Author Topic: Standard deduction vs personal exemption question (non resident alien)  (Read 409 times)

Ttkamara

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Hi everyone,

Iím a 36 yr old Brit who lives in the U.K. and plans to stay there for the foreseeable future. In my twenties though, I worked in New York and contributed to my companyís 401(k). The balance is now c. $70k. Iíve been reading MMM and it sounds like doing a Roth conversion ladder is the right thing to do as I have no US income. However, as far as I can make out, non resident aliens donít get the IRS standard deduction. They used to get the personal exemption but I believe that has been phased out. Does anyone know if that is in fact the case and if so, what the federal tax rate would be on the money Iíd convert to the Roth? And if itís stikl then worth it?

I should add that these sums are of no interest/relevance to the U.K. tax authorities do Im only concerned with US taxes in figuring out whether I should do a Roth conversion now or not.

Thanks so much!

MustacheAndaHalf

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #1 on: November 04, 2018, 09:20:32 AM »
Personal exemptions are now gone, there's just a double-sized standard deduction of $12k.  And based on this page of the IRS, it sounds like you don't get that:

"Standard Deduction
If you are a nonresident alien, you cannot claim the standard deduction."
https://www.irs.gov/individuals/international-taxpayers/nonresident-alien-figuring-your-tax

secondcor521

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #2 on: November 04, 2018, 10:33:19 AM »
Assuming no standard deduction and no personal exemption, I would expect the tax rates for 2018 to apply starting with the first dollar.  You can google "US federal tax rates 2018" to get the numbers, but it looks like it would be 10% on the first $9,525 of conversions, then 12% above that to $38,700 of conversions.

Up to you if that's worth it.  Most here would consider that a pretty low rate and would probably convert it at $9,525 per year for ~8 years.  If you're in a hurry for some particular reason - maybe you have plans to spend those Roth conversions in 2023/2024/2025 - you could do it at ~$38,700 for ~2 years.  Or a hybrid plan of $9,525 some years and $38,700 in other years.

You have to season the conversions in the Roth for five tax years before you can withdraw it penalty-free.  Conversions done in the next 7 weeks or so would be available for withdrawal on or after 1/1/2023.

Goldielocks

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #3 on: November 04, 2018, 10:50:07 AM »
Check UK's "double taxation" agreement with the USA.   

For canada, you can pull the full amount out of the USA, pay full taxes (based on non resident alien) on it and any early US penalties, then when you pay your UK taxes, you include the $70k in your income, pay UK taxes on it, and then claim the US Tax as a foreign tax credit....

Because of the penalties, the US taxes may be higher than your UK taxes.  If you have other UK income, you may actually get some or all of the penalties back on your UK return.  You could split this across years to reduce your marginal UK tax rate, too.

For Canada, I was able to put my US money into a Canadian registered retirement plan that also gave me taxes back / reductions, so in the end, it was effectively tax and penalty free to move it from my US IRA into my domestic retirement plan.

Ttkamara

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #4 on: November 04, 2018, 02:09:54 PM »
Thank you all.

@MustacheAndaHalf thanks for that.
Itís (sadly) what I thought.

@secondcor521 youíre right thatís itís still a low rate although Iíd have to pay the tax from the $ in the retirement plan so there will be less to grow iyswim. Now I have a grip on the figures I can have a play around with a spreadsheet.

@Goldielocks that sounds pretty amazing. Off to google double taxation.

Thanks everyone - Iím bowled over at how knowledgeable and generous people are with their time and smarts here.

secondcor521

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #5 on: November 04, 2018, 05:22:03 PM »
Because of the penalties

@Goldielocks, what penalties are you referring to?  Moving money from a 401k to a traditional IRA to a Roth IRA will generate taxable income in the year of the conversion but there will be no penalties as long as the OP keeps the money in the Roth IRA across five tax years.  That is the essence of a Roth conversion ladder.

Goldielocks

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #6 on: November 04, 2018, 11:45:30 PM »
Because of the penalties

@Goldielocks, what penalties are you referring to?  Moving money from a 401k to a traditional IRA to a Roth IRA will generate taxable income in the year of the conversion but there will be no penalties as long as the OP keeps the money in the Roth IRA across five tax years.  That is the essence of a Roth conversion ladder.

I was able to avoid (technically be reimbursed) the 10% early withdrawal penalty before age 59.5, even though 100% of the IRA was dispersed in one single year.  No Roth conversion ladders needed.  No need to keep the money in the Roth across five tax years.

ETA -- secondcor   
You need to realize that a slow Roth conversion ladder really sucks for most non-resident aliens, because you can not hold your money that you just put into the roth into any kind of investment account.  Very, very few banks will do the securities paperwork to allow non-resident alien clients trading on their accounts... so your Roth, if you already had one because you likely would not be allowed to set one up as a non-resident.... well, the money going into your Roth would be held as cash until you take it ou.
« Last Edit: November 04, 2018, 11:54:43 PM by Goldielocks »

secondcor521

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #7 on: November 05, 2018, 09:20:59 AM »
@Goldielocks, ah, I don't know much about being a non-resident alien and the tax/investment consequences of same.

Given your explanation, I have a couple of things I'm curious about:  First, who reimbursed you the 10% penalties and why?  Second, am I right in guessing that the OP's 401k account is somehow grandfathered and that s/he can still invest as an American citizen would in his/her 401k account because it started when s/he lived here?

Finally, if the OP can't invest in a Roth and can't avoid the 10% penalty, then why bother with the Roth conversion at all?  Just withdraw it directly from the 401k, or roll it from the 401k to a traditional IRA and then withdraw it from there.  The 10% penalty applies in any case, right?  Seems like the Roth conversion just adds an extra account and extra step for no real reason.

Goldielocks

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #8 on: November 05, 2018, 12:14:51 PM »
Agreed about not bothering with a Roth Conversion, if you can't get it invested or even set up in the USA when you are non-resident.  I assume the OP was looking for ways to get the money out of this foreign account without the penalty, and came across the description of Roth Ladders.

Who "reimburses" the penalty?

When I filed my Canadian tax return, I was now able to claim both the US withholding tax AND the 10% IRA early withdrawal penalty as "Foreign Taxes" paid.   On the Canadian return, the full IRA disbursement was considered income (just like in the USA), so I needed to pay Canadian tax on that, but then the Foreign Taxes paid are subtracted from the total that I owe to Canada.   Because Canada does not charge a 10% penalty, I essentially get that back, and it goes as a refund against any other Canadian income I have.

Further, I was able to do this as a "Rollover" to my Canadian account (with some limits, and this is country specific), so I also received a reduced canadian tax for the amount added "rolled over" into the retirement fund -- but I had to ensure that I was paying a LOT of other taxes that year, to absorb all the refunds / credits.

401k Grandfathered account.
I don't think "grandfathered" is the correct term.  When I left the USA, (in the weeks prior) I converted my 401k to a regular IRA (because the tax treaty rules mention IRAs specifically but not 401k's so there are fewer questions about rolling over from the IRA). 

My IRA / 401k was in existence due to my US employment.   When I left the USA, they do not require you to close out the account. 
BUT -- Wells Fargo later put a "freeze" on my account (around 2011 when some SEC filing / reporting rules changes), and I was no longer able to buy or sell my positions, except as a "Sell everything and wire me my money" order to close out the account.    Most US banks no longer allow non-resident aliens to buy or sell investments.  When I researched it, there were at least two (one large, one smaller) brokerages that did so, but the vast majority do not, and those two may have been specific for Canadian residents, not UK.

I would not call a "Frozen" account a "Grandfathered" account.   It is still a valid/ active 401k / IRA to the US government, no different from US residents / citizens, so technically not "grandfathered" or treated any differently by the US government from any other IRA account rules out there.   The only catch is that you need a brokerage that will allow non-resident aliens to trade, or it is "frozen" or held as cash only.  (Non-residents can hold bank accounts / savings)

secondcor521

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #9 on: November 05, 2018, 02:58:51 PM »
^ Thanks for all of the explanation.  Makes sense.

Ttkamara

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #10 on: November 05, 2018, 03:12:46 PM »
Thanks for your replies

I wasnít foresighted enough to convert my 401k to an ira before leaving the States and your reply had made me nervous to, as I definetely donít want to take the money out of a tax efficient wrapper and pay full tax on it now. Itís part of my retirement planning. I would have liked to do a roth to be able to use funds a bit earlier (55 vs 59 so I understand it) with a lower tax burden overall - however, Iíve come to the conclusion with your help that Iím better off leaving the funds where they are rather than take the risk that they wonít be accepted into an IRA then a Roth.

I guess Iíll just have to spend a couple months per year in hawaii every year to spend the dollars when I retire :)

Thanks again

secondcor521

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Re: Standard deduction vs personal exemption question (non resident alien)
« Reply #11 on: November 05, 2018, 03:34:46 PM »
I'm pretty sure:  It's 59.5 for penalty free withdrawals from either traditional or Roth IRAs.  It's 55 for penalty-free withdrawals from 401(k)s but you have to have left the company in the year in which you attained age 55 or later.

Thus:  Moving it to a traditional IRA or Roth would not get you access to your money earlier unless you could do the Roth conversion ladder, which, as @Goldielocks points out, probably isn't very workable.