401K and IRA for foreigners in the United States?

We have been busy with other things in life since more than a year ago and just responded to questions/comments sparingly. I (Yannick) didn’t expect to do another post for a long time but obviously changed my mind because of the excellent question from Abhishek: are there any strings attached to these retirement accounts for foreigners?

If a foreigner plans to stay in US until retirement, then the answer is a straight-forward “no extra string”. For tax purpose, Abhishek has been in the States long enough (6 years) to be treated as a Resident Alien, same as a US citizen. So same rules and penalty apply regarding distribution and early withdraw.

If on the other hand, Abhishek plans to return to his home country after a few years, the answer depends on the tax policy of his home country and the tax treaty (if there’s one) between that country and US. It may very well be less strings (or one more way out) for foreigners. The key questions are usually:
How does the foreigner’s home country treat retirement accounts in US? Is the investiment in a US 401K or Traditional IRA treated as tax deferred as well? Is the Roth IRA treated as tax-free? If not, there’s little reason to use them except contributing to the minimum level in a 401K to get employer match.

If the answers for above questions are yes, then you can have the option to leave the money grow tax-defered or tax-free in US until you reach retirement. US still has the most efficient captial market and lots of long term potenial. So this could be a good diversification investment strategy. Be sure to choose an institution/custodian which keep accounts open when you leave the country. I also recommend to roll-over 401K balances into an IRA accont before you leave. 

What if I need to leave US and also need the money before retirement? First, you want to file a W8BEN with your US custodian to avoid a automated 20% tax withholding at the time of withdraw.  To avoid 10% early withdraw penalty, you need to see if a tax treaty allows a trustee-to-trustee transfer of your money from a US account to a pension fund in your home country.  If not, you want to see if you are okay with annuitizing your traditional IRA money (roll-over 401K to traditional IRA first) or just withdraw your Roth contributions. A SmartMoney article  summarized this approach very well. This applies to all US residents.

If however, you want all of your money within a few years and your home country doesn’t double tax you for incomes in US, then maybe the best bet is to bite the bullet of 10% penalty, while managing the withdraw in each year low enough to avoid US income tax. Income tax is usually much higher than 10%, therefore you may be better off doing withdraw this way, which is not available for most folks staying in US all the time. 🙂

In summary, if you don’t know your long term plan yet, you are likely better off by contributing to 401K and Roth IRA as long as your home country doesn’t double tax you for income earned in US. Please check out our ranked list for savings to manage the trade-off between tax-advantage and liquidity. BEST OF LUCK to Abhishek and all you visitors!

More Tax Returns for International Students!!!

NOTE: Enter a lottery before Noon Sunday (03/25) PT, for a free download of TaxCut Premium (Federal + State + efile) , retail value of $64.99. at my other web site: http://www.latestartersblog.com!

Yannick and I have been students for so long that we were “forced” to become “sophisticated” senior students, at least financial-wise.

We came from China. There is an annual $5,000 exclusion of a student’s wages for the first 5 years. We were very happy back then, because we were optimistic that we could finish our PhD’s in 5 years.

As you know now that we did not accomplish our mission within 5 years. In the 6th year, as we were grudging the loss of the “$5000 exclusion of students wages”, we started extensive research on tax laws, treaties, and even attended a PhD level taxation seminar! (You see, there is a reason that we stayed in graduate schools for such a long time).

And you know what? Our efforts did get rewarded! Here is what we found: The tax treaty from the People’s Republic of China (PRC) contains no time limit, and a Chinese student who qualifies for it may use the article for as long as he is still in valid F-1 status, including during that period in which he is engaged in practical training in valid F-1 status.

So, if you are from P.R.C, still a student after 5 years in U.S., and believe in “NO Taxation Without Representation”, here is something we want to share with you. Hopefully this will save you some time, and help you get out of graduate school early.

Step by Step instruction to get you $5,000 tax exclusion:

I. Download Form 8833 .

II. Fill out the form like this:

1. Enter the specific Treaty position relied on:
(a) Treaty country: People’s Republic of China
(b) Articles: 20(C), Paragraph 2 of 04-30-1984 prot.

2. List the internal revenue code provisions overruled or modified by the treaty asked return position: IRC61; 871(b)

3. Name, identifying number of …. : N/A

4. List the provision(s) of the limitation on benefits…: N/A

5. Explain the treaty-based return position taken:

The taxpayer is a citizen of the People’s Republic of China. He entered the United States on on an F-1 visa (student), and has remained in F-1 status continuously since. Under the residency rules of IRC7701 (b), the taxpayer passed the substantial presence test in and his residency starting date was 01-01-. This means that for 2006, the taxpayer is a resident alien and is filing form 1040 for 2006 as a resident alien.

Article 20(c) of the USA-China income tax treaty allows an annual $5000 exclusion of student wages from gross income. The article contains no time limit, and a Chinese student who qualifies for it may use the article for as long as he is a bona fide student in valid F-1 status. Paragraph 2 of the 04-30-1984 protocol of the USA-China income tax treaty contains the “saving clause” of the treaty, which normally acts to nullify the tax treaty’s benefits once a resident of China has become a resident of the USA. However, paragraph 2 of the Protocol also specifies exceptions to the saving clause, among which is article 20 on student and trainees. This means that, even though the taxpayer has become a resident alien under the substantial present test of IRC 7701(b), he may still claim the benefit of article 20 of the USA-China income tax treaty. The taxpayer has elected to do this, and is claiming an exclusion from gross income for 2006 of $5,000 in student wages as allowed by article 20(c) of the USA-China income tax treaty. TOTAL EXCLUSION CLAIMED: $5,000

Gong Xi Fa Cai!