The Myth about the Secret 401k Backdoor disclosed!

What’s about all this crazy huge tax exemption nonsense?

a 401k deduction that many people speculate with – but simply doesn’t exist!

At the end of the year it’s always stressful when it comes to your personal taxes. Collecting invoices, looking for some options to save taxes, finding a good software that might help you to get some money back from the IRS, or having another fruitful conversation with your personal tax accountant for picking the right 401k plan.

Whatever hassles you have. One hassle is coming every year guaranteed.  And it’s unstoppable. The beautiful topic about taxes.

And like every other year, many people are looking for 401k tax benefits. This year, I found it very interesting to get more and more questions from US-citizens, asking me about retiring abroad.

To be more specific: Imagine you are going to pay all your retirement funds into a Traditional 401k. And when you’ll retire, you’ll consider to live abroad. What happens then with the taxes of all your 401k funds?

Thinking about retiring overseas?

If you chose that lifestyle, what happens with your traditional 401k funds? Do you have to pay US-Income tax, even if you live abroad? Or do you have to pay income tax in the country you’ll retire?

So here we go. I called my tax accountant, and we discussed again all kinds of tax benefits! This time, especially the pros and cons between the Traditional 401k and the Roth 401k.

As we all know by now, no matter what 401k plan you’ll pick – you’ll always have to pay your taxes. 

If you decide to invest money into the Roth 401k, you are going to pay your taxes in the year you invest. And if you put your money into the Traditional 401k you’ll have to pay your taxes when you’ll retire. 

So far so good. Nothing new. You can read more about it in my other article: Roth 401k vs. Traditional 401k

Where do we all go? And what to do with our 401k funds?

We also figured out, that the Roth 401k might be a better option, considering the fact, that taxes usually always go up. And also considering the fact, that you’ll make more money when getting older.

Therefore, when choosing the Traditional 401k Plan (remember it’s pre-tax), you might have to pay higher taxes on more money. That’s why many financial advisers recommend investing in a Roth 401k plan.

History shows, that taxes always go up. The only uncertain factor (we all don’t know) could be the possibility of a general tax change. Imagine, the US government would decide to change their taxes from our current progressive tax system¬†to a flat-rate tax system.

If you would have invested your money into a ROTH 401k – you ‘ll look like a fool.

The other way around.. if the tax system will stay within the progressive system, and if the taxes will rise and go up until you’ll retire – you would look like a king when using the 401k ROTH Plan.

It’s a gamble, because you don’t know what the government will be doing.

When it comes to money, I can’t stand it relying on someone else. Especially when it comes to the government, which is absolutely¬†unpredictable. I should rely on the decisions of folks in the White House, and they will decide if I am lucky with my 401k investments, or if I am not.

Well, well, well… I don’t know how you see that whole situation. I hope you allow me to mention Han Solo: I just have a bad feeling about it. Period.

But let’s get back to our topic. What’s really behind this theory that if you would retire abroad, you would get huge tax benefits? And you will not need to pay any US-Income tax on your 401k funds?

I don’t know why this myth is posted on some forums and spread like wildfire. But I can tell you one thing very clearly. It’s a myth. And nothing else than a myth.

There is no way to walk away with the full benefits of using all tax deferrals and not paying a dime on all your hard earned Dollars. Good Morning America.

401k Backdoor Theory

HOW TO PAY 0% [ZERO] TAXES

zero-401k-taxes
The 401k Zero Tax Myth

So let’s continue my little story with my wonderful accountant. Another day in paradise, I called him again asking about my tax situation. And what he would recommend me to do when it comes to my 401k investments.

Should I use the 401k Roth plan, or should I put my money into the Traditional 401k, or should I mix it 50/50.

As we go over all options, I brought up the question I received already from so many people. How will my 401k money be taxed if I am retiring abroad?

If I could look into the future, and if I would only know what the US-Taxes would look like in the year of 2040. That would be nice. However, like everyone else, unfortunately, I don’t have a DeLorian equipped with Dr. Emed Brown’s Flux capacitor.

I simple can’t tell how crazy my tax rate will be when I’ll plan to retire.

But I can make plans, not living in the US. And I can decide to live in a different country.

If I would do that, what would happen to my 401k retirement savings?

Kaboom. This was the key question so many people already have asked. And now was a good time to pass this question to a professional tax accountant. 

So please tell me, how are those funds treated, if I would decide to retire for example in Belize? Or Cuba, or the Bahamas, or any other country?

Additional to that, I wanted to know if the tax situation will be treated differently between a US-Citizen and a Permanet Alien Resident. The question was rising, because I am originally from Austria [yes, the original sound of music guy]. And the answer was sharp, straight to the point.

The 401k Tax Benefits of living abroad – the myth disclosed

The general tax law is clear. Where ever you’ll live you’ll have to pay your income taxes.  In theory, if you would move to Monaco, you’ll have to pay all your income taxes in Monaco.

But when it comes to the Traditional 401k funds, it’s different. Because all the traditional 401k funds have been deferred from the US-Taxes.

That means. If you put money into the Traditional 401k plan, you did NOT pay any taxes on that money. Therefore, the IRS didn’t collect the taxes from you on the money you contributed.

This is a very special case. As a result, it’s treated also very special. Whatever amount you paid into the Traditional 401k plan – it will be taxed from the US. 

I think the confusion about this topic is caused by mixing up the idea, to live in a country that has no personal income tax. Like listed below, you’ll find 5 countries, you can retire and yes, there is no income tax. That’s right. But that does NOT count for the tax-deferred Traditional 401k funds.

That’s money, that was earned in the United States. And on that particular money, you did not pay any taxes – because it was tax-deferred to invest into the traditional 401k plan.

Countries with no Income Tax

  • 1) United Arab Emirates
  • 2) The Bahamas
  • 3) Bermuda
  • 4) Andorra
  • 5) Monaco

Well, living abroad might be for sure something you can consider for your retirement. But you shouldn’t mix it up with the taxes you didn’t pay when contributing to the traditional 401k plan in the US. Regardless if you are US-Citizen or just a permanent resident.

If you want to do some 401k calculations feel free to use my 401k Calculator. 

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