Take it or Leave it? What to do with your old 401k when you move abroad
The popularity of the 401k as a retirement savings vehicle and its tax implications make this question the most common one we get from cross-border professionals: what should I do with my old 401k?
The answer is a resounding it depends.
Having gotten Captain Obvious out of the way, let’s look at the major options people have and when each may make sense. We would like to be clear that we are focusing on professionals who are residing outside the U.S., as that is where the complexity comes in. Today we are also only talking about the pros and cons of your initial options; the tax implications over time and at withdrawal are varied and the subject of other articles.
Pack it up and take it with you
Many people ask us if there is a way to rollover or transfer, tax-free, their 401k balance from the U.S. to their new country of residence. The answer is no: while the benefits of owning the account may travel with you, the U.S.-based account itself cannot. Any withdrawal will trigger U.S. taxes (and possibly foreign taxes) and an additional 10% tax penalty if you are younger than age 59 1/2. And of course, taking out your 401k plan savings also eliminates the benefit of tax-deferred growth, which often continues even after you’ve moved to another country.
When might a full distribution make sense? Well, we will occasionally suggest that someone consider doing this when the balance of the account is fairly low, making the administrative hassle and potential tax complexities outweigh the benefits. Of course there are also situations when people really need the funds locked up in their 401k, and it is worth the taxes and penalties to gain access to the money.
Leave it where it is
Another viable option is to leave your 401k plan balance right where it is, in your former employer’s plan where you originally made the contributions. This is never a terrible idea, and it definitely is the easiest from an administrative perspective. Plus, commonly you continue to benefit from tax-deferred growth. It is hard to beat – do nothing!
But then one must face some compromises in leaving a balance in an inactive 401k plan. You might think this is the lowest cost option, but that is not always true. Generally, an employer 401k plan pays for the costs of its administration and investment solutions from the assets of the plan. This means that you are paying them via a small draw on your assets, thus eroding your return (fees can be anywhere from 0.25% to over 2.0% per year).
401k plans have evolved over the years, and many of them today offer a good range of investment options at a reasonable cost. In general, you should match your retirement assets to your lifestyle, which typically means having a larger exposure to international investments if you plan to retire abroad. However, these plans are not well designed for global families, and they generally offer very few international investment alternatives.
This void is particularly evident in lower-risk bonds, which tend to be an important holding in larger 401k accounts, given that the owners of these accounts are often older and closer to retirement age. And even when an international bond fund is offered, you may be surprised to know that it is always hedged back to the U.S. dollar, so don’t expect it to provide any protection in a falling dollar environment. This poorly-understood currency risk can be disastrous to a person at or near retirement who also intends to live outside of the U.S.
Many plans now offer a simple target-date retirement fund, which is an “automatic” one-stop option that evolves from aggressive to conservative over many years based on your assumed retirement year. These simple pooled funds are a great option for a large proportion of people. However, those with a more international lifestyle should be very careful, as these funds are overwhelmingly U.S. dollar oriented.
Take control of it
We often recommend inactive 401k balances be moved to an IRA account, which offers broader investment alternatives. You may want to have more flexibility with your investment options, for a variety of reasons, yet wish it to remain in a tax-deferred vehicle. Enter the IRA rollover.
By setting up an IRA at an independent custodian like Fidelity or Schwab, you are likely to have a world of investing possibilities, including sometimes multiple currencies. This approach allows you to consolidate a variety of accounts into one platform, which provides ease of administration and oversight. In addition, U.S. financial institutions are amongst the global leaders in terms of investment choices, low fees, investor protections, and transparency, making the U.S. a preferred financial jurisdiction regardless of one’s country of residency. Maintaining investment accounts in the U.S. is often a preferred route for global professionals on the go.
But, please be aware that many U.S. institutions will not open an account for you if you do not reside in the U.S. So plan ahead, and recognize that this is an age where many large international financial institutions would rather avoid dealing with an internationally mobile clientele.