Are IRAs suitable for US-based NRIs?

IRA for NRIs

Whatever your age or financial situation, it’s never too early to start saving for retirement. For NRIs residing in the US, investing through an Individual Retirement Account (IRA) will save on taxes while providing access to a range of investments. IRAs are retirement accounts for those earning US taxable compensation and younger than 70½ years of age. Because of their special tax advantages, IRAs must be held in designated accounts separate from other investments.
 
As an NRI, whether you are residing in the US through a work visa or as a permanent resident, you are eligible to invest in Individual Retirement Accounts (IRAs), as long as you earn eligible compensation in the US and have a Social Security Number. Their tax advantages give them an advantage over other types of accounts.

 

TYPES OF RETIREMENT ACCOUNTS

The three most popular types of IRA accounts are 401(k), traditional IRA and Roth IRA. Unlike Traditional and Roth IRAs, 401(k) plans can only be offered by an eligible employer. Traditional and Roth IRAs, on the other hand, can be set up independently by any individual at a qualified institution.

 

 

401(k) ACCOUNT

401(k) accounts offer investment of pre-tax income on a tax-deferred basis. Once funds are withdrawn from the account, which is permitted only after 59½ years of age, taxes are due on the amounts withdrawn. For 2019, the IRS has set 401(k) contribution limits of $19,000 plus an additional $6,000 catch up contribution permitted for those over age 50.
 
Many 401(k) accounts offer matching contributions from your employer, whereby the employer contributes an additional $1 for every $1 the employee invests in their 401(k). This free money from your employer allows you to grow your retirement savings more quickly.
                                               
Withdrawals are expected to occur in retirement when most likely a lower tax rate would be applicable. Should you need to access these funds earlier than age 59½, you could be subject to penalties of up to 10% of the amount withdrawn, in addition to an immediate tax bill at your prevailing tax rate.
 
A 401(k) is one of the best options to save for retirement. Given their considerably higher contribution limits compared to traditional and Roth IRAs, and the possibility of employer matching, this is one of the fastest ways to save for retirement. On the downside, as an employer-sponsored account, you may have less flexibility in investment options. Also, once you leave the employer, you will be required to roll over the funds into a traditional IRA. Regardless, the 401(k) remains one of the best options for NRIs to save.

 

 

TRADITIONAL IRA

Traditional IRA accounts allow investment of pre-tax income on a tax-deferred basis. Once funds are withdrawn from the account, which is permitted only after 59½ years of age, taxes are due on the amounts withdrawn.
 
For 2019, the IRS has set an aggregate contribution limit of $6,000 for Traditional and Roth IRAs, meaning you cannot contribute more than $6,000 across all traditional and Roth IRAs. If you or your spouse are eligible for a retirement plan from your employer such as a 401(k), you are ineligible to contribute to a traditional IRA if your compensation exceeds $74,000 individually or $123,000 if married and filing jointly.
 
Withdrawals are expected to occur in retirement when a lower tax rate would most likely be applicable. Should you need to access these funds earlier than age 59½, you could be subject to penalties of up to 10% of the amount withdrawn, in addition to an immediate tax bill at your prevailing tax rate.
 
Traditional IRAs are the best option for those who are ineligible for an employer-sponsored 401(k). They are also a good secondary retirement account for those who have maximized their 401(k) contribution limits and remain under the income limits for a traditional IRA.

 

ROTH IRA

Roth IRA accounts allow the investment of post-tax income with investment gains growing tax-free, resulting in significant tax savings. For 2019, the IRS has set an aggregate contribution limit of $6,000 for traditional and Roth IRAs. A Roth IRA account can be set up by anyone with taxable compensation, as long as their income falls below $137,000 individually or $203,000 if married filing jointly. 
 
Unlike a Traditional IRA, you can withdraw any contributions you have made on a tax and penalty-free basis. Earnings on those contributions, though, are not eligible for withdrawal unless you have had the account for more than five years or have reached age 59½. Accounts that don’t meet those requirements will be taxed on any earnings at the prevailing tax rate plus an additional 10% penalty.
 
Another consideration for NRIs, as Indian tax law may not recognize the tax benefits of a Roth IRA, if you don’t withdraw your funds while residing in the US and withdraw once back in India, you may be subject to Indian tax on the withdrawals. If your children plan to stay in the US long-term, you can make them designated beneficiaries, allowing them to inherit the account and make withdrawals tax-free. Considering that contributions can be withdrawn without penalty, Roth IRAs are a great option to grow your savings while also maintaining immediate access to your contributions.
 

WHICH PLAN SHOULD YOU OPT FOR?

Due to their significant tax benefits and the contribution by an employer, any eligible NRI should opt for a 401(k) plan. Between a Traditional and Roth IRA, the general rule is to choose the Traditional IRA if you expect to be in a lower tax bracket after retirement and Roth IRA otherwise. For salaried NRI professionals, most likely the tax bracket would be lower after retirement so Traditional IRA might be more suitable. For those with a shorter or uncertain time horizon for their investments and who may need more immediate access to their funds should opt for a Roth IRA. This allows you to withdraw your contributions penalty-free while also allowing you to designate your children as beneficiaries to minimize tax consequences.

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