What to do with your 401K/IRA after return to India is an important decision for many returning NRI families given that if you’ve stayed out of India for long, this forms a good chunk of the overall investment corpus. However, answer to this question is not that simple & needs to be carefully evaluated in view of the family’s specific personal financial situation, R21 timeline & financial goals. It is also advisable to hire a competent CA/CPA for this decision as the consequences are significant both from a legal & financial standpoint.
Also read:
A Financial Checklist for the Returning NRI
Financial planning considerations for returning NRI families
I have done these detailed posts on 401K you can check those to get a better idea on the taxation aspects –
Understanding 401K Plans in USA
Before we proceed
- Please note that the Indian taxation of 401K I have covered in a separate post – Taxation of 401K/IRA (USA) in India so this post will be more focussed on financial planning perspective.
- As regards pointers on US tax law & investments in this post, please note that my understanding on these aspects are limited. I advise you to seek professional advice from a licensed CPA before taking any investment or tax decision on your 401K/IRA investment & tax aspects.
General thoughts on what to do with 401K/IRA on Return to India
There is not (and cannot be) a straight yes/no because everything is dependent on a person’s unique personal finance situation. Having said that, a couple of broad pointers that may be kept in mind are as follows:
- Amount of corpus in 401K/IRA:
As we discussed, withdrawal from 401K/IRA before age 59.5, attracts tax and penalty and as far as possible, MUST be avoided. However, if the accumulation has not been much AND you’ve returned to India for good and given the cons of retaining the 401K/IRA (annual disclosure in tax returns, withdrawal tax & FTC claim in India tax), it can be a good idea to withdraw your 401K/IRA completely.
In such case, note that any withdrawal less than $11000 (for 2023) will come under lowest tax bracket in USA i.e. 10% Ensure that you do this AFTER your R2I & prior to becoming a ROR in India. This will ensure that there is less tax & penalty in USA & there is no tax or disclosure requirements in India.
However, if you’ve missed the RNOR window, you can still go ahead and withdraw however you will have to also compute and offer the capital gain to tax in India (in addition to dividend income) and that’s the reason I suggest you not to miss the RNOR window to close your 401K/IRA affair.
- Long term financial goals and plans of moving back to USA
If you have a strong chance of moving back to USA or have financial goals denominated in USD for example your kid’s education, there is a case for retaining the 401K/IRA (especially if amount is substantial) as this will help you mitigate the currency risk in the portfolio. Also read: How NRIs can manage currency risk in their investment portfolio
In such a case, you can recheck the portfolio allocation & align this money with your goal – so if it is for a long term goal, you can have a higher equity allocation. Also, you can rollover your 401K to low-cost avenues like Vanguard IRA. Do all of this within your RNOR period & then leave it untouched till 59.5 years.
Conversely, if you do not have any plans of moving back to USA and are very clear that you’ll educate your kid in India, it can be a better idea to withdraw it within RNOR phase and be content with what you get after deduction of 10% early withdrawal penalty.
- India tax filing on 401K every year.
Continuing with 401K after becoming an Indian tax resident is not an easy affair. Though the provisions of Section 89A have made it easy for deferred taxation of the income, still it will be a pain to file foreign income returns every year. Also missing to disclose properly can cause a INR 10L penalty under Black Money Act. So if you’re the one who does not want a hassle of filing foreign tax returns in India year after year & then at age 59.5 offer the 401K withdrawal to tax in USA & India, then you may want to clean up your foreign investments till RNOR phase & take fresh position in Indian equity markets.
Analysis of applicable options from tax & financial planning perspective
So basically, we are left with 2 options to consider –
Option #1: Retain 401K till age 59.5 & then withdraw
Option #2: Withdraw in full during NR/RNOR phase
Now, let us understand the tax implications & pros & cons of both options:
Option #1: Retain 401K till age 59.5 & then withdraw
USA tax implication:
- No tax implication till age 59.5. After 59.5, withdrawal will be treated as ordinary income and taxed accordingly as per the applicable tax slabs in USA.
India tax implication:
- As long as residential status is RNOR, no requirement to disclose income or asset in Indian tax returns.
- Once residential status is ROR, mandatory file Indian tax return & disclose income & asset in Schedule FSI & FA respectively. File Form 10EE in the first year of being ROR to claim tax deferral of this income in India.
- At age 59.5, offer income to tax in India. Claim tax paid in USA in Indian tax return.
Pros:
- You save yourself from the 10% early withdrawal penalty in USA that applies in case of withdrawal before 59.5.
- You will have a geographical diversification in your investment portfolio.
- If you have USD denominated financial goals, you save yourself from currency risk to that extent in the portfolio.
Cons:
- Tax paid in India on that income every year may NOT be available as tax credit in USA when you withdraw after 59.5 – so effectively, you may end up paying twice tax on same income. This is subject to how foreign tax credit (FTC) evolves with the times in both countries.
- You will have to compulsorily file a tax return in India irrespective of your Indian income & disclose the foreign income/asset in respective schedules – any miss and severe penal implications in India may follow under Black Money Act. Also read: Black Money Act: An Analysis Due to complication & extra effort, your CA will charge a higher fee for filing foreign income returns.
Suggested for:
- Good enough accumulation in 401K
- Can’t digest the fact that you will pay 10% penalty in USA for early withdrawal.
- Have some USD denominated goals or will consider moving out of India if a good opportunity arises.
- Want geographical diversification in your investment portfolio.
Option #2: Withdraw in full during NR/RNOR phase
USA tax implication:
- 10% federal penalty tax.
- Withdrawal will be included in your income and qualify for federal and state tax
See this good resource on calculating early withdrawal costs Link
India tax implication:
As long as residential status is RNOR, no tax implication and no requirement to disclose income or asset in Indian tax returns. Also read – Returning NRI having foreign income/assets should make full use of RNOR phase
Pros:
- You will lose geographical diversification in your investment portfolio to that extent – however, you can still invest in US markets through dedicated feeder funds from India depending on your requirement.
- You settle the tax issues once and for all – no more foreign income returns and associated complexity, no more risks of litigation with tax office etc.
- You get freedom to invest that corpus (especially if it is a big amount) in India in alignment with your INR denominated financial goals.
- Withdrawal within RNOR period will not involve issue with double taxation as income is taxed only in USA.
Cons:
- Early withdrawal penalty of 10% is on the gross payable amount so significant portion of your portfolio accretion can get wiped out.
- Withdrawal will count as income so US tax will apply – since India does not tax foreign income during RNOR, claiming credit in India does not arise.
Suggested for:
- Low accumulation in 401K
- Returning to India permanently with no USD financial goals.
- If you prefer zero tax litigation/paperwork at the cost of some tax.
Copyright © CA Abhinav Gulechha. All Rights Reserved. No part of this article can be reproduced without prior written permission of the CA Abhinav Gulechha. The content of the article is for general information purposes only & does not constitute professional advice. For any feedback, please write to contact@abhinavgulechha.com