Working abroad: Max out 401k or just invest

[alarswilson]

Both my wife and I have recently been hired to work abroad. Our tax home will be foreign, so w should qualify for a foreign income exclusion. Since our employer is American, we can also contribute to a 401k. Our combined income, before contributions, will likely be below the threshold. Unfortunately, there is no Roth401k, as this would be helpful in our low-tax situation. We will continue to max out our Roth IRAs.

It seems quite possible, though not certain, that I might be working until legitimate withdrawal age, and I'm trying to calculate what will be the most tax advantageous solution for saving for (possibly early) retirement.

My question is whether the MadFientist's recommendation of maxing out the qualified plans first still applies in a situation where "early" retirement is not necessarily going to happen, and where I'm already sheltered from all but my half of social security tax.

I'm having trouble thinking my way through it.

Thanks for any direction you can point me.

[ISawTheLight]

There is no 'one size fits all' answer for this.  But here are some things to consider:

1.  Will you be covered under a tax equalization program by your employer?  If so, they will calculate your tax as if you were still in the US and use hypo tax and a tax equalization payment to adjust accordingly.  In this case, the MadFientist's recommendations probably still apply since you're essentially being taxed in the same way as the rest of us in the US.

2.  If you aren't in a tax equalization program, and all of your income is going to be sheltered by the FIE, I don't think it makes much sense to put pre-tax dollars into a 401k.  You're essentially taking tax-free dollars today and turning them into ordinary income dollars later.  That's kind of the opposite of what we typically try to do.

2a.  That being said, I might still do enough to get the employer match.  If you can put in 6% and get a 6% match, you've gotten a 100% guaranteed return on your money.  That seems like a positive result, even though the funds will be taxed as ordinary income down the road.  There's probably some value in the tax-deferred growth aspect as well.

3.  It is possible that your 401k contributions will reduce your local country tax liability.  This is completely dependent on the tax treaty between the US and your local country.  If you can get the local country tax break, then you'd have to look at your local country tax rates to determine if it is worth it.  If you're being equalized, then this will have no impact on you, but may save your employer some money.  If you aren't equalized, then there may be savings directly to you.

4.  What kind of assistance can you get with this stuff from your employer?  Some employers are obviously better / more willing to provide assistance on these types of questions.

[elysianfields]

A lot of the answer depends on how much of the FEIE you and your spouse will fill up.

If your income is so low that it isn't taxed, 401(k) contributions won't give you any immediate tax reduction and you'll pay taxes when you withdraw it.  OTOH, your portfolio will grow tax-free.  Of course, if you instead invest in a taxable account, and the FEIE keeps your CG tax rate at 0%, your portfolio still grows tax-free in the taxable account.

You almost certainly want to contribute the limit to both of your Roth IRAs, and you could also consider HSAs if available in your situation.  Of course, you'd need to know your health needs, how expensive health services cost in the host country, etc.

Call HR / Benefits and lobby them to initiate the Roth 401(k).

[terran]

I think income excluded under the foreign earned income exclusion is also ignored for the earned income requirement of IRA contributions (which make sense, otherwise you would be saying it both is and is not taxable earned income at the same time). This article seems to agree: https://www.thebalance.com/ira-for-workers-abroad-3193218

[alarswilson]

Thank you @terran @elysianfields @ISawTheLight.
Very helpful responses. Clearly I need to talk to HR to see how they are manage this, as it is far from evident.
I believe that I will be paying Japanese taxes (which are thankfully, low), so I may in fact be under the foreign tax credit regime, rather than income exclusion. In which case, contributing to Roth IRAs should be possible; perhaps we can lobby for Roth 401k, too, as our tax rate will be very low.
Clearly there are some more questions yet that need to be answered.

[elysianfields]

Thank you @terran @elysianfields @ISawTheLight.
Very helpful responses. Clearly I need to talk to HR to see how they are manage this, as it is far from evident.
I believe that I will be paying Japanese taxes (which are thankfully, low), so I may in fact be under the foreign tax credit regime, rather than income exclusion. In which case, contributing to Roth IRAs should be possible; perhaps we can lobby for Roth 401k, too, as our tax rate will be very low.
Clearly there are some more questions yet that need to be answered.

You need to look at your household income and look at the amount you'd exclude under FEIE vs. the credit you'd receive under the FTC.  Since you say Japanese taxes are low, you're probably better off taking the FEIE.  Remember that you can still take the $24,000 standard deduction when MFJ.    The 2018 FEIE exclusion limit is $104,100; you may also qualify for the foreign housing deduction.  You also need to check whether you'll qualify for the FEIE via the bona fide residence or the physical presence tests; in some cases it's better to take the FTC the first, especially if it's a partial, year, and to take the FEIE in subsequent years.  Note also that if you select the FEIE in a particular year, it remains in effect until you revoke that choice.

See - IRS Publication 54 - Tax Guide for U. S. Citizens and Resident Aliens Abroad for more details.