Nonresident Aliens: Federal tax withholding from 401(k) and annuity payments
Updated: Jul 27
Nonresident aliens (NRA) may be subject to tax on their US source income unless an exception applies. Payments from U.S. retirement plans such as tax-deferred 401(k) plans made to foreign nationals are subject to US income tax withholding unless exempted. But, then most nonresident aliens want to know: How to cash their 401(k) and minimize the higher 30% tax rate? The below discussion is not for Roth 401(k) plans, but traditional and tax-deferred 401(k) plans. We are also not discussing the foreign country's domestic tax regulations with regard to the 401(k) distributions.
How did a foreign national end up with a 401(k) account?
For U.S. tax purposes and under the internal revenue service, a nonresident alien is a foreign national individual who is not a tax resident. A tax resident is generally a person who is a US citizen, green card holder, or a resident per the substantial presence test (SPT) as defined under IRC § 301.7701(b)-1. A foreign national may elect a treaty article if one exists between the United States and the foreign country to override the SPT test to be treaty as a nonresident alien.
Most often, foreign nationals come to the US on assignment or on local contracts for a few years before they return to their home countries. While on a work visa, foreign nationals become US tax residents due to their substantial presence in the US or by obtaining a permanent residency permit, known as a green card. Therefore, they are subject to tax on their worldwide income while working and living in the US. During this time and while living in the US and working for US employers, a foreign national becomes eligible and may contribute to a tax-deferred retirement plan, under title 26, IRC section 401. With little knowledge or without any future plan, the foreign individual may decide to contribute to a US retirement plan to benefit from the tax-deferred features and be subject to tax on a lower taxable earned income at both the federal and state (if applicable) levels. That sounds good to pay less tax while saving for the future, especially if the individual is unsure about where they will retire.
Withdrawals of money from 401(k) retirement plans
Similar to all participants, tax resident aliens are subject to the rules of contribution to, and distribution from, the tax-deferred retirement plans. Therefore, they cannot take out money from the plans prior to being eligible without paying federal tax and early withdrawal penalty unless exemptions apply. Generally, normal distribution starts at the age of 59 ½ without the 10% early distribution penalty.
What are nonresidents' alien options with regard to their 401(k) while they are in a foreign country?
Am I required to take the money out? Should I withdraw it? What are my options?
You are generally in control as long as the plan is not obligated to distribute the vested money to you when you separated from the U.S. employer. Therefore, you can either withdraw or leave it. Normal distribution starts at 59 ½. Prior to the date you reach that age withdrawal is considered early and a 10% early penalty may apply unless exempted. If you want to roll over the distributions, it must be deposited to another qualified U.S. retirement plans, otherwise, tax and penalty may apply.
How are distributions from 401(k) taxed if the recipient is a nonresident alien?
After a foreign national leave the US for good and repatriated to his or her home country, he or she may want to take some or all of the money he or she has stashed in a 401(k)-retirement account.
401(k) plan are U.S. tax-deferred retirement plans. Payments from these plans to nonresident aliens are subject to 30% federal tax withholding under the internal revenue code section 1441(a). The 30% withholding is required unless documentation exists and the recipients can show they are U.S. persons or nonresident aliens that live in a country with which the US has a tax treaty and a lower tax rate applies. The required documentation includes form W-9 and Form W-8BEN. If no documentation exists, then the presumption rules may apply under the US treasury regulation section 1441-1(b)(3)(iii)(C).
Throughout the year, we receive inquiries about how to cash out a 401(k) and how to minimize the US income tax withheld from the total distribution.
What is the process of cashing out a 401(k)?
A U.S. form W-8BEN must be filled out and provided to the withholding agent in order to benefit from a lower tax treaty rate if one exists. The tax treaty article number and the withholding rate must be included to claim the treaty benefit upfront. The withholding agent may be required to issue you an IRS Form 1042-S to report the payment and tax withholding to the internal revenue service.
Am I required to file a tax return or not?
If you pay more than you should have, then you can request a refund by filling out and submitting the IRS Form 1040NR. If you are correctly withheld, then a tax return may not be required unless you have other US tax reporting obligations.
Do I need an ITIN or SSN to file a tax return?
If you do not have a US social security number, you may need to apply for an ITIN to receive a tax refund, if applicable.
Will I be subject to a 10% early withdrawal penalty if I am under 59 and 1/2?
If you take an early distribution before you turn 59 ½, you generally are subject to an early withdrawal penalty of 10%, unless an exception applies.