Most people I talk to about their IRS problem have already built the worst-case scenario in their head. The reality is usually much more manageable. I'm Darrin Mish, and I've been representing taxpayers before the IRS for 32 years. Here's what actually tends to happen.
As a US citizen you are entitled to withdraw your 401(k) savings upon retirement. But did you know that it is subject to tax when you do so? Click here to read or watch more IRS Help resources.
The 401(k) retirement plan allows you to save up pre-tax earnings during your working career to provide for your needs after you retire. The money you set aside is not taxable when you contribute it to the plan but when you take it out upon retirement, it is taxed as ordinary income. Also it is obligatory for you to start taking distributions from a 401(k) after you turn 70 years old.
Is there any way to avoid this tax?
That is quite unlikely. If you are a US citizen or a resident alien with your home address outside the US, the law states that your 401(k) custodian must withhold the taxes due from your distributions.
Here are some tenets of the Tax Code that pertains to 401(k) taxation:
Generally, you cannot avoid being taxed by seeking permanent residence overseas upon retirement if you maintain your US citizenship. Your income is taxed worldwide, so taxation on your 401(k) distribution remains mandatory.
Some countries that you move to might also tax you. Thus it is not expedient to move to these countries just to avoid being taxed. But there are some countries with which the US has a treaty to avoid double taxation.
If you have earned your income in the US, distributions from your 401(k) plan are considered as generated from the US. However if some or all of your income is earned while you are outside of the US, then things get more complicated. You should consult a tax professional or the IRS themselves for clarification of your case.
If you emigrate and renounce your US citizenship after June 17, 2008, certain rules apply. Whats more, the rules differ according to your income bracket. Higher income earners and taxpayers with a higher net worth are subject to different rules from others. Again, it is advisable to seek professional advice if this applies to you.
The IRS has published Publication 590 that deals with the tax laws pertaining to 401(k) contributions and distributions. You can view Publication 590 from the IRS website. Heres the link http://www.irs.gov/publications/p590/ch01.html.
With the economy still weak, the government has become even stricter in targeting those who try to evade taxes on their 401(k) by leaving the country. So if you plan to take an action like this, the best thing to do would be to consult a tax attorney, accountant or enrolled officer about your particular circumstances.