Watch: Is Investing in a 401(k) Worth It If You're Moving Back to India?
Avinash explains whether you should still contribute to your 401(k) if you plan to return to India. Understand tax benefits, employer matching, rollovers, and how to optimize your 401(k) for your return journey.
The full write-up, with the numbers and the links.
Chapters
- 0:00 Introduction
- 0:56 What is 401k?
- 2:38 Contribution limits
- 4:00 Employer match
- 6:12 Marginal and effective tax rate
- 8:50 Tax deferral savings
- 11:00 Tax deferral compounding
- 13:45 Should you invest in 401k if you have plans to leave US
Transcript
Auto-generated captions, lightly cleaned
0:09 Hello everyone welcome back we have received lot of inquiries and questions related to 401k and so we have decided to do a video that provides comprehensive information related to 401k and related topics so in this video I'm going to talk about 401K give an overview of what 401K is what are the advantages of investing in 401k and should someone invest in 401k if they have plans to move back to India please stay till the end of the video because I'm going to give my perspective on whether someone should invest in 401K if they have plans to go to India in a short term let's talk on the 401K so 401K is
0:57 An employer sponsored retirement plan and one cannot invest in a 401k from their savings the contribution money has to come from the paycheck and it has to be through an employed sponsored plan there are two types of 401K plans the first one is called traditional 401K which is also called pre-tax 401k and the second one is Roth 401k which is also called post tax 401K so in the traditional 401K the contributions that you do to the 401K fund are pre-tax which means you would have tax savings on the contributions you're doing to the 401K fund and however when you withdraw the money from the fund the money that was invested and the money that has compounded or grown from that investment when you withdraw
1:58 The money from the fund that money would be taxed in the case of traditional 401K on contrary with Roth 401k you would contribute after tax money so this is the money that you would have after tax so there is no savings when you contribute to Roth 401k in the current year however the money that you contributed as well as the money that has compounded from your Investments when you withdraw that money you won't be taxed at all so you have tax advantage when you're withdrawing the money so how much can you contribute to a 401k plan as an individual one can
2:40 Contribute up to $23,000 per year towards your 401k plan your spouse can also contribute an additional $23,000 to his or her employer plan please note if someone is above 50 years old there is something called a catchup which means anyone who is above 50 years old can contribute an additional $7,500 to their 401k plan so in a given year if someone is more than 50 years old they can contribute up to $30,500 in a given Year please note there is another Ira which is called traditional IR and Ro and the contribution limit amount for that is $7,000 per year and the IRA contribution is completely different from the 401k
Read the full transcript (16 more sections)
3:43 Contribution so is the maximum that you can contribute to a 401k plan is 23,000 if you are below 50 years old yes that is for you as an individual however as an employer they can contribute an additional money to
4:01 Your 401k plan and lot of employers provide this perk or benefit for their employees where they provide discretionary contribution or they contribute a percentage of salary up to certain percentage so now let's look at a an example of an employer match so typically when an employer is matching a certain percentage of your salary to your 401K funds they typically have something called as a investing period so this is to ensure that the entire money that they contributed doesn't become available on the contribution year it get gets vested over multiple years so let's take an example that you make around $120,000 per year and the employer can match up to 5% of the salary which is 100% every dollar that you contribute
5:02 Up to 5% of salary is matched by your employer and the money that the employer matched gets vested over a period of 3 years so the 5% of $120,000 is $6,000 so if you contributed $6,000 to your 401k plan employer would also contribute $6,000 to your 401k fund however the $6,000 gets vested over 3 years as an example on the year one you have $2,000 gets wested year two another $2,000 and year three another $2,000 so the entire $6,000 was contributed would get vested over a period of three years this is to ensure that you're you know they retain the employee and this is the reason why most of these employer matches have something called as a vesting period now let's talk about the advance advantages of 401k plan like why someone has to
6:03 Contribute to a 401k and what are the advantages related to that before we dive into that let's understand the couple of terms called
6:13 Marginal tax rate and effective tax rate so basically marginal tax rate means the tax bracket at which you are paying for the highest bracket of your income so here is the tax bracket for 2024 and if you look at it for an individual single filer or someone who is filing as a married couple and filing jointly you would be paying only 10% for the income up to 11,600 or 23,200 and as your income increases the tax that you would pay on that marginal income is going to be higher this is called the progressive tax system that is applicable in us so the marginal tax bracket is the the maximum the tax bracket where your income would fall in so for example if you have a 120,000 annual income and you are a married
7:14 Couple filing jointly your marginal tax bracket would be 22% because it is falling in the bracket of 9431 to 2,149 so your marginal tax bracket is 22% let's talk through this what do an effective tax bracket so the total annual income that you have is 120,000 and you have multiple brackets so the first 23,200 is taxed at 10% the next 71,9 is taxed at 12% and then the next 25,7 $71 is taxed at 22% which is your total income of $120,000 so the total tax that you have to pay so this is the total federal tax that you have to pay is 1656 where the 10% of this first bracket
8:16 12% and the 22% so effectively your marginal tax rate is 22% however your effective tax rate is the tax rate that you overall play so this is a 16,560 divided by 120,000 is basically 13.76% so effectively you paid around 1376 of your total income as the tax to the federal and that is your effective tax rate now let's talk about the advantages of investing in 401K the first one is called tax deferral savings
8:54 Let's take an example of 120k annual income and married couple filing jointly and U you contributed 20K to the traditional 401K as we looked at before if you have not contributed anything to the 401K the total tax that you have to pay is 16,560 to your 401k your total taxable income is only $100,000 and you are saving the 20,000 taxes at the highest tax bracket because your are total taxable income is only 100,000 so the savings that you have is basically from the 22% of the 20,000 so your net effectively only paying only 12,16 so the federal tax savings is about 4,400 which is the difference between 16506 and
9:56 12,16 and then you have $2,000 which is let's take an example of a state tax which is California which is around 10% and that is additional $2,000 so the total sa tax savings that you have for contributing $20,000 to your 401k plan is $6,600 so that's a huge savings that you can make this year and the idea is that you saving the tax at the marginal tax and then you are trying to pay it at an effective tax rate that is the key thing where you are trying to do so that's the first thing the second one is you might be living in a state that has a higher income tax but when you retire you might move to a state that might not have any tax rate so you can save this additional state tax that you have to pay currently and effectively you are converting it from a marginal tax to an effective tax rate so that's the first advantage of contributing to the 401q now let's talk
10:58 About the tax different
11:00 Compounding let's take the same example 120,000 annual income a married couple filing jointly and you're are contributing 20,000 every year to your 401k plan and let's assume you have an annual return of 8% and you have contributing to for 22 20 years as we saw before the tax savings that you can have per year 6,600 and the total tax savings that you will have have is from a 20 years so 20 * 6,600 is 1, $132,000 so simply by contributing the 20,000 every year you're saving about 6,600 and the 6,600 for 20 years is around 132,000 let's look at the the eighth wonder of the world which is the compound growth so you have contributing 6,600 and you are contributing 6,600 every every year for the next 20 years
12:01 With an annual rate return of 8% only with that your balance will become 332,000 so the total savings is 132,000 which is what you have contributed and then it has gained close to 200,000 so you have about 332,000 that you have gained from this particular contribution let's look at on a contrary you didn't contribute anything to the 401K so basically the 20,000 because you have to pay the taxes so you would be paying taxes of 6,600 which you didn't save so effectively you would have 13,400 that you would be contributing to the investment so let's take the same scenario where you are contributing 13,400 every year and you have the same 8% annual return for 20 years in this case again 13,400 contributing same thing so you balance is going to be
13:01 67 675,000 675k as the total earnings that you would have however if you have contributed the 20K to your 401k plan you would basically have a 1, 8,458 and the difference between these two is the money that you have gained from the tax savings so it's not only on the tax that you can save but it also the differ tax which can gain because of the compounding so that's another important factor to consider how the tax differ can also help in in increasing your Corpus fund now that you understand why one
13:47 Should invest in 401K let's talk about should someone invest in 401k if they have plans to move back to India let's take the first scenario if your employer is providing an employer match to your contributions to 401K I highly recommend I think you must contribute to the 401K plan at least to the match that your employer provides let's take this example of $120,000 annual income and 5% contribution by your employer so annually they contribute $66,000 dollar to dollar for this $6,000 that you contribute even if you have to pay the penality and even if you have to pay the taxes you would come ahead because of the employer match so I highly recommend and suggest that you would contribute to a 401k plan at least to match the employer matching program
14:50 Otherwise you're leaving money on the table and the other one is hey I'm planning to move back to India in an year or two or three my suggestion is we all have plans but in reality before we realize we might be living in abroad for quite more time than we initially planned so unless you need the money right now I would suggest contribute to 401K have the tax savings and let the savings grow compound you know year over year and there are ways to manage your 401K funds when you are leaving us and moving back to India we will give a deep dive into the options that are available for the 401K funds when you're leaving us which we will cover in our next video on this topic but if you like this content and this is something that was useful please like share and provide feedback and if
15:53 You like more of this similar content let us know and thanks a lot for watching and have a great okay
