Five Mistakes to Avoid When Leaving a 401(k) in the USA

The first option is the easiest. That is to simply do nothing. You can leave your 401(k) with your former employer’s plan, and it will remain invested and generate returns until you’re ready to access it. 

But it’s important to monitor its performance and fees regularly to make sure it’s on track for your retirement goals. Some plans may not allow new investments or might have limited investment options. 

The next option is to consolidate your employer-sponsored scheme into your own IRA. Rolling over your 401(k) to an IRA can provide more investment choices and potentially lower fees. 

IRAs offer greater flexibility in terms of investment options, including stocks, bonds, mutual funds, and ETFs. IRAs can also potentially provide better estate planning options. In short, this option will give you more control over your investments. 

While cashing out is an option, it’s generally not advisable due to the significant tax penalties and loss of potential growth on your investments. 

It can be an easy trap to fall into, thinking that the simplest option is just to cash out your 401(k) and then invest it yourself. In almost all circumstances, this is likely to be a big mistake.

Immediate withdrawals can trigger significant tax penalties. Typically, distributions taken before the age of 59½ are subject to a 10% early withdrawal penalty, on top of income taxes on the withdrawn amount. This can significantly erode your retirement savings.

This means you take an immediate hit on your assets, but it can also severely impact your long-term financial health. The compound returns your investments would have earned over the years are lost, and rebuilding a similar-sized retirement fund outside the US can be challenging. 

If you’ve decided to leave your 401(k) where it is, you might think your job is done. Especially if you’re living in another country like the UK or UAE, where 401(k)s are unlikely to be a topic of conversation, even with many wealth managers (though not Hoxton Capital Management, we help many US expats manage their 401(k)s from overseas).

But that’s not a good idea. Leaving your 401(k) without regular reviews can be risky. The investment options selected when you were in the United States might not be the best fit for your current financial situation and goals. The market conditions that were favourable then might have changed, which could affect the performance of your investments.

Regularly reviewing your 401(k) performance and adjusting your investment strategy is essential. Make sure your portfolio is diversified and aligned with your risk tolerance, and retirement timeline. This last one is particularly important as you get closer to retirement. 

US estate taxes can be as high as 40% on amounts above the exemption threshold (currently $13.61 million for 2024). If you leave your 401(k) in the USA, your beneficiaries could face significant tax liabilities, reducing the net value of your estate.

Luckily, there are strategies you can use to help mitigate these taxes, such as using trusts, gifting assets during your lifetime, or using accounts which offer greater estate planning flexibility. 

But a word of caution. This is not an area to skimp out on professional advice. It’s a highly complex area, and a lack of proper planning could cost your estate millions of dollars. 

Currency is an area of investment strategy that receives very little attention. That’s because, for most investors, it doesn’t matter too much. But if you’re an expat or an investor with an international footprint, it’s something you need to carefully consider.

If you’re living in a country with a different currency, keeping your 401(k) in USD exposes you to currency risk. This is particularly important if you’re planning on retiring outside of the US. 

The reason is that fluctuations in exchange rates can have a big impact on the value of your investments when converted back to your currency of residence. The easiest way to explain is to consider a quick example.

Imagine you had invested into an ETF denominated in USD, but you were living in the UK, and planning on retiring in the UK. At the start of the year, the investment had a value of $100,000, which was worth £78,000 ($1 = £0.78). By the end of the year, the investment had grown, and its value had increased to $110,000.

However, over that same period, the British Pound Sterling had strengthened relative to the US dollar, with $1 now only buying £0.70. With that new exchange rate, the investment in British Pound terms has gone down to £77,000.

As you can see, currency movements add another layer of risk to an investment portfolio, and it’s important that this risk is managed properly.  

We’re only just scratching the surface in this article. Managing a 401(k) from abroad involves navigating complex tax rules, investment options, and regulatory environments. Without expert advice, you might miss out on beneficial strategies or fall foul of tax laws.

A financial advisor with experience in international finance can help you make informed decisions about your 401(k). They can provide tailored advice on investment options, tax planning, and estate planning, ensuring your retirement savings are optimized for your circumstances. 

How Hoxton Capital Management Can Help You Manage Your 401(k)

Managing retirement accounts and the tax implications that come with them is a highly complex area. Not only are the rules and regulations complicated, but they’re also constantly changing. 

Different countries have varying tax treaties with the USA, which can affect how your 401(k) distributions are taxed. Understanding these tax implications is crucial to avoid unexpected tax liabilities, and it’s one of the key advantages of working with professional advisors at Hoxton Capital Management.

Our team is globally positioned and highly experienced in dealing with clients with assets spread across the globe. This makes us especially qualified to navigate the maze of international tax and investment legislation.

But the eventual strategy isn’t the starting point for our conversations. We believe in empowering people to create a financial plan that helps provide them with their dream lifestyle.

When working with us, we ask you to think about your long-term plans and where you intend to retire. Your retirement strategy should align with your future residency plans, considering the tax and legal implications of holding retirement accounts in different countries, while delivering the quality of life you’ve worked so hard for.