Among the questions I received over the 10 years of writing this blog, 401(k) contribution is perhaps the most popular topic of all. As remote work and global mobility becomes more prevalent, more US tax residents overseas have access to 401(k) and need to decide whether to contribute to it.
While I’ve written several related posts, I’ve never pulled all the resources and experience together in one place. It seems a fitting time for creating a systematic guide now I’m back in the boat of evaluating this decision for myself.
Preface
First, some basic information if you are new to the world of US retirement savings or tax planning as a US tax resident living outside of the US.
What is a 401(k)?
401(k) is a qualified retirement account sponsored by an employer for the employee. Read more about it here and how it differs from IRA.
What is Foreign Earned Income Exclusion (FEIE)?
Foreign Earned Income Exclusion allows overseas US tax residents who meet the Bona Fide Residence or Physical Presence test to exclude certain amount of their compensation from US taxation each year at the lowest tax brackets.
Why do I have to worry about contributing to 401(k) and taking FEIE at the same time?
Depending on the circumstances, it creates potential of double dipping of US tax benefits. Continue reading this post so you know what you need to be aware of.
I. W-2 Employees
How can one be a W-2 employee with access to US 401(k) plan but not living in the US?
- Your multinational employer may have put you on a tax equalized payroll plan while working from a foreign duty station. You receive US-based compensation and benefits, pay US tax, and sometimes responsible for additional local tax when applicable.
- Your US employer allows you to be fully remote without restricting your duty station in the US. You are on US payroll but physically overseas. (#1 is the correct way for an employer to do it. #2 is not.)
- You are a US S-Corp owner with W-2 wages that lives overseas. (We’ll discuss this as a separate category.)
Can I contribute to an employer provided pre-tax 401(k) account if I claim FEIE on my income?
Yes.
When you contribute to a pre-tax 401(k) account as a W-2 employee, your W-2 wages (Box 1 on the W-2 form) already shows the gross salary reduced by pre-tax contribution.
In practice, you start the FEIE calculation with declaring W-2 wages on Form 2555. This means that you take deduction for 401(k) contribution first before taking FEIE.
In effect, you only take FEIE up to the taxable amount after pre-tax 401(k) contribution. You are not able to contribute to pre-tax 401(k) from income that is excluded.
Example 1:
Your gross salary is USD 140,000.
You made pre-tax 401(k) contribution of USD 20,000.
You have W-2 Box 1 Wages of USD 120,000.
You qualified for the max USD 120,000 FEIE for tax year 2023.
Your adjusted gross income (and taxable income) after FEIE is zero.
Example 2:
Your gross salary is USD 120,000.
You made pre-tax 401(k) contribution of USD 20,000.
You have W-2 Box 1 Wages of USD 100,000.
Your eligible FEIE is limited to the smaller of actual Foreign Earned W-2 Wages and the max FEIE limit = USD 100,000. (Form 2555, Line 42)
Your adjusted gross income (and taxable income) after FEIE is zero.
How much should I contribute?
- If you get a match from your US employer based on your own contribution, consider contribute enough to get full match.
- If your foreign earned income after Step #1 is already below your *eligible FEIE*, you don’t save extra taxes in current year but need to pay taxes when you take money out. Depending on your investment return and asset allocation, having your investment grow tax-deferred may or may not increase your return overtime.
(Note: it’s not always relative to the “max” FEIE. If you qualify for partial FEIE in the entry and exit year, you may not get the max exclusion allowed.)
- If you have higher foreign earned income than your eligible FEIE, you save taxes in the current year at your highest marginal tax rate. If you expect to be at a lower tax bracket when you take distribution from 401(k), then you should contribute. Otherwise, same consideration as Step #2.
(See this previous post about short-term tax saving vs. tax-deferred growth.)
Can I contribute to an employer provided Roth 401(k) account if I claim FEIE on my income?
If your gross salary is above your eligible FEIE amount
Yes. You can contribute up to the difference between your gross salary and FEIE but below 401(k) max contribution amount.
This difference will show up as adjusted gross income subject to tax before standard deduction and other tax credits you are eligible for. It’s possible you don’t pay tax on Roth 401(k) contribution after other deductions, but you should have adjusted gross income to make Roth 401(k) contribution.
If your gross salary is below your eligible FEIE amount
Do it at your own peril. However, I’ve not heard anyone getting into trouble. (See the multiple discussions in this post comments.)
Roth 401(k) contribution in theory should always be from income subject to tax.
Based on how Form 1040 and W-2 are designed, you may end up excluding Roth 401(k) contribution from being taxed in the year of contribution. There is no way to voluntarily report Roth 401(k) contribution as adjusted gross income or reduce your claimed FEIE accordingly.
II. Schedule C or Partnership K-1 Self Employment
You fall into this category if you are self-employed and report 100% of your net business income as pass-through earned income on your US tax return.
This assumes you do not conduct your business through a foreign entity, which may have its own local rule on when the owner recognizes taxable personal income. Or if you do, you “checked the box” to elect the foreign business income to be taxed the same way as US Schedule C or Partnership K-1 income.
How can a self-employed business owner living outside the US contribute to a 401(k)?
- You must have Schedule C or Partnership K-1 Self-employment income and pay Self Employment Tax.
- You don’t have employees that will prevent you from establishing an individual 401(k) only for owners. If you do have employees, you need to establish the plan for the firm and make fair contributions for all eligible employees to pass 401(k) plan testing.
In the discussion below, we are going to assume that you want to establish an individual 401(k) with no employees.
Note that being able to contribute to US 401(k) does not mean you automatically defer your foreign income tax liability on your contribution. The same applies to your US tax if you contribute to a foreign pension.
Can I contribute to a pre-tax individual 401(k) account if I claim FEIE on my self-employment income?
Yes. Pre-tax 401(k) contribution is a business expense item that reduces how much FEIE you can take. This means that how much you may contribute follows the same formula as if you live in the US, before the FEIE is applied.
Can I contribute to a Roth individual 401(k) account if I claim FEIE on my income?
Yes, but only if you have adjusted gross income after FEIE is applied. Roth 401(k) is only available for the employee deferral portion.
How much should I contribute? Pre-tax vs. Roth?
As discussed, pre-tax individual 401(k) contribution reduces the actual FEIE claimed. This is because you cannot take a deduction on business expenses allocable to excludable income. See this past post with more explanation of this concept.
In addition, before the tax law potentially changes in 2026, FEIE and pre-tax 401(k) contributions also reduce how much Qualified Business Income deduction you can take.
With those two variables in mind, it turns out that maximizing pre-tax 401(k) contribution may not reduce tax at the highest marginal tax rate. In some cases, contribute some to Roth 401(k) may be the better choice in the long run.
Example 1A
Let’s start with the example in IRS Publication 54 of a self-employed person that didn’t contribute to pre-tax 401(k).
As you can see, foreign earned income in this case starts with the gross income (green cell), not net income. The business expense and self-employment tax reduce the actual FEIE claimed (blue cell). No US tax is due.
There is an adjusted gross income of $756 so you can only contribute to Roth 401(k) up to this amount.
Example 1B
Next, you could in theory contribute pre-tax to individual 401(k). Let’s say you contribute employee deferral portion of $10,000 (orange cell). Your tax is still zero, but your FEIE claimed is also reduced. And you pay tax when you distribute that $10,000. Depending on your personal long-term tax situation, it may or may not be beneficial.
Example 2
What about if your gross income is much higher?
With the same example, I increased the gross foreign income to $200,000, and created 3 scenarios.
Contributing $46,937 (max) to pre-tax 401(k) while taking FEIE only reduces final tax liability by $3,423, which means you only deferred 7.29% of the taxes on the contribution. When you distribute, the tax rate on the same $46,937 is more likely to be higher.
On the other hand, just contribute the employee portion to Roth 401(k) and not make pre-tax contribution results in similar tax liability as if you were in the US and contributed max to pre-tax 401(k).
This is why you need to run your own scenarios, or in conjunction with your tax adviser, to determine the optimal contribution in your situation. Don’t be surprised if sometimes the answer is it’s better to save in taxable account!
III. S-Corp Self-Employment
S-Corp is a hybrid tax structure that allows US business owner to reduce W-2 earned income subject to self-employment tax. FEIE is only applied on the W-2 portion. The K-1 distribution is considered passive income.
Assuming the S-Corp consists of only self-employed owner/employee, the S-Corp may utilize individual 401(k) plan.
Can I contribute to an individual 401(k) account if I claim FEIE on my W-2 income? How much? Pre-tax or Roth?
Same consideration as in Section I.
Can the S-Corp contribute to an individual 401(k) account for the W-2 owner/employee? How much?
The employer can only contribute pre-tax up to 25% of the W-2 wages. It will reduce the amount pass-through as taxable passive income to the employee. This applies regardless of whether employee claims FEIE.
However, the S-Corp owner should also consider whether the company runs afoul of employer’s payroll responsibility in the foreign country. Normal W-2 employees may choose to ignore this issue if the employer takes the risk. A S-Corp owner/employee may need to consider their business’s liability more closely.
I can choose between S-Corp and Schedule C. Which one is better if I take FEIE?
At a high business net income level, S-Corp would more likely allow you to control income subject to self-employment and income tax after FEIE and to optimize your US retirement contributions. However, it adds multiple costs such as S-Corp tax return, payroll software, and potential payroll tax that applies only to employee. In the worst case, you may need to consider the same payroll responsibility in the foreign country. If your business or you personally are also tax residents in the foreign jurisdiction, make sure you consider all the compliance cost and tax in both countries before electing an entity for tax purpose.
Nevertheless, assuming you don’t have foreign tax liability, S-Corp may produce overall lower tax rate. See comparison below showing one of these scenarios.
I'm Hui-chin Chen, a globetrotter & certified financial planner helping you manage your finances from afar and on the go.