TedSwippet »

tinytortoise wrote: Mon Jan 24, 2022 7:59 pm
Not a tax professional, but ... on my reading of the US/India tax treaty, IRA and 401k withdrawals made by a resident of India who is not a US citizen are taxable only to India. Article 20 paragraph 1 and paragraph 3. See also the tax treaty withholding tables that the IRS publishes for use by payers. To the extent that there is any tax withheld on the US side then, it should be fully reclaimable by filing the appropriate 1040-NR tax return with the IRS.
What happens to early withdrawal penalty in this case?
No treaty that I know of is explicit about this, but the current thinking is that a treaty that reserves taxing rights to the country of residency only would also protect from any early withdrawal penalties (the main argument being that these penalties are defined in US law as "taxes"). Most recently discussed in this thread:

Fidelity 401k And W-8BEN - Page 2 - Bogleheads.org
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Hyperborea
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by Hyperborea »

international001 wrote: Mon Jan 24, 2022 5:19 am I also didn't understand the 15% withholding. I think this may be applied if you decide to take a pre-tax 401k distribution, but not sure.

What you should investigate it's how Roth distributions are treated by India. Whether they have a clear policy or not, or whether it's even enforced. Note that the treaty date precedes the invention of Roths.
Not just how they are taxed on withdrawal but whether or not a Roth is counted as a retirement account before withdrawal. Not many countries do and that means that income inside the account (selling, rebalancing, dividends, etc.) could be taxable in your country of residence. This makes a Roth type account a bad choice for anybody planning to leave the US at a later date.
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Topic Author
tinytortoise
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Re: Non-US citizen: Trad 401k vs Roth 401k vs Taxable account

Post by tinytortoise »

TedSwippet wrote: Tue Jan 25, 2022 3:04 am No treaty that I know of is explicit about this, but the current thinking is that a treaty that reserves taxing rights to the country of residency only would also protect from any early withdrawal penalties (the main argument being that these penalties are defined in US law as "taxes"). Most recently discussed in this thread:

Fidelity 401k And W-8BEN - Page 2 - Bogleheads.org
[ quote fixed by admin LadyGeek]

Thanks a lot for sharing this. It was very informative read.

Is there any advantage of setting up ROTH IRA account right now? I read somewhere, 'if I decided to convert Trad 401k to ROTH IRA in future, I do not need to reset 5 year clock as it starts when I open my first ROTH IRA account '
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