Should an international coworker contribute to a 401k?

[35andFI]

Hi all!

A new colleague of mine is debating whether or not he should contribute to our company's 401k since he will be returning to Germany in 2-3 years.

Our company matches 100% of contributions up to 3% of our salary.
The vesting starts at 20% and increases by 20% each year until it is at 100% on year 5.

I suspect that he should put in enough to get the full employer match even if he has to pay the 10% early withdrawal fee to get it out in 2-3 years but I'm not sure so I'm checking with the big guns.

Any suggestions?

[Chris @ Saturday Financial]

Great question! Long story short, it almost always makes sense to invest up the company match, even for temporary U.S. residents.

Here's an article that discusses some of the pros and cons: https://www.magnifymoney.com/blog/retirement/should-foreign-nationals-contribute-to-401k/

And you're right, in your colleague's situation it is prudent to invest enough to get the match. Let's assume the following:

-Your colleague only stays 2 years.
-They invest 3%, and for simplicity we'll say that 3% equals a total of $10,000 after 2 years.
-They would have $4,000 of company match vested after 2 years.
-We'll assume the market stays flat, so there is a total of $14,000 vested in the account.
-If they withdraw that $14,000 with a 10% penalty, they'd have $12,600 left even though they only contributed $10,000.

So with the assumptions above, your colleague would receive $2,600 of funds because of the company match. If they stay longer than 2 years, that benefit increases.

They could also avoid the 10% penalty if they keep their 401k open even after they move back to Germany and wait to withdraw it until they are 59 1/2 years old. That would be an extra administrative hassle, but it could be worth it if the balance is large enough.

The last thing I'll mention is that if your colleague's marginal tax rate is greater than 10%, it likely makes sense for them to contribute as much as they can, up to the max of $19,000 per year. Saving 15%+ on taxes now and paying a 10% penalty later is not a bad prospect.

[35andFI]

Thanks for the reply @SlowAndSteady!
I appreciate the help.

I put your sample into a spreadsheet that I built and found that his salary would have to be $163,522.01 to get a $10,000 match.
That would leave him with $12,600 after the penalty.
My numbers then match yours up to this point.

Wouldn't we also have to calculate the extra fed and state income taxes due on the employer match?
So for this example, that would be:

Extra Federal Income Tax Paid = 32%*($10,000*40%) = $1,280
Extra State (NJ) Income Tax Paid = 6.37%*($10,000*40%) = $254.80

For a total profit of $1,065.20
Total Profit = ($12,600-$1,280-$254.8)-$10,000 = $1,065.20

Does that look correct?
His actual salary is likely much lower than this but as long as the logic is sound, we can use this template on a more accurate salary.

[Chris @ Saturday Financial]

Sure thing!

Employer matches are actually not taxed, which is awesome. And if you want to get super accurate, you’ll actually need to account for reduced taxes at both the federal and state level. Every dollar that your colleague contributes will reduce their tax burden. (I’m assuming it’s a Traditional 401k and not a Roth 401k.)

In other words, when accounting for taxes your colleague’s “profit” will only increase.

[35andFI]

Employer matches are actually not taxed, which is awesome.

Correct me if I am wrong here but isn't everything (including employer match) that is in a traditional 401k taxable upon withdrawal?
My understanding was that you don't pay taxes on it until you take it out since it is tax deferred (not tax free).

Every dollar that your colleague contributes will reduce their tax burden. (I’m assuming it’s a Traditional 401k and not a Roth 401k.)

Yes but then it will increase his tax burden when he takes it out in 2 years, right? It is traditional not Roth.

The reason why I didn't calculate taxes on what he would put in is because he wouldn't pay taxes while contributing but then would pay taxes upon withdrawal so that amount would be a wash.

[Chris @ Saturday Financial]

Ah, I understand now that you're calculating tax upon withdrawal. And you're right, both employee and employer contributions will be taxed upon withdrawal at marginal tax rates.

I was assuming that your colleague would wait at least one tax year after working in the U.S. to withdraw.  If that's the case, they would need to pay the 10% penalty but they wouldn't owe any income tax because their marginal tax rate for the year would be zero.

Keep in mind I'm not a CPA and this isn't tax advice for your colleague. :)

[35andFI]

I was assuming that your colleague would wait at least one tax year after working in the U.S. to withdraw.  If that's the case, they would need to pay the 10% penalty but they wouldn't owe any income tax because their marginal tax rate for the year would be zero.

Oh good point! I didn't think about him waiting to take the money out until the following year when he had no taxable US income.

Keep in mind I'm not a CPA and this isn't tax advice for your colleague. :)

Of course! I appreciate your help and don't worry, we won't sue you haha.

He came to the conclusion that it probably wouldn't be worth the hassle for him to contribute to the 401k for the 2 years that he will be here.

I just wanted to make sure that my numbers were accurate!

[Chris @ Saturday Financial]

Cool! Glad to help. Sorry to hear he decided against it - but I understand the administrative burden might not be worth it if his salary is relatively low.