As promised, in this post we will discuss Roth IRA contribution for US visa holders.
This is the second installment of the series to discuss Roth IRA contributions for those with international planning considerations. (Read the first installment on the same topic for US expats here.)
I will answer the Roth IRA questions that I’ve gotten over the years from those who are not sure how long they will stay in the US, such as:
“Can I make Roth IRA contribution if I file tax return as a nonresident alien?”
“Should I contribute to Roth IRA if I plan to leave the US in 2-3 years?”
“Can I make both 401(k) contribution and Roth IRA contribution?”
“Can I keep my Roth IRA account open if I no longer live in the US?”
“Can I withdraw from my Roth IRA when I leave the US?”
As we are approaching the deadline for Roth IRA contribution once again, I think it’s fitting to finally pull all the info together in one comprehensive post. I hope this will help you make the right decision for years ahead.
US Visa Holder Definition
This post is for foreigners living and making an income in the US legally. Depending on your visa type, you may be filing as US tax residents or nonresident alien. The filing type also determines what type of income is taxable in the US.
I have written a separate post next on Roth IRA contribution for US taxpayers who are US citizens or Green Card holders. If you intend to apply for Green Card, you may want to refer to the other post as well.
What is Roth IRA?
Roth IRA is a type of tax-advantaged retirement account in the US. What makes it a desirable saving vehicle for US taxpayers is its tax-free growth. As long as you meet the qualified distribution criteria, you do not have to pay US taxes annually on the dividends, interests, or capital gains generated, nor when you take a distribution from the account.
IRS Publication 590-A has the full rule around Roth IRA contributions if you wish to go over any detail not discussed in this post.
Who can make Roth IRA contribution?
Any US taxpayer with taxable compensation AND meet the Modified Adjusted Gross Income (MAGI) limitation can contribute to Roth IRA. If you are married and filing jointly, only one spouse needs to have the taxable compensation to contribute for both spouses.
If you are in the US on work visa (H1, O1, L1, etc.) and file tax return as a US tax resident, the rules above apply to you. You also report and pay taxes on worldwide income, like a US citizen taxpayer.
On the other hand, if you file taxes as nonresident alien (F1, J1, G4, etc.), only US-source income is reported and taxable. You need to check that your income is within the “taxable compensation” category. As long as you have taxable compensation in the US, you are able to contribute.
For example, if you are a G4 visa holder as a full-time employee at the United Nation, you will not have taxable compensation to contribute to Roth IRA. However, your spouse, also on G4 dependent visa with a work permit working for a US company, may have US-source wages as taxable compensation. Furthermore, nonresident aliens are not allowed to file jointly, so the spouse on work permit may contribute for him/herself, but not for the full-time employee at the UN.
Note that if a nonresident taxpayer wishes to file jointly with a US tax resident spouse (the 6013(g) election), the nonresident will be treated as a US person taxpayer and required to report worldwide income and fulfill foreign asset reporting.
For international students on F1 or J1, taxable non-tuition fellowship and stipend payments are now considered taxable compensation.
What is the maximum I can contribute?
The maximum contribution is adjusted annually by the IRS. For Tax Year 2020 and 2021, the most anyone can contribute is $6,000. If you are at least 50 years old, you can make an additional $1,000 catch-up contribution, which makes the max $7,000.
How to calculate how much I can contribute?
IRS publishes a table annually to help you determine your allowed contribution amount based on your filing status and MAGI.
Can I still make Roth IRA contribution if I have high income?
Yes, in a roundabout way. You can contribute to a Traditional IRA instead and convert Traditional IRA balance to Roth IRA at any time in the future.
There isn’t income limitation on Traditional IRA contribution. However, since your income is too high to take a deduction, your contribution will be after-tax. This means that when you convert the balance to Roth IRA, only earnings and growth will be taxed. You need to report your after-tax contribution and Roth conversion on Form 8606 when you file tax return.
Can I transfer Roth IRA into my home country’s retirement account?
No. When you take money out of Roth IRA, it will count as a distribution. There is no “direct transfer” to a foreign account.
Can I take the Roth IRA balance with me when I leave the US?
Yes. However, there might be some tax consequences depending on how you distribute from the Roth IRA account.
Your Roth IRA account is subject to the same distribution restriction as those of US citizens’. There isn’t a particular rule that only applies to foreigners leaving the US for good. This is a departure from many other countries in the world, where foreigners are allowed to exit the country’s tax system fully when they depart.
Below are the rules that apply to everyone:
- You can take out your original contribution at any time without paying extra taxes.
- Earnings and growth (balance above your original contribution amount) is taxable and subject to additional penalty if your distribution isn’t “qualified”.
The general rule for a distribution to be qualified is to take it after you reach the age of 59 and ½ and have the Roth IRA account open for at least 5 years. There are a few exceptions to withdrawal prior to retirement age. Notably, exiting US tax residency isn’t one of them.
If you take a partial withdrawal from Roth IRA account, you are considered to take your contribution portion in full first, then your earnings.
For those who have only contributed for a few years, it’s possible the US tax and penalty is low enough so that it still makes sense to take the balance in full if you require the funds. That is, you do not have tax liability from Roth IRA distribution from the country you move to.
For example, let’s say you contributed $6,000 for two years, and decide to return to your home country. When you want to distribute the funds, the balance is $15,000. Assuming you are at 10% marginal tax bracket and not state tax, you pay the following:
Tax + Penalty = ($15,000-$6,000*2) * (10% + 10%) = $600
Overall, you still made $2,400 from this example after tax and penalty.
When should I take the Roth IRA distribution if I choose to – before or after I leave the US?
If you choose to take the money and close Roth IRA account when you leave the US, you pay taxes and potentially penalty as discussed above.
Nevertheless, your actual tax liability may change depending on the total income in the tax year and filing status. This makes a bigger difference for those who go from paying US taxes as resident to nonresident alien.
For example, let’s say you are on H1B visa and leave the US for good toward the end of the year. If you take the Roth IRA distribution in the same year, you will pay taxes on the distribution on top of your wages for the year – likely at a higher marginal tax bracket.
On the other hand, if you take distribution in the new tax year after you leave, you will be paying taxes on US-source income as a nonresident alien and subject to different withholding rules. Many US custodians default to not withholding from Roth IRA distribution, as opposed to the 30% mandatory withholding on 401(k) and Traditional IRA. However, there is always a chance that they apply a different withholding rule on nonresident alien accounts. Eventually, custodians are responsible for interpreting W-8BEN form and withhold taxes to comply to IRS regulation.
Regardless of withholding amount, you can file a US tax return to claim a refund of excess withholding. However, some may find the cost and time spent on filing US tax return not worth the refund.
Can I keep my Roth IRA account open in the US after I leave the US?
Yes. However, not all custodians work with nonresident aliens. Most Robo-advisors and mobile-only Trading apps do not have the system to work with foreigners and specifically exclude nonresident aliens.
If you already started your account as a resident alien, you may want to find a custodian that will take foreign address and withhold taxes according to W-8BEN. You can initiate a direct transfer of the underlying securities from the existing Roth IRA to a new one with a different custodian. You do not need to sell the investments you own. Direct transfer also does not count as a distribution.
As the moment, I only know of two custodians, Interactive Brokers and TDAmeritrade, that accommodates nonresident aliens through its ONLINE account open access. However, it doesn’t mean that other custodians will not work with you if you call to inquire and open account through paper forms. All US custodians have internal guidelines on who they can acquire as customers based on their country of residence. This it to comply with laws in foreign jurisdiction.
I can make Roth IRA contribution. But should I?
In my opinion, this is the most important question to ask. Just because you can do it doesn’t mean it’s necessarily the most beneficial in your situation.
The main decision points are:
- Do you expect to apply for Green Card or even US citizenship?
- Do you know for sure where you will be going next and how long will you stay there?
Apply for Green Card and citizenship
While life is never certain, if you have decided to try to remain in the US for the foreseeable future, planning your finances like a US permanent resident may be the way to go. As discussed in the first installment of this series, Roth IRA contribution is rarely a bad idea when you are eligible.
Will definitely leave and know where you will go and stay forever
If you know for sure you will definitely leave the US for another known country, you can look up how your home or your next long-term resident country treat Roth IRA accounts.
Roth IRA is only mentioned specifically in eight US income tax treaties. When Roth IRA is recognized in the treaty, it means its tax-free status in the US may be reciprocated in the host country as long as certain conditions are met. Therefore, Roth IRA contribution may also be a good idea.
When the Roth IRA tax-free treatment is not recognized like in the US, you can be taxed in two possible ways:
- Treated as a normal investment account
- Distribution treated as a foreign pension income.
Depending on how your resident country treat reporting and taxation of foreign income and investment, Roth IRA may be great or may become a nightmare.
For instance, some countries don’t tax foreign income at all, even though they tax your earned income while you live there. In such case, your investment in Roth IRA may never get taxed.
On the other hand, some countries have higher tax on investment earnings than the US and also treat Roth IRA as a normal investment account rather than pension. Assuming you will continue to be tax residents in both countries, Roth IRA may just make your tax reporting complicated without any additional tax savings.
Any scenario in between
If your future location is uncertain, investing in a US taxable brokerage account can be almost as good as Roth IRA contribution. The main difference is that you will need to report dividend and realized capital gain every year. While resident aliens pay taxes at the same rate in the same way as citizens, nonresident alien taxpayers that stay in the US for over 183 days will pay 30% flat tax on the earnings.
As the next example shows, the difference in return may not be as huge as you think.
Let’s say you stay in the US for 4 years under F1 and 6 years as H1B visa. We assume that you invest in diversified, low-cost ETFs over this time period. The average return is 4%, where 1.5% came from taxable dividends and 2.5% from unrealized capital gains. You only add to the account, reinvest all dividend after-tax, and never sell.
Your balance after 10 years between the two different accounts will be like the below:
Assuming you meet the retirement age requirement after 10 years, you don’t pay any US income taxes on Roth IRA withdrawal. You will get the entire $62,431 back.
What about the taxable brokerage? Once you become a nonresident alien, you do not pay capital gains taxes when you sell (unless you move to a country with treaty rate). So you will also get the entire $61,554 back.
Only $877 less in earnings over 10 years, but it saves you whole lot of headache from figuring out what to do with Roth IRA after you leave the US. I say just invest through the taxable brokerage account.
Needless to say, if you won’t be close to 59 ½ when you may leave and want the flexibility to take the money with you, taxable brokerage gives you higher return!
Last thing to note here is that the example ignored the fact your new country may tax your capital gains from a taxable brokerage account. Nevertheless, your Roth IRA may be treated as a normal taxable brokerage account outside of the US anyway! If you truly have no idea where you may go in the future, keeping things simple and flexible definitely trumps strategizing too much on short-term tax gain.
What about Roth conversion on my existing Rollover IRAs?
Roth conversion is treated as a type of rollover and a taxable distribution in the US. When you convert any Traditional IRA balance to Roth IRA, the part that represents pre-tax principal, earnings and gains will be taxed in the US. Therefore, Roth conversion is treated as a taxable distribution under US law.
Before considering the tax law of your new resident country, a distribution from IRA is subject to 30% withholding, unless a tax treaty reduces it.
The mandatory withholding basically forces you to distribute a percentage of your IRA in cash so the rest can go into a Roth IRA. It requires further calculation to know whether Roth conversion gives you any financial benefit in the long run.
What if the treaty reduces your withholding to zero? As discussed early, most countries treat Roth IRA as a foreign pension or normal taxable investment account.
Under the former scenario, if the tax treaty specifically mentions the pension status will be preserved when you transfer an existing pension plan to another, then there will be no foreign tax due at the time of conversion.
On the other hand, if the Roth IRA is treated as a normal taxable investment account, distribution from Traditional IRA at the time of Roth conversion will be taxed as pension income. Depending on how your local tax system treat foreign pension income and future foreign investment earnings, Roth conversion may or may not result in lower global tax liability in the long-term. This situation also requires further analysis.
Please comment below if I fail to address any major decision point. I’ll try to update the post as they come in. Please note I cannot comment on your particular country or situation. Thanks!