In this video, Abhinav is explaining the US/India tax implications of various 401k/Traditional IRA withdrawal scenarios on Return to India
Video transcript (auto-transcription can cause errors):
Hi. This is Abhinav, and I welcome you. In this video, I’m discussing, options that are available for, returnees to India. People who have worked in US, they have accumulated a sizable sum in the 4 one k and or the I IRA. So, they always this big question is that what are their options on return to India.
Now in this video, I am doing some scenarios, which we are basically, we are evaluating some scenarios, and the pros and cons of scenarios. Then there is a follow-up video that I’ll be doing, after this video, where I’ll be actually discussing the main factors that, we need to watch out for and some of the strategies that we can do. So please also do check out the next video after this video, as a follow-up video, then that you know, you’ll get a better understanding. Right? So let us start.
So, basically, some few scenarios here we can take is that okay. So you have worked in US for, like, 5, 6 years, 7 years, 10 years, and then you are coming to India. Now the options that you have, number 1, is the option is that you can leave the fund as it is. Right? Do not touch that fund.
Leave it as it is, and then you withdraw it after 59.5, age 59.5, which is when the there is no penalty. 10% penalty is there. Only the tax, is applicable. So you okay. Check out my, previous videos on what is 401 k, IRA, then, check, the foreign k taxation in US.
Then there is a video I’ve made for 1 k IRA taxation in India so you’ll get more clarity, right, on how the taxation works in US as well as India. This whole thing is a complex thing. So, you need to spend some time, understanding, the product, the taxation in US, taxation in India, and then the scenarios. So first scenario is that you leave it as it is, and then you withdraw it after each 59.5. Second option is that you decide to roll over to a Roth IRA.
So some people do that. They roll over the fund to the Roth IRA because the fact that, you know, withdrawals from Roth are tax free, and it’s good for estate planning, especially if you have, like, children who, you know, may want need these funds. So from an estate planning perspective, there is this plus, of moving to a Roth IRA. So that’s the second option. 3rd is withdraw it completely before returning from US.
Some people may decide to withdraw it totally before returning. They don’t want the headache. So that’s the 3rd option. 4th option is withdrawing it after returning from US in the r north phase. Within the r north phase, if you are entitled to the 2 or 3 years of r north phase after return from US, in India you get, 4 scenarios, you withdraw in the r o r phase.
5th is that you withdraw it after returning from the US in the ROR phase. That means you are a resident ordinary resident, as per the Indian tax law, and you withdraw it after becoming an ROR. So let us discuss each of the scenarios. This may be a slightly long video, so bear with me. The first option, leave it as it is and withdraw after 59.5.
So here, what will be the tax implication? Under the US tax, there’s no tax till 59.5. Nothing. That’s basically a tax deferred investment. That’s why that’s why the advantage is there.
Right? So there’s no tax. After that, the withdrawals are treated as income in US, and there is no penalty. Right? So on the full withdrawal that you do in in US, there’s the tax that you need to pay at the, graduated rates.
If you’re a US citizen or a resident or if you’re a nonresident, alien, then there is a basically, a chunk will qualify as, effectively connected income, and it will be taxable that’s taxable on graduated rates. And the other chunk, which represents income, the dividend income, that will be taxable at 30%. So that division is there. But, yes, the withdrawal will be treated as income in US, and there’ll be no penalty. India tax.
Now India tax, if you make an election under root in 2021, a new regulation had come, section 89 a, which mandates that under root 21, triple a, you can make a election. And, that election has to be done in form 10 e e, and you can defer the tax till withdrawal. Right? So it will not be taxed every year in India. It will be deferred till your withdrawal.
So in the 1st year of becoming a resident & ordinarily resident (ROR), you can file that form, with the Indian tax department, and you can do it online. I’ll make a separate video on that form, and the taxes will be deferred till the withdrawal. Right? Now pros. What are the, good points?
Good points is that there’s no tax penalty your, in US. Basically, there is tax, but no penalty in US. Basically, the funds grow tax deferred in US for till 9.5. That’s a big advantage. The you get a geographical diversification.
That means your funds are not only in India. Your funds are there in US, which is a very, very big important thing very important thing. You should always try to geographically also diversify. That reduces the risk of your portfolio, and a currency level diversification is also there. That means it’s not only the INR fund.
It’s basically the USD funds. So both INR and USD are splitting the funds. Right? So later on, if you have the US any USD lead goal, like sending your kids to for US education, you have the ready currency, right, where you have made the investments. Now cons.
The cons is that amount is blocked with 59.5. So you basically don’t want to withdraw it because there’s a early withdrawal penalty that that will apply and that will eat away a big chunk of the gain that happens. Second is a state tax estate tax. Right? Estate tax liability will arise if you because you will be qualifying as a nonresidential as per US tax law and more than 60,000 of US the stock used assets.
If you have, then there are extra tax that will apply, and then it’s, from ranging from 18% to 40%. And there are complications like filing form 709. You have to wait for 9 months up to the filing of the return and then, you know, all that blockage is there. So that risk is there. If the amount is more than 60,000, then then that risk is there.
Right? Okay. Option 2 option 2 is rollover to a Roth IRA before returning from US. Now here, the in the US tax, the rollover amount is subject to tax. Right?
Before returning from I don’t know whether after returning from US, you can do a rollover to Roth IRA or not. But, in US, which is your last year in US, if you do a rollover, then you have this income, existing income, plus, which is subject to tax, plus the rollover amount will also be subject to tax, and, but there is no penalty. Right? That’s the good thing. Under India tax, the income from the Roth IRA now Roth is a bit tricky in India.
It doesn’t qualify for rule, triple a election, right, if you strictly go by the wordings of the rule. My interpretation is that Roth IRA doesn’t qualify for the benefit of rule triple a. So even if you make it rule triple a election, the income of the Roth IRA will still be taxable with the dividend and capital gains every year after becoming ROR. So every year, you have to file a very complicated tax return in India where you have to disclose the income, pay tax on the Roth income, and there is no FTC. Right?
There’s no foreign tax the credit of the US tax because, anyways, the income is tax free. Right? So in so, basically, you have paid the tax on that income the in the year that you’ve made the contribution, and you are not paying any further tax, but Indian government is taxing you every year. So it’s a tax disadvantaged, investment, from Indian tax point of view. And when you talk when you consider the Indian tax angle.
Right? So the pros is basically no tax liability on withdrawal in US. So good for if you want to do it for an from a estate planning perspective, cons was cons is definitely that you have to file a complicated return in India every year. Right? So then there’s no credit in India of the tax paid in US due to the year mismatch.
Right? So in India, you are, claim filing the plink tax in a particular year. In US, the income this particular income, the tax has been paid in a particular year, different year, earlier year. So there is a year mismatch, so you cannot claim any credit of the tax. The amount will be blocked to 59.5 because in raw in Roth also, yes, withdrawals, you can claim early, but the earnings, you have to keep it till 59.5.
Right? So that still the blockages, they are not exactly till, to the extent that, of IRA is there, but traditional IRA, but even Roth that, slight, the liquidity issue is there. Plus the estate tax is always is there if the asset is, more than 60,000, and, I will not recommend. In that from that point of view, I don’t recommend this particular option. This is just my view.
There can be different views here. Okay. Let us come to option number 3. Option number 3 is withdraw completely before returning from US. So option 3 is for those people who say that I don’t have to do I don’t want to do anything with my US investments on return.
Right? I don’t want to make any complicated tax returns and do competitions and, you know, pay a very high amount to a Indian, CA for making all the returns and then expose myself to, scoot me from the Indian tax department for this foreign income. I just want to completely withdraw before you return from US. In that case, the entire withdrawal will be taxed as income as per the slab rate. So you are withdrawing as per the last year as a US tax resident.
It will be withdrawn, entire withdrawal will be taxable, plus there’ll be a 10% penalty if you are is below the age of 59.5. So that 10% penalty implication will be there. India tax, there is no implication because you have withdrawn the funds totally before you become a ROR in India, so there is no tax implication in India. Right? The pros are basically peace of mind.
Peace of mind from taxation of 401 k in India. Now taxation of 401 k to a large extent has now become kind of simplified with the introduction of rule triple a, rule 21 triple a. But still, you don’t want to risk anything with but second thing, still rule triple a’s 21 triple a’s there, but you have to do the schedule FSI and FA reporting every year in the Indian tax return because you hold a foreign asset. Right? So you are free from all those problems.
You have done and dusted completely. You have come out of this 401 k thing. No complicated return in India. You save money, from the fees that you pay to a CA. You have a simple return which you can file on your own.
No need to take help from a CA. Ready fund available. Okay. The amount that you withdraw, now you have a ready fund that you have available for investment in India. Right?
So that’s, again, a big positive. There’s no estate tax implication in US because there’s no fund in US. Right? So these are pros. Cons.
Cons is basically the penalty that will be applicable. The tax will be applicable. So tax is actually not a cause because tax is anyways applicable if you withdraw it later also. But, yes, the penalty is applicable, if you withdraw before 59.5. No US diversification in the investments.
That means your portfolio, you lose this opportunity of having a US diversification. Right? So it’s, or, basically, what you can do is to remove this con. Whatever amount that you have take it in India, then you can a part of that amount, you can invest directly in US stocks. Right?
Or you can, invest in Indian feeder funds, basically, which invest in US stocks like Motilal Oswal and others have, Indian funds, which take exposure to the S and P 500. So that way you remove that to a certain extent, then higher tax are outflow in the US. Because in the in the year that you are withdrawing, that is the last year of your stay in US where you have a US income also, plus you have this income also. So maybe that tax slab will be higher, right, as compared to the situation where you withdraw it after returning from US. Right?
And, say, one more thing is that you need to also include this distribution in your state tax return, Right? Because you are still continuing to live in US, so in your state, you need to also file, for the state tax, and you need to include this distribution and the separate tax will be approved. Then we come to option number 4, which is withdraw it after returning to India in the r NOR phase. So if you qualify for the are nor phase, which is 1 to 3 years after you return in India and you withdraw, then US tax again, you qualify as now for US tax purposes, you qualify as a nonresident alien. Now, again, when you come back become a nonresident alien, there’s a flat 30% withholding that the provider will do.
However, when you file the tax return, you will be taxed at a mix of the slab rates and 30%. That means to the extent of your contribution that you had done, it will be taxable at graduated rates. Now that rates will be much less, the slab rates that that tax taxation will be much less because there’s now no income in US. You probably are at a zero income in US, so this is probably the only income. Right?
So that tax will be bit less. Then there’s a flat but, for the dividend, what you receive, that’s a flat 30% tax. That is not at graduated rates. It’s a flat 30% tax. Right?
Whereas, otherwise, in the US, it would have been taxed it would have been taxed, at a 0, 15, 20% rate as per your income. Right? So it here, it will be flat 30% or 25%. In case of India because there is a India US DTA is there. You can claim at a 25%.
Right? So that is there, and 10% penalty will be applicable, right, because you are withdrawing it before 59.5. India tax will be nil. No knee no any tax no any reporting because it is the are not phase. That’s the beauty of, being in a are not phase is you can you can do all the settlement work, all the clearing work of your foreign financial affairs, without any, tax complications in India.
So that is a very good thing. Now pros, no complications in India tax return. Right? Because in the r naught phase also, you don’t need to report anything, and ROR phase also you need to not report because you have closed your, whole thing in the are not stage itself. Less tax implication in US if no other income be right?
So that is a, positive. No state tax return. Now because you have come out of that, particularly you are not residing in that state, the early states levy need to require you to file a tax return only if you are earning income living in that state, but there is a source of income which is generated within that state. Right? So both the things are not there, so there’s no requirement of a state tax return.
So, correspondingly, that much less tax also. And so, basically, less tax as compared to option 3. Sorry. It should be option 3. Right?
So it’s a basically less tax, option as compared to option 3. Now cons. Now not all IRA providers support your non US citizens. So if you, try and update your non US address to your 4 one k in the year of withdrawal or after the, you know, you have left, none not all providers will allow you. So, basically, before returning from US only, you have to move your IRA to a provider which allows, it for non US residents like Fidelity.
Right? So that hassle is there. A direct to direct rollover, you can do IRA to IRA rollover. Another con is that there is 30% withholding tax. Even if you file w8ben, still there will be a generally, there’s a 30% withholding that the administrator will do.
So India, US treaty is a weak treaty. Right? So there is no significant benefit. Only is instead of 30% tax for dividend, it’s at the 25%. But still, even if you state that treaty clause, they will withhold full 30%.
Then what you have to do is that you have to file a 10.40 n r to claim a refund of the excess tax. Right? There will be certain excess tax in that 30%. You have to file a 10.40 nr, and claim the refund of that excess tax. So you have to only file the federal return.
No state return you have to file. Then there is a estate tax risk because the money if it is more than 60,000 USD, then there is a estate you live with that estate tax risk. You should not die. Right? Basically, estate tax risk is only if you have more than $60,000 as a nonresident alien and you die.
And then there is a very complicated process that happens, and there is a tax that gets levied on your entire estate. Right? On the entire income, not the income, in the entire fund. Then there is a 30% tax on the FTAAP component, which is the dividend. Otherwise, it would have been less.
That’s also a comp. Then the process can stretch till, like, 2, 3 years after return because you may want to kind of withdraw in tranches, not every year. So that means, you know, every year filing 10:40 n r every year, you know, doing all that effort. Right? So for someone who is okay with doing that, can do that.
For other person who is just doesn’t want to take any risk, he’s saying, like, might as well pay some extra tax, but I want to get it done. For them, option 3 is there. But, yes, option 4 has a potential of a lesser tax. Right? But then you have to file 10.40 an hour.
Then we come to option 5, which is withdrawing it after return to India, which is ROR. Right? So option 4 was RNOR, withdrawing in RNOR. Option 5 is withdrawing after return to India, ROR fees. So ROR can be a situation where you straightaway are, qualified as a so you are only there in US for, like, 2, 3 years, and you return back, and you have a small accumulation in your, four one k, and the year that you return, you are in ROR.
So those cases will fall here. So what will be the US tax? The US tax will be as for the slab rate plus a 10% penalty. Right? In India so it’s not sorry.
It’s not as per slab rate. It’s basically again, it’s a mix of the slab rate and flat 30% because you will be construed as a in, nonresidential as per US tax law, plus there is a 10% penalty. Now for India tax purposes, again, it will involve a a competition. Right? Here, basically, only the income component, not the complete withdrawal, will be taxable because Indian government has the right to only tax the income from the fund.
Right? So earnings will be taxable, and you can claim an FTC of the lower of the India and US tax. Now in the year where the withdrawal is done, it will be taxable in US, and same year, it will be taxable in India also. So there is a possibility that when you compute the tax as for the India tax law, you can claim a tax credit of the tax that is paid in US. Right?
So not full credit is available, lower of the Indian and the US tax rate. So you accordingly, those computations have to be done. So pros is that, less tax liability in US and India if it is withdrawn. Cons, there are a lot of cons. So one is that the not all, I IRA providers support non US residents.
30% withholding even if you file W8 band. Estate tax, if it is more than 60,000 USD, that risk is there if you die within that period. 30% tax on FDAP component because you are a nonresident alien. Complicated India return. Full credit of US tax may not be available, right, because there are certain rules.
Then the process stretches after some years. Need to file 10 40 n r to claim a refund of the excess tax. Right? So all that thing is there. So, again, it is not recommended.
Ideal thing is withdraw before returning from US, or you would do it, within if you want to withdraw, either withdraw before returning or within the r naught phase, which is option 3 or 4, or the best option is leave it as it is if you can afford to do that. Right? Just leave that fund in in in US. Let that fund grow tax deferred way. Right?
And, at the same time, build the India fund. It’s and then there’ll be this diversification will be also there. So this is it. This is it. There’s one more thing.
You can also collect consider electing for periodic payments. Right? Now here what in the earlier options, we have talked about taking up lump sum payments. Right? Even if you take it tranches, that will qualify as a lump sum payment.
One more option is that you can consider electing for periodic payments. Now periodic payments is basically a complex thing because, you need to there are 3 methods that the IRS gives, which is called substantial periodic payments. And as per the life expectancy tables, you get a fixed amount every year. If you opt for that, there is no penalty. You can opt for that.
There’s no penalty. And you can also take the DTA benefit under Article 20(1), whereby the taxation will only happen in India. There is no taxation in US, no return filing in US, taxation is only in India, there is no penalty in US. Right? So that is there.
That option is there, but it’s a bit complicated. You need to have guidance of a financial adviser, in US to evaluate and choose whatever is the best option. I’ve that’s why I have not selected it in the options here, but that is definitely an option that you can consider. Right? So this is, this is, basically the, some options and the pros and cons.
Next, we’ll cover, the, topic on what to do with your 401 k on return to India, which is a good follow-up to this particular, video. So do basically stay tuned and check that out. Thank you so much for watching. Thank you so much. Bye.