These are “rare and unprecedented times,” as countless newspaper articles suggest. The global pandemic has Americans taking a closer look at their finances to see where nickels and dimes can be scraped up, and where resources can be allocated for the future. Here are four smart money moves you can make in 2020 — pertaining specifically to your 401(k).
1. Let your nest egg grow.
Resist the urge to pull all your money out of the market.
There are two enemies to your secure financial future in this pandemic – coronavirus and human behavior. The human element is one aspect that can be controlled. Emotional reactions will hurt your finances in the long run. The Stock Market rarely moves continuously in one direction or the other. It jumps in fits and spurts, climbs and dips, drops and then rebounds.
Opportunity cost is the main reason investors advise against taking cash out of the Stock Market, as you lose the chance for these dollars to grow and compound while invested. Pulling money out of the stock market requires a comparison between the growth of your cash portfolio (which will be negative over the years, as inflation erodes your purchasing power) and the potential gains in the Stock Market (which averages 7% over a 10-year period).
2. Rebalance your 401(k) account portfolio.
On the other hand, asset allocation and diversification still work. A balanced portfolio of stocks, bonds, and cash will take care of you in retirement. Financial planners recommend that you rebalance your 401(k) investments at least once a year, but you can make adjustments up to four times in a more aggressive growth strategy.
Check your account statement for a pie chart to see how your money is invested. When you are 5% or more off your initial target, it’s time to rebalance. If you don’t have access to a pie chart, you can calculate what percentage each category represents of the total value, buying and selling from the largest category to get closer to your original asset allocation percentages.
For instance, if you initially allocated 40 percent of your portfolio to bonds and 60 percent to equity funds, but it shifts to 30 percent bonds and 70 percent equity funds, you should shift 10 percent back to bonds. The market currently offers unique opportunities to sell off some of your gains and buy assets that are undervalued.
If this all sounds like another language to you, consider taking advantage of Ubiquity’s CensiblyYours® Custom Index Portfolios, which allocates resources based on risk profile.
3. Get free cash from your employer.
Half of US employers offering a 401(k) also offer to match employee contributions. Employers match contributions to encourage employee participation in their plan, incentivize workers to remain loyal, and prevent themselves from failing nondiscrimination tests.
If you haven’t done so already, find out what formula your employer uses for matching and increase your funds to reach the maximum. The average 401(k) match can be worth 4.3% of a person’s pay. A common match is dollar-for-dollar on the first 3% and 50-cents-on-the-dollar for the next 2%. The money your employer puts in is literally free money – free money that compounds over time – so you don’t want to leave any of it lying on the table.
Remember that, unless you have a Roth 401(k), the money you put into your account isn’t taxed until you pull it out in retirement, so you’re lowering your tax obligations AND growing your savings account at the same time by meeting the full employer match.
4. Take an early distribution rather than a loan.
The best course of action is to leave your money where it is, rather than tapping it for emergency cash. However, if you’re really in a rut and have no 0% APR credit card access, home equity to borrow, or low-interest-rate loans to consider, then you have the last resort of taking an early 401(k) distribution or loan. Normally the loan would be the better deal, given that you can avoid paying the IRS penalty, but 2020 comes with new rules that make early distributions more favorable.
Typically, folks under age 59.5 would be subject to a 10% IRS penalty, on top of losing the compounding interest on the money taken out of the account. However, as part of the CARES Act, investors are able to take up to 100% of the money put in (to a maximum of $100,000) as a distribution — without paying the 10% penalty. You’ll still owe income taxes on the distribution, but you have up to three years from now to pay them. Money can be redeposited into the account as a rollover contribution at any time within three years.
Not all employers allow the new rules, so be sure to check with the plan administrator to find out if this is an option for you.
Up to 100% or $100,000 can be taken out of a 401(k) as a loan in 2020 as well, but the repayment period is only delayed by one year (December 31, 2021). So, if you were to take out a five-year loan of $100,000 at typical loan rates, you’d be paying about $1,800 per month. Worse yet, defaulting on the loan would lead to full taxation due on that $100,000, PLUS the 10% early withdrawal penalty in the year of default.
Whether you’re a business owner or employee, you can always contact Ubiquity, your 401(k) plan administrator, to discuss what 401(k) small business options exist, given your unique situation.