If you ever worked in the USA you may have been lucky enough to of had the opportunity to contribute to a 401K retirement account. Your contributions are pre-tax and your employer is able to make contributions on your behalf as part of your compensation package. Each individual employee can contribute up to $16,500 per year. Participants who are at least 50 years old can contribute an extra $5,500 per year. While the money is invested in your account it can grow tax free. All in all, a very robust retirement planning tool. The problem comes when you leave your old company, or maybe even emigrate abroad (to somewhere like Japan). If your company permits, you can leave your 401k account with their custodian. If not, you can roll the account over into an IRA with another custodian. The last option would be to cash out the account and pay the taxes and penalties for an early surrender. Whenever possible, by far the best option is the rollover IRA.
Can I Contribute To My 401K From Japan?
Techincally, yes. As long as you are still under the employ of your US employer. If not, you should consider contributing to an IRA account. For those earning below 97,600 USD p.a, or 195,200 USD p.a as a couple you should be taking advantage of the Foreign Earned Income Exclusion (FEIE) which means that you pay zero US tax on those earnings. There is a caveat however, and that is that if you do not have any US taxable income, you are unable to contribute to US specific tax privileged accounts like IRA’s. For those excluding all of their overseas income, and those maxing out their annual tax privileged contributions (401k: 18,000 USD p.a, IRA: 5,500 p.a or 6,500 USD p.a for the over 50’s) then you should look to set up a standard brokerage account or investment platform to make your money work, and just pay taxes on the gains made there.
Why Should I Rollover My Old 401K Account?
If you are now overseas and unable to contribute to your old 401K account you should consider dusting it off and making sure that everything is in order, to ensure that it will grow with you into later life. The “rollover” procedure simply takes funds which have up until now been categorized as “401k” monies and relabels them “IRA” monies. There are a number of benefits for completing the procedure.
1) It Doesn’t Cost Anything
Everybody loves “free”. Luckily, the reclassification of your account does not cost anything. Realistically, you will need to be working with a new custodian or advisor and they will likely want to be paid for their services. The transfer procedure itself however is a simple one and the benefits of making the switch will likely outweigh the other potential costs of having your money managed by professionals. For most people who write off their old 401K’s for dead and never think to re-acquaint themselves with the investments contained, let alone manage them, the change from disinterested to pro-active is sure to produce dividends in the long run.
2) More Investments
It is likely that your current choice of investments is limited to a list of mutual funds. IRA‘s are able to access most types of investments; including ETF‘s and single stocks. Not only does this mean that your advisor will be able to create a better portfolio, it also means that you’ll be paying less in fees owing to the fact that ETF’s are on average 1/3rd of the cost of Mutual Funds. This, alongside the fact that it costs institutions less to manage IRA accounts than it does 401K accounts (owing to regulatory requirements), means that you pay less and your money works more.
3) More Efficient Estate Planning
When you die, your 401K balance will be paid out as a lump sump to your beneficiaries, which is extremely tax-ineffecient and can result in some eye-watering tax bills. IRA accounts can be paid out over time to potentially lessen the tax cost, or even allow your beneficiary to roll your IRA account over into their own.
4) Continue To Save
You can continue to make annual contributions to your IRA account moving forward (albeit with a modest annual contribution limit of 5,500 USD p.a). That said, if you were to save 5,500 USD p.a for 20 years, and your account was to grow at 7% p.a (which is less than the historical average CAGR of the S&P500) then your IRA contributions would bank you a total of 225.475 USD at the end. Not bad.
5) You Can Borrow Money…From Yourself
There is ordinarily a penalty for early withdrawals from your tax-privileged retirement accounts. This is fair when you consider that the tax-break on the growth is given on the condition that you use the funds to take care of yourself in old age. There are however two scenarios in which the government will allow you to “cash-in” early.
1) You can pay for tuition at an IRS approved college for a family member
2) You can use 10,000 USD of your IRA funds to pay for your first home. If your spouse also has account you can access 20,000 USD for a downpayment and/or closing costs.
The best thing about this is that unlike a 401K loan, the funds do not have to be paid back. Because of this you’ll require extra discipline to get back on the retirement savings track later on; if you don’t you will end up like the millions of people who fail to ever create substantial retirement funds and end up being dependent on the government in old age. Your house probably wont pay the bills for you. You’ll have to hope that your university graduate child is still feeling grateful all those years later…
[ Sources ]
– IRS: Individual Retirement Accounts
– IRS: The Taxation of Foreign Pension and Annuity Distributions
– Deloitte; Tax planning for US individuals living abroad—2016