401k Rollover to IRA: The Process, Transfer Options, and Tax Implications Explained for US Expats

This guide will provide a comprehensive overview of a 401k rollover to an IRA, examining its benefits and drawbacks, available transfer options, and the associated rules and tax implications. It also offers practical advice for reporting the rollover on your tax returns and avoiding common rollover mistakes.

What Is a 401(k) Rollover to an IRA?

A 401(k) rollover refers to the transfer of assets from an existing 401(k) plan to another qualified retirement account, such as a new employer-sponsored plan (including 401(k) and 403b) or an Individual Retirement Account (IRA).

Since US workplace retirement plans are available only through US-based employers, US expats are typically presented with the option of rolling their 401(k) into an IRA. IRA is an alternative to 401(k) and other employment-sponsored schemes, designed for individuals regardless of their employment or residency status, as long as they possess earned income that is taxable in the US.

A 401(k) rollover to an IRA allows US expats in the UK and other countries to continue contributing to their retirement savings after relocating and commencing employment overseas. It also allows them to avoid potential tax liabilities and penalties associated with withdrawing the 401(k) balance in full.

There are two general ways to roll over your 401(k) into an IRA:

1. Direct rollover
2. Indirect rollover

Direct Rollover

A direct rollover involves a direct electronic transfer of assets from one retirement account to another. The process is relatively straightforward and requires you to ask your 401(k) plan administrator to deposit your retirement funds directly into your IRA. In some cases, the administrator may issue a check payable to your new account.

A direct rollover is considered the preferred method for transferring your 401(k) to an IRA. It doesn’t expose you to the risk of potential tax liabilities or penalties as it doesn’t involve any direct payments to you.

Indirect Rollover

In an indirect rollover, also known as a 60-day rollover, the funds from your 401(k) plan are initially paid directly to you. You must deposit (roll over) the entire sum or a part of it into an IRA within 60 days of receiving it. If you fail to do so, the distribution of funds will be considered a withdrawal, which will make you liable for income tax and penalties on the full transferred amount.

The 401(k) funds you receive as part of an indirect rollover are subject to a mandatory 20% withholding tax imposed by your former employer. Therefore, if you wish to roll over your entire 401(k) balance to an IRA, you’ll have to contribute the missing 20% from other sources. To reclaim the withheld amount, you’ll report it as taxes paid on your next tax return.

What Are the Advantages of Rolling Over a 401(k) to an IRA?

In addition to allowing you to resume contributions to your retirement savings while living and working abroad, rolling over your 401(k) to an IRA provides the following benefits:

• More flexible investment options: An IRA typically offers more diverse investment opportunities than a 401(k). You have the freedom to choose from various options like stocks, bonds, and exchange-traded funds (ETFs), depending on your financial objectives and risk appetite.
• Consolidation of retirement funds: Merging one or more 401(k) plans into a single IRA allows you to reduce duplicate fees and manage your assets more efficiently.
• Tax efficiency: Transferring your 401(k) to an IRA allows your retirement savings to grow tax-deferred or tax-free, depending on the type of account.

What Are the Disadvantages of Rolling Over a 401(k) to an IRA?

While rolling over a 401(k) to an IRA is a preferred option for US expats, it entails several drawbacks you should take into account:

• Loss of loan options: When you roll over your 401(k) to an IRA, you forfeit the ability to borrow against your 401(k) plan.
• Lower contribution limits: IRAs generally have lower annual contribution limits compared to 401(k) plans. With certain types of IRAs, you may not be eligible to make any contributions depending on your filing status and income.
• Reduced creditor protection: Funds held in 401(k) plans are protected by federal law against all creditor judgments except IRS tax liens and specific child support or spousal orders. In contrast, the creditor protection of IRA funds depends on varying state laws.

What Is the Process for Rolling Over a 401(k) to an IRA?

The general process of rolling over your 401(k) to an IRA involves several steps, as outlined below:

1. Check your eligibility: Confirm that you’ve terminated employment with your US-based employer and that they allow 401(k) rollovers.
2. Determine whether you have a traditional or a Roth 401(k): The type of your 401(k) plan will dictate the type of IRA you can transfer the funds into.
3. Choose between a traditional and a Roth IRA: The type of IRA you opt for will impact your tax liabilities and the applicable rules.
4. Choose between a direct or an indirect rollover: If you opt for a direct rollover, you’ll have to contact your 401(k) administrator to initiate the transfer of funds between the accounts. If you choose an indirect rollover, you’ll receive the funds directly and will have 60 days to deposit them into your IRA.
5. Decide on your investment options: An IRA allows you to choose the type of investment that best suits your financial objectives and risk tolerance levels.
6. File the necessary tax forms: Once the rollover is completed, it is crucial to report it on your next tax return. You’ll likely need to submit documents such as IRS Form 1099-R, in which your 401(k) provider details the transfer of funds, as well as IRS Form 5498, in which your IRA provider confirms the receipt of funds.
7. Regularly review your investment performance and expat tax status: As an expat, it is essential to stay informed about the performance of your IRA investments, potential double taxation of your income, and any reliefs and exemptions you might receive based on US treaties with other countries. This proactive approach ensures compliance with tax regulations in both the US and your country of residence.

What Are Your Options for Rolling Over a 401(k) to IRA as an Expat?

The type of retirement account you’re rolling your assets to and from is a crucial factor in determining your tax obligations and applicable withdrawal rules. Since the IRS doesn’t allow transfers from a Roth 401(k) to a traditional IRA, you’re left with the following three options:

1. Rolling over a traditional 401(k) to a traditional IRA
2. Rolling over a Roth 401(k) to a Roth IRA
3. Rolling over a traditional 401(k) to a Roth IRA

Rolling Over a Traditional 401(k) to a Traditional IRA

Rolling over a traditional 401(k) to a traditional IRA doesn’t incur any immediate tax liabilities as both types of accounts involve tax-deferred contributions and earnings. This transfer allows you to resume deferring income taxes until you start withdrawing the funds in retirement, so your investment earnings can compound over time.

Like a traditional 401(k) plan, a traditional IRA requires you to start withdrawing funds from your account—and pay due income taxes—once you reach a certain age, regardless of your employment status overseas. Failing to make these withdrawals, referred to as required minimum distributions (RMDs), will expose you to a penalty equaling 25% of the amount that should have been withdrawn. As of 2023, the age at which you have to start withdrawing from your account is 73.

While you can withdraw or use your IRA assets at any point, you will be liable for a 10% early withdrawal tax on top of the regular income tax payable if you are below a certain age, currently 59½. There are a few exceptions to the early withdrawal penalty, including events such as tertiary education, disability, or purchase of your first home.

Rolling Over a Roth 401(k) to a Roth IRA

Roth 401(k) plans and Roth IRAs are both funded by after-tax contributions, so rollovers between them typically don’t trigger any tax consequences. While you won’t be able to receive any tax deferrals on your Roth IRA contributions, your investments will grow tax-free.

When you roll over your Roth 401(k) to a Roth IRA, you will be able to withdraw your original contributions at any age without being liable for income taxes (as they’ve already been paid). You might also opt not to make withdrawals in retirement to accelerate investment growth since the RMD rules don’t apply to Roth IRAs.

While you can withdraw your original contributions from a Roth IRA at any age, without taxes or penalties, specific rules apply to withdrawing the earnings generated by your investments:

• Five-year rule: Your Roth IRA account must have been active for at least five years to be eligible to withdraw earnings without tax consequences.
• Early withdrawal rules: Withdrawing the earnings component of your Roth IRA before reaching 59½ may make you liable for an early withdrawal penalty as well as the income tax on the part of the withdrawal.

Rolling Over a Traditional 401(k) to a Roth IRA

Rolling over a traditional 401(k) to a Roth IRA is typically referred to as a Roth conversion because it involves transferring pre-tax funds into an account that receives after-tax contributions. As a result, the entire balance you convert from a 401(k) to a Roth IRA may be subject to income tax in the year of conversion.

While the immediate tax burden associated with a 401(k) to Roth IRA conversion can be substantial, it is offset by flexible tax-free withdrawals in the future—provided you meet the five-year holding rule and have reached 59½ years old. As such, a conversion is particularly beneficial for expats who anticipate retiring with a lower income than they currently receive or those who believe that income tax rates will rise significantly by the time they retire.

Additionally, since Roth IRAs are not subject to RMDs, expats can allow their investments to grow tax-free indefinitely, potentially creating an additional stream of retirement income.

What Are the Contribution Limits After Rolling Over a 401(k) to an IRA?

The total annual contributions you can make to your new IRA in 2024 can’t exceed $7,000—or $8,000 if you’re 50 or older.

It’s important to note that this yearly contribution limit applies across all traditional and Roth IRAs you hold. For instance, if you contribute $5,000 to one account, either traditional or Roth, you will be able to contribute only $2,000 (or $3,000 if you’re 50 or older) to all other accounts in a single year.

If your annual IRA contributions exceed the established limits, the excess amount will be subject to a 6% tax for each year it remains in your account. The penalty tax is capped at 6% of the combined value of all your IRAs at the end of the tax year. To avoid the tax, you must withdraw the excess contributions—along with any earnings they generated—before the deadline for filing your tax return.

Specific Roth IRA Contribution Limits

Besides the general contribution limits applicable to all IRAs, your ability to contribute to a Roth IRA may be limited or prohibited based on your filing status and modified adjusted gross income (MAGI). The following table outlines the Roth IRA contribution amounts for 2024:

Traditional IRA Deduction Limits

Your contributions to a traditional IRA are generally tax-deferred, allowing you to deduct the contributed amount from your taxable income on your federal income tax return. However, the deductions you can claim may be limited if you or your spouse participate in an employer-sponsored retirement plan and your income exceeds certain thresholds.

As an expat employed abroad and not covered by a US workplace plan, your traditional IRA tax deductions will be limited only if your spouse is working in the US and participates in an employer-sponsored plan, such as a 401(k) or a 403b. The following table outlines the available deduction amounts based on your income and filing status, assuming your spouse is covered by a US employer-sponsored plan:

Does a 401(k) Rollover to an IRA Count as a Contribution?

The amount you roll over from a 401(k) to an IRA, whether a traditional or Roth, is not treated as a contribution and is therefore not counted toward the annual contribution limits.

If you need assistance with calculating your contribution limits or eligible tax deductions following a 401(k) rollover to an IRA, it’s advisable to consult a US-regulated cross-border adviser. At Titan Wealth International, we provide expert support to US expats throughout the 401(k) rollover process, ensuring compliance and minimising unexpected tax liabilities.

How To Report a 401(k) Rollover on a Tax Return?

Regardless of whether your 401(k) transfer to an IRA incurs immediate tax liabilities, you’ll have to report the rollover on your tax return. The exact process and the information you’ll need to provide depend on the type of rollover and the type of account you’re transferring funds to and from.

Reporting Direct Rollovers

If you opt for a direct rollover, you must file Form 1099-R (provided by your former employer or 401(k) plan administrator) and Form 1040 (your individual tax return).

Below is a summary of the key information you’ll need to include on Form 1099-R:

• In Box 1: Include the total gross amount distributed from a 401(k) to an IRA.
• In Box 2a: Add the taxable amount of the rollover. The box should be left empty in case you’re transferring funds between two accounts with the same tax treatment.
• In Box 7: Enter code G to indicate a direct rollover.

Below is a summary of the essential details you’ll need to provide on Form 1040:

• On line 5a: Enter the total total distribution amount from Box 1 of Form 1099-R.
• On line 5b: If applicable, include the taxable amount from Box 2a of Form 1099-R. Write “rollover” next to the line to indicate the transfer type.

Reporting Indirect Rollovers

For an indirect rollover, your 401(k) administrator will first issue Form 1099-R. You will use the information provided on this form to complete your Form 1040. Report the total distribution on line 5a of Form 1040 and the total withheld federal tax in Box 4 of Form 1099-R and on line 25b of Form 1040.

If you fail to deposit the funds distributed from a 401(k) into an IRA within 60 days, any unrolled amount will be treated as taxable income and must be reported as such on line 5b of Form 1040.

Regardless of the transfer type, your IRA trustee will send you Form 5498 to verify that the rollover was properly executed and reported to the IRS. The form is for your records only and you don’t have to file it with your tax return.

What Are the Common 401(k) Rollover Mistakes?

While a 401(k) rollover to an IRA is generally a straightforward process, failing to comply with rollover rules may result in substantial tax penalties and diminish your retirement savings. The table below outlines some of the most common 401(k) rollover mistakes and practical steps to avoid them:

What Are the Alternatives to 401(k) in Different Countries?

Being a US employer-sponsored retirement plan, 401(k) has no direct equivalents in Europe or anywhere else in the world. As a result, you can’t roll over your 401(k) to a foreign retirement plan without incurring significant tax penalties.

However, depending on your country of residence and your foreign employer, there are various workplace retirement plans that allow you to grow your pension pot in a tax-efficient manner. The table below provides an overview of the most common 401(k) alternatives for US expats in select countries: