As a US expat, transferring your 401(k) to a foreign pension plan can incur significant tax penalties since tax-free rollovers from US plans to non-US plans, and vice-versa, are generally not allowed under IRS regulations. However, rolling it into a US-based Traditional or Roth IRA may offer more flexibility, potential tax benefits, and greater control over your savings. In this article, we explain the rollover process, its advantages, and tax implications to help you make informed decisions in partnership with your expat investment advisor.
Benefits of rolling over a 401(k) into an IRA
Rolling over your 401(k) into a US-based Traditional IRA or Roth IRA may provide greater flexibility and control over your retirement savings and potentially increase your returns.
1. More investment options
Expats often roll over their 401(k) into an IRA for greater investment flexibility. While 401(k) plans offer limited employer-selected funds, IRAs provide access to a wider range of investments, including stocks, bonds, mutual funds, ETFs, and international markets. This expanded choice allows expats to diversify their retirement savings more effectively.
2. Lower fees
Although 401(k) plans often have low fees, the investment options available are usually mutual funds, which may have high internal fees that reduce returns. Many IRAs, especially from low-cost brokers, offer low maintenance fees and a choice of lower cost ETFs or individual equities and bonds, helping preserve more of your retirement savings.
3. Simplified account management
If you have multiple 401(k) accounts from past employers, consolidating them into a single IRA can make managing your retirement funds easier. This simplification can be especially valuable for expats, who may already be juggling financial accounts across different countries.
4. Potential Roth tax advantages
Rolling over a 401(k) plan or Traditional IRA to a Roth IRA requires upfront taxes but offers US tax-free withdrawals. This is beneficial for expats in countries with favorable US tax treaties. Since Roth conversions trigger immediate taxation, this is mostly beneficial if the account-holder is in a low tax bracket in the year of conversion and will be able to benefit from Roth tax-free withdrawals when the time comes. Most tax treaties do not specifically mention Roth IRAs, therefore care should be exercised to ensure the tax treatment for local taxation does not result in double taxation while the funds are in the Roth account or when they are withdrawn.
5. Long-term financial planning benefits
Rolling over to an IRA allows you to align your investments with your long-term financial goals, whether you plan to stay abroad or return to the US. The greater variety of investment options available in an IRA account compared to a 401(k) may allow you to better tailor your investment program to an expat situation, ensuring that your retirement savings continue to grow efficiently.
Considerations before rolling over your 401(k)
US tax implications
Rolling over a 401(k) to a Traditional IRA does not trigger immediate US taxes if done as a direct rollover between providers. However, if you withdraw funds instead of rolling them over directly, you could face a mandatory withholding tax.
Foreign tax treatment of IRAs
Expats should carefully consider how their country of residence treats IRAs for tax purposes. Some tax treaties recognize the tax-deferred nature of US retirement accounts, while others may not and could tax IRA distributions differently than 401(k) withdrawals. This could result in higher tax bills. Always consult a cross-border tax expert when considering an IRA rollover as an expat.
Access to loans and penalty-free withdrawals
One advantage of a 401(k) is that you can get a loans against your balance, while with an IRA you can’t. Additionally, 401(k)s allow early tax-free withdrawals under as the Rule of 55, which permits penalty-free withdrawals from an employer-sponsored 401(k) if you leave your job at age 55 or older. IRAs on the other hand generally impose a 10% penalty for withdrawals before age 59½.
Required minimum distributions (RMDs)
Both 401(k)s and traditional IRAs require RMDs starting at age 73. However, if you’re still working for the employer sponsoring your 401(k), you may be able to delay RMDs until you retire. An IRA does not offer this deferral however, so if you plan to work past 73, keeping your 401(k) could be advantageous.
Rollover costs and fees
Some 401(k) plans charge rollover fees, and certain IRA providers may have account setup or maintenance fees, so compare costs to ensure that the benefits of the rollover outweigh the fees.
How to rollover 401k to IRA
● Check your eligibility: You have to have left your US-based employer to be eligible to roll over your 401k.
● Consult a financial adviser: Before rolling over your 401(k), consult a US expat financial advisor who is experienced with IRA rollovers for expats and familiar with both US and local tax laws in the country where you live, especially in countries that don’t recognize the tax-deferred status of US retirement accounts.
● Initiate the rollover: Contact both your 401k and IRA providers to initiate a direct rollover.
● File tax forms: Report the rollover to the IRS, typically using Form 8606 for Roth IRAs.
Note that you have 60 days to complete a rollover, as otherwise withdrawing funds could trigger mandatory withholding and early withdrawal penalties.
Should you roll over your 401(k)?
The decision to roll over your 401(k) into an IRA as a US expat depends on your specific circumstances and long-term financial goals. An IRA may be a better choice if you seek greater investment control, lower fees, and potential tax advantages. However, if you need loans, penalty-free early withdrawals, or RMD deferrals, keeping your 401(k) might be the better option.
Since every expat’s situation is unique and local and US tax rules should play a central role in your decision making, consult with a financial advisor who understands cross-border retirement planning to establish whether an IRA rollover is in your long-term best interests.
If you have any questions about financial planning as an American living abroad, get in touch.
This article is for informational purposes only; it is not intended to offer advice or guidance on legal, tax, or investment matters. Such advice can be given only with full understanding of a person’s specific situation.
