living abroad 401K question

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pbandj1027
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Joined: Fri Apr 22, 2011 11:44 pm

living abroad 401K question

Post by pbandj1027 »

My husband and I are currently living in Cuba and working for a government contractor and will be here for at least another 3-6 years.

My husband's boss suggested that we switch our 401K contributions to contributing post tax instead of pretax due to us not paying income tax while we are here. His thought process is that he will never pay tax on the money since he puts it in post tax here (while he doesn't pay taxes) and then will withdraw it without penalty or taxes after he retires.

What do you guys think, it sounds a little too good to be true to me but, I don't know enough about 401K withdrawals since we are over 20 years away from retirement. I just don't want to cause us to pay more tax in the long run by doing it this way.
xerty24
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Post by xerty24 »

If you presently owe no income tax and your 401k offers a Roth 401k option (post tax), that sounds like it'd be a good idea.
acidZen
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Post by acidZen »

Sounds like a very interesting option. I would certainly max out on that.

It's ironic that this is possible in Cuba, where the tax code is normally especially penalizing.. no dual tax agreement, and various other tax benefits and credits are blocked. No foreign tax credit allowed there either.

If it works, it will only be by way of the Roth 401k. Direct Roth IRA contributions are not allowed when income is not US-sourced (or so I hear).

Why aren't the Cubans taxing your income? And why isn't the US taxing it? From reading various tax articles, I would expect double tax.
livesoft
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Post by livesoft »

Guantanamo Bay is in Cuba. I would be surprised if the Cuban government has much say on any US citizens working there.

And if your company provides the Roth 401(k) option and your tax rate is very low or zero, you should use it.
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Topic Author
pbandj1027
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Post by pbandj1027 »

No Roth 401K option, though I wish there was one. Yes, we are in Guantanamo Bay, Cuba on the US Naval Base here so it's considered American soil. My husband works for a US company based out of MS but, our US state of residence is GA for tax filing purposes since our home is there.

Since the income is earned overseas we have to go by the 330/35 rule to avoid tax since we fall under the income limitation we are ok there. We file US income tax (fed and state) each year but, since we are out of the US more then 330 days of the year for work, we don't owe any tax to the US since we fall within the guidlelines of income and time out of the US each year.

So if we max out our 401K post tax now while we are here, should the withdrawals be tax free during retirement? (since they were deposited post tax into the 401K)
livesoft
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Post by livesoft »

So this new information adds a big twist as far as I am concerned.

Without a Roth 401(k), how can you even contribute post-tax without first contributing up to the pre-tax limit? I am totally unsure about that.

The problem with post-tax contributions to a 401(k) is that all the gains will be taxed at ordinary income tax rates when they are withdrawn. That rate is generally much higher than long-term capital gains tax rates and certainly higher than the 0% rate on the gains of Roth 401(k) or Roth IRA contributions.

Folks do contribute after-tax to their 401(k)s in special circumstances. Those circumstances tend to be where they can almost immediately roll the money over to a Roth IRA before is has any gains. That would mean the gains will be tax-free instead of taxed.

But to answer your question: Yes, the post-tax contributions to the 401(k) will be tax-free when you withdraw them. So if you contribute $5000 post-tax the 401(k) and it grows to $20,000 then when you withdraw only $5000 will be tax-free. I think that Form 8606 is used to show post-tax contributions and to keep track of them, but I am not sure. Many people forget to fill that form out. Do not forget.
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livesoft
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Post by livesoft »

Furthermore, if you contribute $5000 (or any amount) to a taxable account, you can also withdraw the $5000 (or whatever you contributed) without paying any tax on the part you contributed. That is, return of capital is tax-free. Any gains on any investments held more than one year will be taxed at the long-term capital gains tax rate. You can also deduct any losses from your taxes as well, but there are rules on that.
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Topic Author
pbandj1027
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Post by pbandj1027 »

livesoft wrote:So this new information adds a big twist as far as I am concerned.

Without a Roth 401(k), how can you even contribute post-tax without first contributing up to the pre-tax limit? I am totally unsure about that.

The problem with post-tax contributions to a 401(k) is that all the gains will be taxed at ordinary income tax rates when they are withdrawn. That rate is generally much higher than long-term capital gains tax rates and certainly higher than the 0% rate on the gains of Roth 401(k) or Roth IRA contributions.

Folks do contribute after-tax to their 401(k)s in special circumstances. Those circumstances tend to be where they can almost immediately roll the money over to a Roth IRA before is has any gains. That would mean the gains will be tax-free instead of taxed.

But to answer your question: Yes, the post-tax contributions to the 401(k) will be tax-free when you withdraw them. So if you contribute $5000 post-tax the 401(k) and it grows to $20,000 then when you withdraw only $5000 will be tax-free. I think that Form 8606 is used to show post-tax contributions and to keep track of them, but I am not sure. Many people forget to fill that form out. Do not forget.
I think that my husband's boss doesn't realize that he is going to have to pay capital gains tax once he starts withdrawing in retirement (at some point) .

It sounded a little too good to be true to me. I think we will keep all of our contributions pre-tax and not have to worry about them. :wink: We are planning to invest up to my husband's company match and then start funding Roth IRA's after that, then opening an account with Vanguard for the rest of our investing needs. (Fidelity has my husband's 401K)
cliffedelgado
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Post by cliffedelgado »

Check if your plan allows post-tax contributions. You already know it does not take Roth 401k contributions. I believe you should be able to make post-tax contributions without pre-tax contributions, but it may depend on the plan.

If so, then you want to check if it allows in-service withdrawals so that you can roll out the after-tax money as livesoft mentioned.

I think the 8606 would only be filled out when you withdraw some of the 401k money. Your 401k administrator should keep track of the after-tax contributions and the gains associated with that amount.
livesoft
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Post by livesoft »

pbandj1027 wrote:I think that my husband's boss doesn't realize that he is going to have to pay capital gains tax once he starts withdrawing in retirement (at some point) .
It's not capital gains tax on the gains. It's worse. It's ordinary income tax on the gains.
It sounded a little too good to be true to me. I think we will keep all of our contributions pre-tax and not have to worry about them. :wink: We are planning to invest up to my husband's company match and then start funding Roth IRA's after that, then opening an account with Vanguard for the rest of our investing needs. (Fidelity has my husband's 401K)
In order to contribute to a Roth IRA you cannot use earned income that has been excluded from your income. So from what you have said, you may not be eligible for a Roth IRA unless you have stateside earned income.
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pbandj1027
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Post by pbandj1027 »

On our taxes will fill out From 2555 for Foregin income earned, would it still be considered not included in our income? We report 100% of our income that way.
livesoft
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Post by livesoft »

You gotta read Publication 590 from the IRS. Here is a link to the html version: http://www.irs.gov/publications/p590/index.html You may find the pdf version easier to look at.

In particular: What is not compensation?

http://www.irs.gov/publications/p590/ch ... 1000230355

See where it says you cannot use income excluded on Form 2555?
Compensation does not include any of the following items.
...
Any amounts (other than combat pay) you exclude from income, such as foreign earned income and housing costs.
So you are not eligible to make contributions to Roth IRAs from the info you posted here.
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Topic Author
pbandj1027
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Post by pbandj1027 »

That sucks, I guess we'll just max out the 401K and then put the rest in an account with Vanguard to invest it. Thanks for the info!
northernisland
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Post by northernisland »

I'm in the same situation and have suggested that maybe a part of the wiki could be devoted to this question, which affects a number of us.

Here is what I have figured out for those of us who, because we live abroad, declare no taxable income:
-We can contribute to a 401k, but with no obvious tax advantage
-We can contribute to 529s for kids (some advantage)
-We can contribute to Roth 401ks, but my employer doesn't have this
-We can't contribute to an IRA or a Roth IRA
-We can contribute to a taxable account, and if we periodically cash it out we get can do so at the lowest capital gains rate (is this right)?

My current strategy is to contribute to taxable. I will probably sell out the accounts in rotation every few years to take the gains. Then, this will be used for a house down payment or to contribute to Roths when we come back. If we're back in the States for a few months and have taxable income, we'll contribute to a Roth. Does this make sense?
plats
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Post by plats »

northernisland wrote:...We can contribute to a taxable account, and if we periodically cash it out we get can do so at the lowest capital gains rate (is this right)?
As long as your passive income is below your standard deduction/exemption you will be the lowest tax bracket--zero. Above that, your foreign earned income is added back to determine your tax bracket. Luckily, for the time being, the maximum tax on capital gains is 15%.
acidZen
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Post by acidZen »

pbandj1027 wrote:That sucks, I guess we'll just max out the 401K and then put the rest in an account with Vanguard to invest it. Thanks for the info!
You can still do the Roth. You just have to roll it over from the 401k TIRA. This is an interesting option, because you get around the prohibition on making direct RIRA contributions, and also exceed the $5k RIRA annual contribution limit. Since you're not otherwise paying tax in the US, the tax on the rollover will be in very low brackets.
Topic Author
pbandj1027
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Post by pbandj1027 »

We are thinking about renting out our house that we just have sitting in the US to my niece and her husband for 1K a month. It's not the entire house payment but, it's 2/3. If I were to claim it as income, could I use that to fund a Roth IRA?



From the idea of the PP, can you still rollover a 401K while you are still employed with the company and contributing to it?
livesoft
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Post by livesoft »

pbandj1027 wrote:We are thinking about renting out our house that we just have sitting in the US to my niece and her husband for 1K a month. It's not the entire house payment but, it's 2/3. If I were to claim it as income, could I use that to fund a Roth IRA?
After I went to the trouble of providing the link the IRS publication 590 with the answer to this question, I feel like I have been totally taken advantage of and I have failed as a teacher. I'm bummed out.
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DSInvestor
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Post by DSInvestor »

In order to contribute to Roth IRA, you must have taxable compensation. Here's a link to IRS Pub 590 for "What is compensation?"
http://www.irs.gov/publications/p590/ch ... 1000230355

There is a section called "What is not compensation?"
Compensation does not include any of the following items.
  • Earnings and profits from property, such as rental income, interest income, and dividend income.

    -Pension or annuity income.

    -Deferred compensation received (compensation payments postponed from a past year).

    -Income from a partnership for which you do not provide services that are a material income-producing factor.

    -Conservation Reserve Program (CRP) payments reported on Schedule SE (Form 1040), line 1b.

    -Any amounts (other than combat pay) you exclude from income, such as foreign earned income and housing costs.
cliffedelgado
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Post by cliffedelgado »

pbandj1027 wrote:From the idea of the PP, can you still rollover a 401K while you are still employed with the company and contributing to it?
This relies on the "in-service withdrawal". Allowed by the IRS but not all 401k plans allow it. And not all types of money in the 401k are eligible. Check your plan.
Topic Author
pbandj1027
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Joined: Fri Apr 22, 2011 11:44 pm

Post by pbandj1027 »

livesoft wrote:
pbandj1027 wrote:We are thinking about renting out our house that we just have sitting in the US to my niece and her husband for 1K a month. It's not the entire house payment but, it's 2/3. If I were to claim it as income, could I use that to fund a Roth IRA?
After I went to the trouble of providing the link the IRS publication 590 with the answer to this question, I feel like I have been totally taken advantage of and I have failed as a teacher. I'm bummed out.
I forgot that you posted the link with your answer and I didn't scroll up to check when I asked the question. I apologize for not reading the supporting documents that you kindly proveded.
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