For many of us, our 401(k) plan is our main retirement savings vehicle. It’s important to ensure that you don’t ignore this key retirement asset account during the market downturn that has resulted from the coronavirus pandemic.
Review Your Account
As painful as it might be, this is a key time to review your account. Check your asset allocation. With the rapid and steep decline in equities over the past few weeks, your account’s asset allocation is likely well off from your target allocation. Your allocation to equities is likely much lower than your target allocation.
This is a good time to rebalance your account. Even if you have your account set up to rebalance periodically, say every six months or annually, you might consider doing an interim rebalance in light of the recent activity in the stock market.
This is also a good time to review your investment choices. Have the funds you own performed in line with your expectations? How have they fared compared to their peers? For example, if you are invested in an actively managed large-cap growth fund, how has that fund performed compared to other funds in the same category? You can check this using an independent service like Morningstar (MORN) - Get Report or others.
If your plan offers low-cost index funds as options, this might be a good alternative to any poor performing active funds you may be holding.
Rebalance your 401(k) in conjunction with any outside investments you might hold. If you have accounts such as an IRA or a taxable brokerage account outside of the plan, take a portfolio approach to your overall asset allocation.
Beyond the current situation, be mindful of your account’s asset allocation. If you are closing in on retirement, you might look to lighten up on equities as your account balance recovers down the road. You need to balance out any need for growth with the realization that retirement is looming on the horizon.
Increase Your Contributions
If you aren’t contributing the maximum amounts to your 401(k) plan, $19,500 (or $26,000 for those who are 50 or over in 2020) this is a good to time increase your contributions if you can do so. Any increase in your deferral percentage will be compounded over time and you will be contributing this additional amount starting at a low point in the stock market. If your employer offers a match you will want to be sure to contribute enough to receive the maximum match if you are not there already.
Increase Your Emergency Fund
All investors need to have sufficient liquid reserves outside of their 401(k) and other retirement accounts in case it is needed. This might be the type of unforeseen emergencies like needing to replace a furnace or air conditioning unit in your home, or if you are one of the many workers in the U.S. that are being furloughed or laid off in the wake of the business downturn arising out of the coronavirus pandemic.
Money allocated for an emergency fund should be held outside of your 401(k) in a liquid account, one that can be tapped easily, quickly and without any penalties, taxes or restrictions. This account might be a checking account, a savings account, or money market fund.
Convert to a Roth 401(k)
If your company offers a Roth 401(k) option and they allow participants to convert from a traditional 401(k) account to their Roth option, this might be a good time to consider converting some or all of your traditional 401(k) holdings to a Roth 401(k).
The decline in your account value coupled with the already low tax rates in place due to the tax reform changes enacted starting with the 2018 tax year allows for lower taxes on the conversion and the possibility to convert a higher percentage of your account. The amount converted can then grow tax-free in a Roth account with potentially no taxes due when withdrawn in retirement.
In deciding whether or not to do this, consider:
- Do you anticipate being in a similar or higher tax bracket once you retire? If yes then it potentially makes sense to do this conversion.
- Do you have the cash outside of the 401(k) plan to pay the additional tax? If you don’t then this can become an expensive proposition.
- With the rule changes from the SECURE Act regarding inherited IRAs, with a Roth account ultimately be a better vehicle to pass retirement plan assets to no-spousal heirs?
Special Rules Under the CARES Act
The CARES Act passed to provide relief to businesses and individuals in the wake of the coronavirus pandemic included two provisions that allow 401(k) plan participants the ability to access the funds in their account. For those who are impacted by this situation, their 401(k) plan can be a source of funds if needed.
Retirement Account Distributions
The CARES Act allows 401(k) participants who have been impacted by COVID-19 to withdraw up to $100,000 from their account without having to pay a 10% penalty if they are under age 59½. You may make the withdrawal if you or a family member was sick or quarantined, or if you suffered financial consequences because of the crisis. While this withdrawal will still be subject to taxes, the taxes can be spread out over the next three years. Additionally, you will be able to recontribute the funds back into the plan over the next three years. Annual plan contribution limits will be waived to allow for this. Any money contributed will not be subject to taxes.
The CARES Act also increases the limit on outstanding 401(k) loans from the lesser of $50,000 or 50% of a participant’s account balance to the lesser of $100,000 or 100% of a participant’s account balance. It also extends the time for those with outstanding loans for the rest of 2020 to repay those loans to their plan account.
While the participant is supposed to show some sort of COVID-19 related hardship, this is a self-certification process so as a practical matter these increased loan limits are available to all participants.