I started my career in the US in an offshore based system integrator where a majority of the people working were on H1-B visas. The six years, that I worked there, I use to wonder why most of the expats in the US avoided investing in 401K like a plague.
This company used to fail the 401K stress test each year clearly indicating that most of the Non-HCE (Highly Compensated Employees) are not investing enough in 401K. Now, investing in retirement plans is something that everyone should do it seems even more surprising that folks who come to the US to save and earn more don’t utilize the best saving tool available.
The most common notion that I found while working there was that people felt that they are blocking their money and won’t be able to access it till they are 65 and since they are in the US for only 5-6 years, they are not interested in blocking the same. Now, we do know for a fact that this is not true. Anyone can withdraw from their 401K although there are tax consequences.
Someone who is on an H1-B visa can easily utilize these to his benefit and realize that 401K offers way more benefits to temporary workers than citizens or permanent residents. Look at the following scenario that applies to most of the junior software developers (the bulk of people working on H1-B):
- Average salary – 80K
- Marginal Tax Bracket – 25%
- Average Marginal State Tax rate – 4%
- Company match – .5% for first 6% of savings.
- Average growth rate – 10%
- A timeframe of 6 years for an H1 person in the US.
Now, take two scenarios:
Scenario 1: No money is saved in a 401K and all of the money is disbursed in cash. The cash is invested in a taxable account. Money is withdrawn slowly once the person leaves the US to avoid capital tax.
Scenario 2: 15K is invested in 401K and the money is invested in index funds.
In 6 years, the amount of money saved in taxes amounts to 26,100 and additional salary earned due to company match is 14,400
|No 401K investment||15K in 401K investment|
|Amount invested / Year||10,650 *||15,000|
|6 Years growth||87,074||142,261|
* 15K of pre-tax salary gets reduced by 29% due to marginal tax brackets
After 6 years, if someone leaves the US, they can safely withdraw money slowly to stay below the standard deduction rate and avoid paying federal or state taxes completely. The only tax one would have to pay on 401K withdrawals is the 10% early withdrawal penalty. Even just from the taxation purpose, anyone can utilize this to bring their taxation rate down from ~29% to just 10%
Within 6 years, the gap crosses 50K even after assuming 10% of withdrawal penalty and if someone is able to let the money grow for 10 years, it crosses 115K.
2 thoughts on “How most H1-B holders make a 6 figure money mistake”
“After 6 years, if someone leaves the US, they can safely withdraw money slowly to stay below the standard deduction rate and avoid paying federal or state taxes completely. The only tax one would have to pay on 401K withdrawals is the 10% early withdrawal penalty.”
Since you are no longer a resident, don’t you have to pay a direct 30% tax?
Good point. IRS mandates a 30% tax withholding rate but that doesn’t imply that the tax would be 30%. It depends on the tax treaties. Here are a few links that talks about this in more details.