As the economy continues its gradual recovery and Americans look forward with cautious optimism to the end of the pandemic, many have questions about the right moves to make with their retirement savings plan. Here are some tips for how to maximize your 401(k) in 2021.
1. Use a retirement calculator to make sure you’re saving enough.
If you’re in the dark about your 401(k) plan, check your most recent 401(k) statement, which may be on paper or delivered electronically. If you don’t have one of these statements handy, ask your Human Resources Department or investment manager. Then you’ll have the information you need to use an online tool – like Ubiquity’s 401(k) calculator – to see the possibilities.
- What will your savings be when you retire?
- How much should you be saving for retirement to live the lifestyle you desire?
- If you put away a little more each pay period, how big an impact will it have years later?
- What happens if you withdraw some of your retirement savings early?
All these questions can be answered in just a few minutes with a free online retirement calculator.
2. Mitigate risk of CARES Act borrowing.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act was the rescue plan many Americans needed in 2020, but it was not free money. The CARES Act allowed qualified individuals to withdraw up to $100,000 from their 401(k) plans, penalty-free. Normally early withdrawal would incur a 10% penalty. It also increased the amount a person could borrow (the lesser of $100,000 or up to 100% of the balance) and authorized delayed repayments (within three years). However, it is important to remember income tax is still due on the withdrawal, though the bill can be minimized or delayed.
If you took advantage of the CARES Act retirement withdrawal in 2020, here’s what you need to do:
- Start paying your taxes. Report one-third of the distribution on your income tax returns for 2021, 2022, and 2023. So if you borrowed $9,000, you’d pay taxes on $3,000 worth of the distribution over the next three years. This could be the best option if you’re still struggling financially.
- Avoid having to pay taxes at all. If you can put the money back into your account over the next three years, you can avoid paying taxes on your withdrawal. If you took out $9,000, you could repay $3,000 back into your account in 2021, 2022, and 2023 – and you’ll owe $0 in taxes. This is the best option if you’ve recovered from the financial hit of the COVID-19 pandemic.
- File an amended tax return. It’s still possible to avoid paying taxes, even if there is great uncertainty this year. Start by paying a third of your tax obligation. If by 2023 you are able to repay your account, you can file an amended return and get the taxes you’ve paid returned in a refund from the IRS.
- Pay the whole bill up front. If your income for the year is very low, putting you into a lower tax bracket, it might be more advantageous to pay the entire tax bill this year. Some people went from a 22% tax rate down to 12% due to unemployment. In that case, it could mean a $900 tax bill difference on that $9,000 borrowed.
Failure to take care of the IRS obligations of CARES Act borrowing will result in a surprise tax bill in 2023 and hefty penalties that accumulate month after month.
3. Contribute more to your 401(k) plan.
Even if you do not have the financial resources to comfortably reach the $19,500 maximum 401(k) contribution for 2021, there are still a number of ways you can contribute more to your retirement this year:
- Aim to contribute 1-5% more each pay period.
- Increase your contribution when you get a bonus or a raise.
- Make sure you can at least reach the company match, as this is free money that can double savings.
- Plan participants over 50 years of age can contribute an additional $6,500 above this maximum limit to catchup in 2021.
4. Review your investment fees.
Fees can eat away at your portfolio balance over time. You may not have full say over investment fees if your employer manages your plan. If you have a small business 401(k) or solo 401(k), you could be overpaying for your plan administration. The lowest-cost plans, like Ubiquity’s, assess a low, flat, monthly fee for service. However, some 401(k) administrators charge per eligible participant or a percentage as an Assets Under Management (AUM) fee that puts more money in the administrator’s pocket as your balance grows over time. Administrators and investment managers can also charge expensive fund trading fees or loan servicing fees.
One way to bring down the cost is to request that your plan manager add low-cost index funds and ETFs as investment options; investing in funds with low annual fees could potentially boost a nest egg by hundreds of thousands of dollars by retirement time.
Locate your plan’s summary annual report and look under the basic financial statement section to see the total plan expenses and benefits paid. Subtracting the benefits paid from the total plan expenses will give you an idea of what you’re paying for administration. If you divide that number by the total value of the plan, you’ll see your administrative cost percentage. The average American pays between 0.37% and 1.42% in plan fees. If you’re paying a percentage that’s too high, it’s time to consider switching your 401(k) plan administrator. Call Ubiquity today to see how we can help.