If you are an American living abroad who is considering renouncing your US citizenship, you likely have have wondered, what happens to 401k when you renounce citizenship? One of the most common questions we are asked relates to what happens to US investments, specifically 401Ks, when you hand over your passport. We’ll explain if there are any negative consequences when renouncing your citizenship when you have a sizable 401k in the US.
What Happens When You Renounce Your US Citizenship?
Anything to do with renouncing citizenship can get pretty complicated. So, let’s go this step-by-step to see what happens when you renounce your US citizenship. Part of the answer to this will depend on where you’re going to be a citizen. If you’re going to be a resident or citizen of a country that has a tax treaty, you should look at that specific tax treaty to see how the foreign 401K investment would be treated locally. Generally speaking, the tax treaty will say that you’ll be taxed either in your resident country or in the United States. You have to look back and forth to see which one you’re going to be taxed in.
Does your 401K savings qualify you as a covered expat?
The next thing you need to know is that on the expatriation form–the 8854–you must check box 7A, which is ‘do you have any eligible deferred compensation items’. A 401K would fall under this category. If you do have this, and if you have a sizable 401K plan, you may be considered a covered expat. To be a covered expat, you must meet one of the following requirements:
- Your net tax liability is over $168,000 for the past 5 years
- You have a net worth exceeding 2 million dollars
- You failed to meet your filing requirements for the 5 preceding tax years
If you’re a covered expat, you’ll be treated differently when you renounce your citizenship. For one thing, you’ll be required to pay the exit tax. Based on this, covered expats will pay a 30% tax on retirement income when distributions are made.
Is Your 401k Protected by a Tax Treaty?
If the country in which you become a resident has a tax treaty, you’ll want to research the specific treaty to see how a foreign 401k investment would be treated locally. In general, you could expect the treaty to say you’ll be taxed either in your resident country or in the United States. Doing your research will help you determine in which country you’ll pay tax for expats.
Reporting Your 401k on Form 8854
This is the expatriation form you’ll be required to fill out before parting ways with the US. If you have a US 401k, you must check box 7A (which states “Do you have any eligible deferred compensation items?”), as a 401k would fall into this category. If you must check box 7A and you have a sizable 401k plan, you might be considered a ‘covered expat.’ This means your net tax for expats liability is over $168,000 (for 2019) for the past 5 years or you have a net worth exceeding $2 million.
Covered expats may be required to pay an exit tax, and will have one of two tax options regarding deferred compensation plans. You can elect to have received a full payout on the day before you renounce, and are taxed accordingly on your US tax return, or you can elect to forego tax treaty benefits on these items and your retirement income will be taxed at a flat 30% tax rate when distributed.
The bottom line for 401K plans when renouncing citizenship
If you’re considering renouncing your U.S. citizenship, the main concern is to check whether or not it’s going to cause you to be considered a covered expat. If you do qualify, this is where you’re going to get hit with taxes. You also have to look at how your 401K will be treated locally to see if you’re going to be taxed in the U.S. as well as in your host country.
Our expert accountants are here to help!
If you would like a consultation with one of our expat experts to discuss what happens to 401k when you renounce citizenship, simply contact us!