Many U.S citizens or people that may have worked in the U.S have got some form of 401k. In this article, I will aim to cover the different types of company schemes, rules that legislate U.S. pension schemes and then what are your options if you are living abroad with one of these schemes.
First before, we get into the different types of schemes both qualified and non-qualified you have in the U.S and what you might have contributed. Let’s have a look at the rules that deem all qualified U.S company pensions schemes.
Corporate plans must meet both IRS and Employee Retirement Income Security Act (ERISA) requirements. The Employee Retirement Income Security Act is there to protect the retirement assets of people working in the private sector. All private employer-sponsored, tax-qualified retirement plans must meet the following ERISA requirements:
- The plan must be available to all employees who are at least 21 years of age and who work at least 1,000 hours a year (no employees that fit these requirements can be excluded from the plan).
- Employees must be covered by a retirement plan within a reasonable time of their employment.
- Pension sponsors must fully fund the participants’ benefits, and the contributed funds must be held separate from other corporate assets.
- Participants must be furnished a summary plan, in writing, that contains the plan’s terms and the benefits offered.
- Participants must receive a statement of the plan’s benefits and the status of their account at least annually.
- Participants may choose a beneficiary.
- Employees must be fully vested—that is, their accrued benefits must be guaranteed them—within a reasonable period of time, usually five to seven years.
- Employees must receive their entire retirement benefit within a reasonable amount of time of their employment, even if they no longer work for the employer.
- A party-in-interest (for example managers, counsel, or employees of the plan; service providers to the plan; the employer whose employees are covered by the plan; or employee organizations whose members are covered by the plan) is prohibited from selling assets to the plan. (Registered representatives of member firms are exempted from this rule, so they may provide advice and receive commissions on transactions.)
- Plan assets must be put into a trust for the sole benefit of the employees. If the company is forced to liquidate, creditors will not be able to access these assets.
This means that if you have a 401k or other qualified pension plan that it must meet these requirements.
Additionally, many plans also have an investment policy statement (IPS). In addition, an IPS outlines how many of the ERISA Section 404(c) requirements are met, including how an employer screens and selects the underlying investments and investment managers, monitors performance, limits expenses in the plan, etc.
Typical investment policy statements include:
- Investment goals and objectives
- The way the plan will meet these objectives
- The selection process for the investments within the plan
- The way that the goals and investments will be measured, monitored, and reviewed
- An asset allocation and a description of when the assets will be rebalanced
- Any limitations on what can be invested in
As you can see from the rules that state qualified retirements plans meeting ERISA rules and IPS (not mandatory) that your 401k is protected quite well. As well as having Investment options and how it is invested. This I will come on more to later. But, the aim is by IPS and ERISA to ensure that all schemes are save and contributors are full informed about the decisions and investments.
Types of Qualified Pension
A qualified retirement plan is one that satisfies the Internal Revenue Code. That means the provisions in the plan document must satisfy the requirements of the Code and the plan must follow those plan provisions. A qualified plan allows the participant (the employee) and the sponsor (the employer) to make allowed deductions from federal income taxes. Contributions to a qualified plan can also be made on an after-tax basis if allowed by the plan.
Qualified employer-sponsored retirement plans come in two types: defined benefit plans and defined contribution plans. Defined benefit plans promise a specific benefit upon retirement for eligible employees, no matter how much was contributed to the plan. For example, a defined benefit plan might pay an employee $1,000 per month beginning at retirement for the rest of the employee’s life. Defined contribution plans do not promise a specific benefit, but rather pay out an amount dependent on how much was contributed to the plan. They are at least partially funded by the employer but are managed by the participant.
401k Defined
This is sourced from Investopedia (a great source of financial knowledge that would recommend to any investors)
A 401(k) plan is a tax advantage defined-contribution retirement account offered by many employers to their employees. It is named after a section of the U.S. Internal Revenue Code. Workers can make contributions to their 401(k) accounts through automatic payroll withholding, and their employers can match some or all of those contributions. The investment earnings in a traditional 401(k) plan are not taxed until the employee withdraws that money, typically after remitment. (Source Investopedia)
Note that the limits of 401ks are $19,500 for under 50’s and you have RMD (which will go into more detail later) is that by April 1st on the year your turn 72, if you don’t take out the required distribution account holders who do not take their required minimum distribution by the deadline will be subject to a tax equal to 50% of the undistributed RMD.
Other types of plans, 457 and 403b are for government workers and charity personal. These plans do have certain exemptions but as not to common will focus less so on these.
Other plan’s if you were self employed include
SEP Plans
SEP plans are IRA-based retirement plans for any sized business but are usually favored by small businesses. Under this type of plan, the business owner can make pre-tax contributions into IRA accounts set up for eligible employees and also for herself if the owner is self-employed. The plan allows employers to skip contributions in years when business is bad, but if the owner makes a contribution for herself she must also make contributions for her employees. When contributions are made, they must be made for all participants who actually performed work during the year for which the contributions are made, including those over 72 years of age (the latter feature is unique to the SEP plan). Contributions for all participants generally must be uniform; for example, they must represent the same percentage of the hourly wage for each participant.
The business owner can make contributions of up to 25% of an employee’s salary, or an annual maximum of $57,000, whichever is less. Only the employer, and not the employee, make contributions to the SEP-IRA, but an employee is always 100% vested in her SEP IRA.
Simple IRA
The Simple IRA plan is a retirement plan for businesses with no more than 100 employees. With a Simple IRA, the employee may make pre-tax contributions to the plan. The employer is required to either match these contributions up to 3% of the employee’s compensation or to contribute 2%, whether the employee makes a contribution or not. All employees who earned more than $5,000 in the preceding year are eligible under this plan. Unlike the SEP plan, however, premature Simple IRA distributions (withdrawals of account funds) will incur a 25% penalty in the first two years the account exists if made before age 59 1/2.
Keogh Plan
Private employers of any size and structure, from the largest C corporation to a sole proprietorship consisting of a single self-employed individual, may set up and use any of the qualified employer-sponsored plans described above, except for the 403(b) and 457 plans. You may encounter customers who talk about having a Keogh plan, also called an HR-10 plan. These were created to allow small businesses access to qualified retirement plans. But in 2001, changes in the law eliminated many distinctions between the retirement plans of large and small businesses. As a result, there is technically very little difference between Keogh plans and other qualified plans, so much so that IRS guidance on retirement plans prefers not to use the term “Keogh plan.”
Non-Qualified Plans
As well as these you also have non-qualified plans such as payroll deduction plan and deferred contribution plan.
What are your options if you area U.S expat or have a 401K or Qualified plan.
One of the options is to leave your 401k in the scheme, like stated above it is well protected and has a lot of legislation around the qualified plans. You also (like stated above) must have 3 investment options to choose from and IPS should make the Investment objectives clear.
One other option would be to transfer to an IRA plan. I have done a few videos on why this might be feasible but one of the main aspects id that it is now applicable for U.S expats.
IRA is described as Individual retirement accounts (IRAs) are retirement plans that allow individuals to contribute to a retirement account with pre-tax dollars. In other words, individuals are permitted to deduct a certain amount of money from their taxable income if they put it into an IRA, which will reduce the amount they will pay in taxes.
In shorts, IRA a lot of the same aspects as 401k in terms of withdrawal age without tax penalty at 59.5. And subject to the same RMDs at 72. Where an IRA differs from a 401k is the fact that you can have a wider option of investment and this can not help you modify the portfolio to your needs.
However, it can also help potentially reduce the tax. From taking out of funds that are down. More control over the withdrawal of the funds. More flexibility over the movement of the funds can aid in selling funds that are not performing or have shown significant gains. As well as a wider choice of beneficiary options to multiple beneficiaries other than your Spouse.
Conclusion
If you are a U.S expat or a holder of a 401k and you are outside of the U.S and not contributing to your 401k, it would be wise to at least review your situation and your 401k. Some of the main points I would check are:
- Is it in line with your Investment target?
- Do I want my 401k to go to multiple spouses?
- Would it be better from a tax or Investment perspective if I had more control of the Investments?
- What is the current IPS in the 401k and can I change it if its not performing?
These are just a few questions that I would ask your self as a general rule of thumb (not specific financial advice) younger expats with a longer time frame have more to benefit from compound interest and it could be more useful to look at a more equity-based portfolio that would aim to achieve 7-8%.
Ultimately, it is one that you will have to make if you do have any questions or need help reviewing your 401k as an expat please feel free to get in touch at info@investmentsforexpats.com
