Here’s an email I received from a reader:
I’ve been a passive reader of your blogs for quite sometime and i’ve a learnt a lot about finance.
I am Indian student in F1 visa status. I recently got a job and I plan to work for around 5 yrs in H1B status before I go back to India. I don’t want to settle down in the US until my retirement. My company offers 401(k). For the first 3% they match every dollar, the next 2% they match 50 cents on the dollar. I don’t want to lose the free money from my employer. Is it worth investing in 401(k) even after knowing that I will be taking the money before retirement and will be paying the tax and penalty when I withdraw it? I want to know if I could profit, even after taxes and penalty, from the free money that my employer matches. My gross salary is 78k and I’m in the 28% tax bracket.
Interesting question and I like a challenge so I decided to take it on. Now, since I’m not getting paid for this, DON’T take this example as advice. It’s merely an exercise to see what could happen in a situation like this.
Here’s what I came up with:
First off, I know nothing about F1 status or H1B status and have no idea whether or not any of this would have an impact on the outcome of this situation. Also, I have ignored Social Security and Medicare in this situation. Here are some other assumptions I made:
- The $78,000 salary remains the same for the 5 years.
- The 401(k) grows at 8% per year. To compute this I simply took the year’s ending balance and grew it at 8% and then added the next year’s contributions to it. It’s not precise but it will work for this example.
- I used 2007’s tax brackets, personal expemption and standard deduction throughout the example.
- In year 6 I assumed his only income would come from the termination of the 401(k). If he had additional income that year, it could have a huge impact on his tax situation.
So that represents his five years of working. Now let’s see what could happen when he withdraws the money. Remember that an early withdrawal from a 401(k) is taxed as income AND is assessed a 10% penalty (except in certain situations that don’t apply here).
So, according to my math, he will contribute $19,500 (his personal contribution not including company match) into the plan over 5 years and get to keep $33,758 when he terminates the plan and pays the taxes and penalty on the withdrawal. It would be better to keep the plan as is and let the $41,184 grow but I’m not sure if this option is open to him. Also, keep in mind that the plan provider may withhold 20% of the balance, which he will get back the difference once he files his taxes.
Dreamer, I hope I answered your question. Now, take this with a grain of salt and go see your CPA.