Pardon the clickbait title, but there was no easy way to get my friends to learn about 401K, HSA and similar “boring” things. Quite a few of my friends are coming to the US in the next few months and if I can summarize my experiences and my many hours of research, it should help them get up to speed quickly and avoid making the same mistakes I did.
Let’s start at the beginning. I came to the US from India, mid-march this year on an L-1B visa. Some of my experiences may only be relevant to those coming from India but most should be relevant to anyone coming to US on a work visa.
At the port of entry (ahem, Airport)
- Don’t bring any fruits or uncooked vegetables.
- You probably won’t get an I-94 card from the immigration officer. My lawyer had told me that I would get an I-94 card at entry which I must bring to office on my first day. I remembered this only after leaving the airport and was afraid that they were gonna send me back. It turns out that this whole process has now been made online and you can access your I-94 form any time at https://i94.cbp.dhs.gov/I94/consent.html. So you can take a print-out whenever you need to.
Social Security Number
- It’s like PAN number in India but much more confidential. You are supposed to keep it a secret, so much so that I see regular ads showing a stranger tricking someone’s grandma in revealing her social security number.
- SSN is needed for everything in the US, from opening a bank account, getting a credit card to sending money online through different sites. To apply for an SSN, you have to go to a local social security office. There is no need to bring a pre-filled form, you will get the form there.
- Many people advised me to wait a week before visiting a social security office, saying that if you go early, your information may not have propagated through all the systems (what?), which may trigger a manual verification process, taking up to 4 weeks instead of the usual 2 weeks. But some people told me that if you can access your I-94 online, your information has already propagated through the system and you can go apply for an SSN. This is something you should do during your first week here.
- It took 10 days for my social security card to arrive but some people got it in 3-4 days. Until you get your SSN, you can’t apply for benefits or get online banking access.
Wow, that was a big jump, from entering the country for the first time, straight to retirement. For most people entering the country for the first time, it’s the farthest thing from their mind. But it is something that you have to set up and it’s a complicated system (which might be a reason for why the savings rate is so low in the US). Most people just accept defaults and some outright opt out of it, saying they are not planning to stay in the US till retirement. This is no reason to throw away the tax benefits and “free money” if your company offers a match on your 401K (I don’t like to call it free money; I won’t get it if I wasn’t working, would I?).
If you understand the retirement savings system in India (PF, EPF, PPF), then there are some similarities but many important differences. Like PF, you can get an employer match, although it’s not government mandated. Like EPF and PPF, you can contribute extra for your retirement. The crucial difference is that you are not guaranteed a fixed rate of interest, instead you decide how to invest that money. So basically you are setting aside some money which you can’t withdraw before the age of 59.5 without incurring penalties and taxes, but then you treat it as any other investment account.
Now for the complicated stuff, there are many ways to contribute to your 401K:
What it means is that you allocate money into your 401K from your pre-tax income and this amount is deducted from your total income to calculate your taxable income for the year, so you pay less taxes in that year. Your pre-tax money then grows tax-deferred, which means you don’t pay taxes on your capital gains each year. When you finally withdraw that money (make a distribution), you pay taxes on the principal as well as the capital gains. My understanding is that the amount you withdraw is added to your taxable income for the year in which you make a withdrawal. The benefit is that since you are presumably retired when you make a withdrawal, you would likely fall into a lower tax bracket and pay less taxes.
The money that you allocate in this way is part of your taxable income, so you pay taxes on it in the same year that you earned it, but then it grows tax-free and any qualifying withdrawals are also tax-free. My understanding is that if you make a withdrawal after 59.5 years of age, it wouldn’t show up in your taxable income and you won’t have to pay taxes on it (neither on principal nor on capital gains).
This option is after you have reached your pre-tax + Roth limit for the year and want to save additional money for your retirement. It doesn’t provide the same tax benefits as the other two options. Frankly I didn’t research it as much because I’m not going to do it, but my understanding is that similar to Roth, the amount you allocate here is part of your taxable income for the year, and similar to pre-tax, it grows tax-deferred not tax-free so when you make a withdrawal, you pay taxes on the capital gains, although not on the principal.
But there’s a trick, you can rollover your after-tax dollars to a Roth IRA. With the other two options, if you make an early withdrawal (before the age of 59.5), you pay a penalty but not with after-tax and you can withdraw that amount and rollover to a Roth IRA. When you roll it over, you pay taxes on the capital gains accrued so far but afterwards a Roth IRA offers the same benefits as a Roth 401K (tax-free growth and distribution).
You can learn more about 401K here: http://about401k.com, but here’s a summary of my research:
- Early on in your career, you are earning less than what you would be earning later and so may have a lower tax rate. Also you are a long way from retirement, so capital gains would form the major portion of your 401K at the time of retirement (that’s the power of compounding). So Roth makes more sense early on in your career and pre-tax makes more sense if you are closer to retirement or at the peak of your career.
- Political climate: If you expect the taxes to go up, it makes sense to pay them now and go with Roth. With rising inequality and automation taking away jobs, I think there is no other way but for taxes to go up.
- What I thought was best for me was to contribute the IRS limit 18000$ as Roth contribution, which also gives the maximum match from the company and not contribute anything after-tax.
- Now comes the fun part, where to invest that money. I had my 401K plan with Fidelity, which offers only a few options: a few target-date retirement funds (which start out aggressive and then become more conservative as they approach the target date), a few index funds and other managed funds, and a brokerage link to the outside world (to go buy any stocks, bonds, mutual funds).
- An age-appropriate target-date retirement fund was the default but I’m a little more interested in investment so I choose a complex mix of small-mid-large cap growth managed funds, which had relatively higher past returns. I didn’t try the brokerage link because I didn’t have enough time and thought that the transaction costs may outdo any benefits, but I’ll try it when I’m more knowledgeable.
- I was happy with my choices but then I watched and read a lot of material on value investing, which says that value investing (investing in companies with more tangible assets, say cement companies) has, in general, performed better than growth investing (investing in companies with fewer tangible assets, say internet companies). It also said that complicated allocation strategies rarely perform better than a 1/N allocation (i.e., allocating equally between different stocks and funds), and managed funds (which have a higher expense ratio) usually struggle to beat index funds (which have a low expense ratio).
- Index funds are very popular in the US, which is a highly efficient market, not so much in India.
- Finally, I choose a few Vanguard index funds (both growth and value) and one managed mid-cap fund (because I didn’t see a Vanguard mid-cap index fund) and allocated equally between them.
Health Savings Account (HSA)
Health insurance in the US is very different from what I had in India. In India, everything was paid for by the insurance company and there was an upper limit on expenses in each category (domiciliary, vision and dental, preventive health checkups and hospitalization). The health insurance I have in the US is different: there’s no upper limit on coverage but there are lower limits.
I don’t know if the health insurance details for my company are confidential so I won’t mention specific amounts, but describe the health insurance in general. Each year, the first few medical expenses are paid entirely by you, until you have paid a total of a certain amount, which depends on your plan and are called deductibles. After you have reached your deductible limit for the year, the insurance kicks in and pays some percentage of the expenses. You pay the remaining percentage of the expenses until you have paid a total of a certain amount, which again depends on your plan and is called co-pay and co-insurance (these two things might be different but in my mind are the same). Everything after that is paid fully by the insurance company.
If you are in good health and rarely have to see the doctor, this sucks because your insurance may never kick in, but healthcare is very expensive here. A single visit to the doctor can cost several hundred dollars.
Anyway, I got two options for health insurance, one without and one with an HSA. I was inclined towards choosing the plan without HSA because I don’t know how long I’ll be in the US, but then choose the one with an HSA because of the tax advantages. An HSA is triple-tax advantaged, which means that any amount you contribute is tax-free, capital gains are tax-free and qualifying withdrawals are tax-free. In contrast, both pre-tax and Roth 401K are double-tax advantaged. Your company may also contribute to your HSA, which is like a cherry on top of a triple chocolate fondue! Too much to resist.
What I felt was best was to contribute enough to reach the IRS limit (3350$), which is the sum of yours and your employer’s contribution. Here’s again the fun part: like 401K, you don’t get a fixed rate of interest but choose how to invest your money. I was explaining this to someone and he said he felt investment was like spending because there’s risk involved, you could lose your principal. Well if you don’t invest and keep it at zero interest or anything lower than inflation, your money is being eaten away by inflation and that’s much more like spending.
I got many more options for investing my HSA than my 401K and I choose a few index funds with low expense ratios and relatively higher past returns and allocated equally between them. There’s something called tax-advantage in funds, which comes from the fact that you can trade-off your losses against your gains and pay lower taxes. Some funds are designed to be tax-advantaged i.e., they may sell something in loss solely to balance it against other gains, and it’s advisable to keep funds which have poor tax-advantage in tax-free/deferred accounts like HSA and 401K. I don’t know enough about it yet so haven’t structured my investments to take advantage of this.
US-India tax laws and other tidbits
- US government doesn’t recognize Indian mutual funds, so there is an unfavorable tax rate on capital gains in Indian mutual funds. It’s better to just sell off your mutual funds before coming to the US. You can’t sell them after coming to the US and not show it in your tax returns. I haven’t figured out all the rules yet but this seems like the easiest way. Also, you shouldn’t buy more units in any mutual funds. Most Indian mutual fund houses specifically prohibit US residents from buying into them.
- In India, you can gift any amount of money to your blood relatives without incurring any gift-tax. Maybe someone can correct me but so far what I’ve figured out is that IRS imposes a limit of 14000$ per person that you can send to your blood relatives abroad per year.
- There are many ways to send money abroad. Banks usually charge a lot and offer lower exchange rates, but there are many sites which offer better exchange rates and have low or no transaction charges. You get better exchange rates if you are not in a hurry and are willing to wait 3-4 days for the money to be received abroad (economy vs premium service). I tried quite a few different services and found the following to be better than others:
- Some other services, which I felt offered lower exchange rates or charged higher transaction fees are Xoom and Transferwise. Some of these have my referral links, so if you create an account and make a transfer using them, both of us would get some reward depending on their policies.
- Another change that I felt after coming to the US is that food is very expensive here. Vegetarian options are more expensive than non-veg. If you eat outside, it’s already very costly and then you pay state tax (which is 9.5% in Washington) on top of it, and if the restaurant wasn’t self-service, you need to pay tips (I think recommended is 18% of before-tax amount). Needless to say, you would want to learn cooking.
This is the first time I’m writing a disclaimer. Posts about algorithms and data structures usually don’t require disclaimers, but I’m now a non-immigrant alien with poor knowledge of my rights and responsibilities so it’s better to be safe than sorry. Here goes.
Disclaimer: I wrote this post in my personal time. All opinions expressed in this post are my personal opinions and not that of my employer. I’m not an expert in investment, immigration or tax laws and this post merely describes my own experiences, research and choices. This may or may not be good advice for you.