MANAGING YOUR 401(K) AFTER RETURNING TO INDIA: OPTIONS AND TAX IMPLICATIONS

"I am back in India but I have some money lying in my 401(k) account in the US. What should I do?" This question is becoming increasingly common among Non-Resident Indians (NRIs) returning home after working in the US. Here, we explore your options and the tax implications.

What is the 401(k) Plan

A 401(k) plan is a retirement savings plan sponsored by employers in the US. Employees contribute pre-tax dollars, reducing their taxable income for the year. Employers may match contributions up to a certain limit. The funds are typically locked until age 59½, with withdrawals taxed according to the employee's tax bracket. Early withdrawals incur a 10% penalty in addition to taxes.

Options for NRIs with a 401(k) Plan who are returning to India

1. Leave the Plan As Is: You can leave your 401(k) account intact until you reach the age of 59½. At that point, you can withdraw the funds, subject to US taxes.

Considerations: The 401(k) plan has restrictions based on the employer's selected options. If the employer terminates the plan, you must either withdraw the funds or roll them over into an Individual Retirement Account (IRA).

2. Rollover to a Traditional IRA: A traditional IRA functions similarly to a 401(k) but is not tied to an employer. It offers more flexibility in investment options without immediate tax consequences when rolling over funds from a 401(k).

Considerations: Some financial institutions may not allow opening an IRA with an international address. Ensure you check the specific policies.

3. Rollover to a Roth IRA: Contributions to a Roth IRA are made with post-tax dollars. Withdrawals are tax-free up to the amount of the contributions, with only earnings taxed. This option can be advantageous if you are in a lower tax bracket when you move to India.

Considerations: You must pay taxes on the rollover amount at the time of conversion. Roth IRAs do not require mandatory withdrawals at any age, making them suitable for long-term savings beyond retirement.

Tax Implications for Withdrawals

Lump Sum Withdrawal: According to the US IRS Tax Code, any income sourced from the US is taxable there, regardless of the recipient's residency. Under Indian law, residents are taxed on their global income. Thus, a lump sum withdrawal from your 401(k) will be taxed in both the US and India.

Double Taxation Avoidance Agreement (DTAA): Article 23 of the India-US DTAA states that income arising in the US is first taxed in the US. NRIs can claim a credit for the taxes paid in the US when filing their Indian tax returns.

File your tax returns in the US even if tax has been withheld. If eligible for a refund, claim it. Subsequently, file your returns in India and claim a credit for the US tax.

Monthly Pension Withdrawal: Article 20 of the DTAA specifies that private pensions are taxed only in the country of the recipient's residency. Hence, if you receive a monthly pension from your 401(k) or IRA while residing in India, it will be taxed only in India.

Considerations: Ensure to submit the necessary documentation to avoid US withholding taxes. Consult with your financial advisor to determine the best approach based on your tax profile and financial goals.

Choosing what to do with your 401(k) depends on various factors including cash flow needs, tax brackets, risk appetite, and financial goals. Consult with an independent financial advisor to make an informed decision and actively manage your retirement funds.