Thursday, September 10, 2009

R2I - What to do with the 401(k) account?


Have you decided to Return to India (R2I)? Wondering what to do with your 401(k) account? Handling your 401(k) account is one of the big things in R2I checklist. This blog post explains the different things you can do with your 401(k) account, during your R2I. (Also read: R2I Planning Guide)

When you quit job during your return to India, your 401(k) account will move to 'terminated status'. On your last day of employment, you'll be given a 'participant distribution' form. You'll have to decide what you want to do with your 401(k) account.

You'll have the following options:

1) You can still maintain your 401(k) account without making any contributions to it. You'll be allowed to manage the funds. You can wait till your retirement to close your 401(k) account. You'll need to pay taxes only when you close the account (i.e., after your retirement). Many 401k providers allow you to manage the account online. So, you don't have to be worried about remotely managing the account from India.

2) You can close your 401(k) account. In which case, there is a 20% federal tax + 10% penalty for early withdrawal. You'll have to settle the remaining taxes (based on your income bracket), when you file your taxes next year.

3) You can rollover the funds to an IRA account. No tax will be deducted when you rollover the funds to an IRA account. However, when you close the IRA account in the future, you'll be taxed.

4) You can rollover the funds to a Roth IRA account. Tax will be deducted when you rollover the funds to a Roth IRA account. However, when you close the Roth IRA in the future, you won't be taxed.

Filling the 'participant distribution' form is a must on your last day of employment or a few days after that.

You should talk to a financial adviser for greater insights.

Note:
  • You'll be in Resident but not Ordinarily Resident (RNOR) status for the first two years after your R2I. Subsequently, you'll have to pay taxes in India, for the money that you are bringing from USA. Yes, you'll be taxed twice.
  • Some people will close their 401(k) after they R2I. They'll withdraw funds in small amounts so that they'll fall under the 'minimum' tax bracket. That way, they'll have to pay very less tax to the US government. However, after 2 years, you'll have to pay taxes in India too (since you won't be in the RNOR period)

Related posts:

Return to India (R2I) - 25 things to do
R2I - 401(k) closure FAQs
How can I get my Social Security benefits/money?

5 comments:

  1. Hi Saro,

    Thanks for putting together such wonderful information. You are God for people r'ng2i.

    I am relocating on 30th July and my family has moved to B'lore last year. So looking forward to it and yr blog is helping me do a few things to make the transition easy.

    I just had a question and wondering if you might be able to help me. I took US citizenship, whereas my wife retained her Indian citizenship. Will I also have the same 2 yrs grace period (RNOR) to have that tax shelter or be eligible to bring my 401K/IRA funds later on? Please advice.

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  2. Yes. You'll have the RNOR status for the first 2 years. You don't have to report your foreign income when you file your tax returns in India (i.e., the money you are bringing from US will not be taxed in India during your RNOR period. However, you'll have to file tax returns in US for that income).

    After the RNOR period, you'll have to file taxes both in US & India.

    Here is the link to a relevant discussion in R2I Club forums. Hope this helps.

    http://www.r2iclubforums.com/forums/showthread.php/1553-MT-Tax-for-US-Citizen-living-in-India

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  3. Saro,
    you may want to check http://www.incometaxindia.gov.in/publications/6_Advance_Rulings/Chapter07.asp for the double tax avoidance agreement between Indian government and USA (this is directly from the source and not from the r2i forums where in spite of the spirit and passion, many mis-informations get propagated). Specifically, "The relief of DTAA can be sought only when a person has paid the tax in one of the countries and the same income is liable to be taxes in another country. But if the person is exempt from taxation in one country then he cannot claim the benefit of DTAA to get scot free from paying any tax".. This agreement is valid from 1993.
    Sai.

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  4. Yes Sai. You are right. However, based on my reading so far, I believe there are some "exceptions" to the rule. Will do some more reading and provide appropriate pointers :)

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  5. Sai,

    Can you please read Article 11 from the Tax Convention? It provides more details regarding the exceptions to the DTAA.

    http://law.incometaxindia.gov.in/DIT/File_opener.aspx?fn=http://law.incometaxindia.gov.in/Directtaxlaws/cbdt/dta/A1_USA.htm

    "4. The term “interest” as used in this Convention means income from debt-claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor’s profits, and in particular, income from Government securities, and income from bonds or debentures, including premiums or prizes attaching to such securities, bonds, or debentures. Penalty charges for late payment shall not be regarded as interest for the purposes of the Convention. However, the term “interest” does not include income dealt with in Article 10 (Dividends)."

    - Saro

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