Which year to withdraw 401K?

[leoman78]

What is the name of your state? Georgia

Hi, will try and be as clear as possible regarding my situation.
I will be working in the USA until December 24, 2004. After that, I move back to India permanently.
I will be filing my taxes for Georgia for the year 2004.
However, I will have around 50K in my 401K account at that point of time.
I am aware that there is a 10% withdrawal penalty and a 20% Federal Tax withholding if I withdraw before the age of 59 1/2.

Would it be wiser to just withdraw the amount in 2004 or should I wait to withdraw the amount in tax year 2005 ? In 2005, I will be paying taxes in India but will be filing Tax Returns in the US on Global Income.

Can you please advice which option is better ?
Thanks.

 

[Snipes5]

It would be wiser to either leave it there until you are eligible to remove it without penalty, or talk to the plan administrator and have it set up so you receive level periodic payments, which would also enable you to remove it without penalty.

You will still have to pay tax, but not much. As a matter of fact, as long as you are neither a US Citizen nor Resident Alien either for tax purposes or otherwise, any money received from US sources while a resident and citizen of a foreign country will be taxed at non-resident rates, and only the US source income is taxed on that type of return.

You should consult an Enrolled Agent to determine the best course of action unique to your situation.

Snipes

 

[leoman78]

Snipes, Thanks for your reply.
In my case, I will have to pay the Penalty since I do not plan to wait until I am 59 1/2 since that is a long way off.
I am a Permanent Resident of the US but am moving back to India. From what you mention in your message, it is better to pay the tax at the Resident Rate rather than at a Non-Resident Rate since it will be higher.
Can you please tell me what is an 'Enrolled Agent' ? Any CPA or is this different ?

 

[abezon]

An enrolled agent is a tax pro who has passed an IRS exam & can represent you before the IRS (but not in court).

Since you have a green card, you will have to file a US 1040 until you give up your green card status. Chances are the border patrol will try to take your card when you leave in December; tell them you will be returning in a year & they won't confiscate the card.

I recommend you set up a traditional IRA and a Roth IRA now. When you leave employment, roll your 401k directly into the traditional IRA. This is not a taxable transaction. When you move, be sure to keep a US mailing address & email account so your broker doesn't know you have left the country. (If your financial advisor finds out you live outside the US, s/he cannot help you with certain financial transactions.)

Next year (2005), you will file a US tax return & probably exlclude your Indian wages on Form 2555. This will put your taxable income near $0, which will let you convert some of your traditional IRA into a Roth IRA without paying any taxes on the conversion. To convert a traditional IRA into a Roth IRA, you declare the amount converted as income & pay income taxes on it. Obviously, if your income is only $100 after excluding foreign earned income, you can convert nearly $8000 of your trad IRA into a Roth IRA *for free*. ($4800 standard deduction for single person + $3100 personal exemption - AGI = amount you can convert for free) Repeat this yearly until you have converted everything to a Roth IRA.

Since the money put into the Roth IRA was aleady taxed, you do not pay income taxes on withdrawals of the converted amounts. If you leave the money in the Roth for at least 5 years, you do not pay any taxes or penalty on the earnings either! If you pull the earnings out before 5 years have passed, the earnings are taxable & subject to a 10% penalty, but the contribution (converted amount) is still tax free.

Example: You have a 401k of $48,000 & convert $8000/year over 6 years. You pay about $10 in tax in 2005 & nothing in the following 5 years. If you are married or have kids, you can convert a larger amount each year, as your deduction + exemptions are larger. In 2006, you can withdraw the $8000 converted in 2005 without paying any taxes. Or you can leave the money in the Roth and after 6 years, the entire $48,000 is yours tax free. Some of the money earned by that $48,000 is also tax free, though you will have to prorate the earnings & may have to pay taxes on some. But overall, a gradual conversion plan could save you thousands in taxes if you're willing to take your money out gradually.

If you're married or have kids who are US citizens, things get a little more complicated, but you get to make the conversion faster.

 

[leoman78]

Abezon, thank you so much for the detailed response. This is going to take me a while to digest.
I am married and have a daughter (an US Citizen). They are already in India.
Have to really plan this one well so that I dont lose too much on taxes.
You have certainly guided me in the right direction.
I do not plan to give up my Green Card when I depart from the US since I may visit the US once in a way.

 

[abezon]

Is your wife a US citizen? If so, she has to file taxes every year. If she's not a US citizen, you 2 might consider making an election on the 2004 return for her to be taxed as a US resident. This obliges her to file a US return every year, which allows you to file jointly with her even when you're both out of the US. The standard deduction for MFJ will be around $9600 for 2005, + 3x$3150 in exemptions. This lets you convert about $19,000 to a Roth for free in 2005.

An alternative is to file for a foreign tax credit; don't exclude the Indian wages, but claim a credit for the amount of taxes you pay India. This would leave you with some tax liability after the FTC, but you would be able to use the child tax credit to pay the remaining tax. Whether this is a good plan for you depends on how much taxes you pay India on your income & whether the $1,000 child tax credit gets extended or reverts back to $700. How much you can convert every year is much harder to determine. You'll have to determine how much you're going to pay India for the year by December, then mock up a bunch of US returns and figure your FTC each time. Once you figure the maximum you can convert each year, you'll have to get the conversion done by 12/31.

Once you've digested this a bit, you should make an appointment to consult with a tax pro in your area who has experience with international returns. Be sure the person you talk to has done a few 2555s & 1116s & understands the nonresident alien spouse elections. Take these postings along as a beginning point for your discussion.

 

[leoman78]

Once again, Thank you so much Abezon for your detailed responses.

My wife is not a US Citizen, but we have always been filing Jointly. She has never worked in the US.

Will definitely take these postings along to a Tax Consultant.

Thanks a lot !!!