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Optimize for your 401K/ IRA in India

If you are an NRI returning to India, there's an important update to taxation of Foreign Retirement accounts in India. This includes all of the following:

  1. Traditional or Roth 401K

  2. Traditional or Roth IRA

  3. Any other retirement accounts in Canada, UK, Ireland or USA.

We know our earlier article on 401K/ IRA taxation in India was very popular. This article covers all the latest updates to the Income tax rules.

Here's what we cover:


Comprehensive Taxation Guide:


We know a lot of people liked our one-page taxation guide for 401K/ IRA taxation. Here's an updated version:

Taxability of 401K and IRA_30 May 2022
.pdf
Download PDF • 677KB

While this guide gives an overall overview to tax in India on 401K/ IRA, we strongly recommend reading the specific details for each of the retirement accounts below:



Taxation of Traditional 401K:

If you don't know what type of 401K you have - it's most likely a Traditional 401K. Your employer matches your 401K contribution. This is pre-tax money that is taxed only on retirement in the US.


Tax in India:


If you have returned to India, India will tax this income only on withdrawal. The rule specifically mentions that the taxable event will match the taxable event in the US.


Foreign Tax Credit: Foreign Tax Credit on Traditional 401K is a complex subject. While FTC shall be available, this is rarely a one to one credit. More on Foreign Tax Credit here.


Pre-Withdrawal Penalty:

If you withdraw money before 59.5 years of age, a 10% penalty applies on the proceeds from a 401K as per US tax laws.


India hasn't clarified how this should be treated. On a conservative basis, you may assume that the Indian tax rate will apply on the full 100% of 401K proceeds (and not 90% after reducing the 10% penalty).


Further, FTC may not be available in India. for the 10% pre-withdrawal penalty.



Taxation of Roth 401K:


Roth 401Ks are extremely rare. However, if you do hold a Roth 401K, here's how this is taxed in India:


Tax in India:


There is a lack of clarity when it comes to Roth 401Ks in India. There is 2 possible interpretations of the rules:

  • Tax will be payable on maturity based on appreciation in value of 401K

  • No tax will be paid in India since there is no taxable event on withdrawal in the US.

The first option is more conservative and might be what the Income tax department follows.


Foreign Tax Credit: Foreign Tax Credit on Roth 401K is a complex subject. While FTC shall be available, this is rarely a one to one credit. More on Foreign Tax Credit here.


Pre-Withdrawal Penalty:

If you withdraw money before 59.5 years of age, a 10% penalty applies on the proceeds from a 401K as per US tax laws.


India hasn't clarified how this should be treated. On a conservative basis, you may assume that the Indian tax rate will apply on the full 100% of 401K proceeds (and not 90% after reducing the 10% penalty).


Further, FTC may not be available in India. for the 10% pre-withdrawal penalty.



Taxation of Traditional IRA:


This is pre-tax money that is taxed only on retirement in the US.


Tax in India:


If you have returned to India, India will tax this income only on withdrawal. The rule specifically mentions that the taxable event will match the taxable event in the US.


Foreign Tax Credit: Foreign Tax Credit on Traditional IRA is a complex subject. While FTC shall be available, this is rarely a one to one credit. More on Foreign Tax Credit here.


Pre-Withdrawal Penalty:

If you withdraw money before 59.5 years of age, a 10% penalty applies on the proceeds from a Traditional IRA as per US tax laws.


India hasn't clarified how this should be treated. On a conservative basis, you may assume that the Indian tax rate will apply on the full 100% of IRA proceeds (and not 90% after reducing the 10% penalty).


Further, FTC may not be available in India. for the 10% pre-withdrawal penalty.



Taxation of Roth IRA:


Here's how this is taxed in India:


Tax in India:


There is a lack of clarity when it comes to Roth IRAs in India. There is 2 possible interpretations of the rules:

  • Tax will be payable on maturity based on appreciation in value of IRA

  • No tax will be paid in India since there is no taxable event on withdrawal in the US.

The first option is more conservative and might be what the Income tax department follows.


Foreign Tax Credit: Foreign Tax Credit on Roth IRA is a complex subject. While FTC shall be available, this is rarely a one to one credit. More on Foreign Tax Credit here.


Pre-Withdrawal Penalty:

If you withdraw money before 59.5 years of age, a 10% penalty applies on the proceeds from a IRA as per US tax laws.


India hasn't clarified how this should be treated. On a conservative basis, you may assume that the Indian tax rate will apply on the full 100% of 401K proceeds (and not 90% after reducing the 10% penalty).


Further, FTC may not be available in India. for the 10% pre-withdrawal penalty.


Other Retirement accounts - General Rule

Tax in India:


If you have returned to India, India will tax this income only on withdrawal. The rule specifically mentions that the taxable event will match the taxable event in the country in which account is held.


Foreign Tax Credit: Foreign Tax Credit on Retirement accounts is a complex subject. While FTC shall be available, this is rarely a one to one credit. More on Foreign Tax Credit here.


Option to be Exercised:

Anyone who wants Tax to apply on maturity will have to exercise this option before filing their ITR in India in Form 10-EE.


Note that if option is not exercised, earlier rules continue to apply and tax will apply every year. Earlier rules and strategies are covered here.



Change in Residential Status:

If you become a Non-Resident again, you cannot exercise the option to tax the full proceeds only on withdrawal.


This means that any appreciation in the value till date (or any capital gains) shall be taxed in the year you become a Non-Resident.


This is to prevent people from changing their Residential Status to get a tax exemption.

Conclusion and Strategies:


Overall, these new provisions bring much needed relief to Non-Residents returning to India. You can now leave your 401K/ IRA untouched and pay tax only on maturity in both countries.


While some of our strategies covered earlier continue to apply, these new rules mean there may be more scope to be creative for tax saving purposes.

Resetting of cost basis is one strategy that will continue to be popular for US residents returning to India.


Taxation of retirement accounts can be an extremely complex topic. Please contact your tax advisors prior to making any decisions considering the huge tax impact.


If you are returning to India, feel free to contact us. Our team of experts will be happy to help.

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