Nonresident Aliens and U.S. Retirement Plans
The nonresident alien (NRA) exclusion can be tricky. It is necessary to include NRAs with U.S. source income in a U.S. retirement plan, despite having an NRA exclusion.
Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in Minnesota is representative of a common question on plan eligibility.
“We have a client that currently excludes nonresident aliens (NRAs) from participating in their retirement plan, but some of the NRAs receive U.S. income. Is my client applying the exclusion correctly?"
Highlights of the discussion
It is necessary to include NRAs with U.S. source compensation in a U.S. retirement plan, despite having an NRA exclusion. The statutory exclusion from eligibility for NRAs under Treas. Reg. 1.410(b)-6(c)(1) specifically states that the NRA must have no earned income that constitutes income from sources within the United States under the meaning of IRC Sec. 861(a)(4). A statutory exclusion allows a plan to exclude a class of employees without having to worry about any impact on nondiscrimination testing.
U.S. source compensation is, generally, the amount of compensation that results from multiplying the total amount of compensation an NRA employee is paid by his U.S. employer, by the fraction of days in which the NRA performed services in the U.S.
Even if a plan includes all NRAs (i.e., no NRA exclusion), if an employee has no U.S. source compensation, covering them under the plan does not benefit them, because they will have no eligible compensation upon which to base contributions to the plan.
Some employers with NRA employees address their retirement benefits by providing them with retirement benefits in their resident country.
Conclusion
A plan cannot exclude NRAs who do receive U.S.-source income. Incorrectly excluding eligible employees could lead to plan disqualification if not properly corrected.