by David Rae
April 30, 2020
by David Rae
April 30, 2020
You may find a slew of tantalizing reasons to stop contributing to your retirement account during the COVID-19 recession. Some of you have likely lost your jobs; others should be concerned that they may be next in the unemployment line. Wherever you look, there appears to be bad news. This is often the best time to be saving for retirement. If you’ve been hoarding toilet paper, you may be tempted to start stockpiling cash and skipping retirement plan contributions. I am here to help guide you away from this unfortunate mistake that could derail your future financial security.
Everyone is facing two terrible scenarios: A horrible pandemic (thanks COVID) and a quick and steep drop in stock market values around the globe (again, thanks COVID). If you have opened your first quarter retirement account statements, you have likely seen your account balances drop below where they were on New Year’s Eve. Being scared is totally understandable. That doesn’t mean panicking is a smart money move.
If you are still employed, you need to keep contributing to your employer-sponsored plans, like a 401(k). Time is on your side. Most of us have years, or even decades before we will need the money. For those who are in their fifties, or even sixties, you will need this money to last another 20 or 30 years (maybe more). You have time for your retirement investments to recover.
Has the stock market bottomed out yet? Who knows? But I am confident that people who invest in a diversified portfolio will be rewarded when the stock market eventually rebounds. Those who panicked and stopped contributing, or worse, pulled their money out, will find themselves further from achieving financial freedom.
For 2020, you can contribute up to $19,500 to a 401(k) as an employee. For those who are 50 or older, you can also make a catch-up contribution of $6,500 for a total of $26,000 into a 401(k) for 2020. Self-employed individuals can potentially contribute $57,000 into a Solo 401(k) in 2020, or $63,500 if you are at least 50 years old.
If you need a little more motivation to keep the money flowing to your 401(k), you get a tax break for the money you invest. You may also receive a matching contribution. Most matches are between 50 cents to one dollar for every dollar you contribute. This means your investment accounts would need to drop by 33 to 50 percent before you start not coming out ahead immediately. Again, I expect that the market will continue to recover from the coronavirus recession before most of us get anywhere near retirement. That being said, I do expect more volatility through the pandemic, as well as the presidential election later this year.
If you are still employed, you should continue making contributions to your retirement accounts. If you are not contributing yet, now is a great time to get started. Stocks are on sale, and we don’t know how long the COVID-19 discount will last.
If you have been laid off, your 401(k) plan contributions will stop on their own. No paycheck will mean no further contributions to your retirement accounts. For the underemployed, continue making your regular contributions if you can. At the bare minimum, contribute what you need to in order to get the full employer 401(k) match. Missing out on the employer match could turn into a million-dollar mistake over your working career.
For those who are out of work, consider maxing out an IRA for 2019. Assuming you worked the full year, you will likely have earned a higher income and have a larger tax liability based on your 2019 taxes. In this case, you would likely get a bigger tax break making a 2019 IRA contribution than you would with a 2020 contribution. Considering using some of your savings to top off your 2019 IRA contributions. The deadline for IRA contributions for 2019 has been pushed back to July 15th, so you still have a little extra time.
Getting money out of a retirement account is a little easier right now during the coronavirus pandemic, thanks to the CARES Act. Normally, withdrawals from an IRA, 403(b), 401(k), or similar retirement account would be subject to a 10% early withdrawal penalty, and taxes would be owed on the withdrawals.
I am working with a few small business owners right now who are rightly concerned about the future prospects for their businesses. They also happen to be facing taxes on substantial income for 2019. We are having to make a choice between conserving cash and lowering taxes that are due. Should they fully fund their Profit Sharing Plans for 2019? Do they make the low or the maximum Defined Benefit Plan contributions? The numbers are big, but some of the tax savings are in the six figures.
The CARES Act has made this burdensome choice a bit easier. If, and we hope that it will just stay an if, we need to make a withdrawal from the retirement account, we will have three years to pay the taxes and/or three years to put the money back into the account. The way I see it is, we make the contribution now and get the benefit of the tax savings today. From there, if we happen to need to make the withdrawals in the future, we can deal with that then.
In these cases, my business owner clients are optimistic that they will weather the coronavirus storm. While they may face a cash crunch during this difficult time, they will benefit from lowering their taxes on the high-income year of 2019. Ideally, if they needed to take withdrawals, they would pay taxes in a lower tax year, like 2020. Or even better, they would fully recover and put all the money back in their retirement accounts within the three-year window, thereby avoiding taxes that would have been owed. There are some rules that need to be followed here, so talk with your tax preparer and Certified Financial Planner and be proactive in keeping your income taxes to a minimum.
The reality is that in more than 17 years helping people plan for an enjoyable and financially secure retirement, I’ve never heard anyone say, “I wish I’d saved less for retirement.” What I have heard often and repeatedly is, “I wish I had started earlier and saved more for retirement.” Millions of Americans are on track to maintain their standard of living, while millions more need to catch up. Keeping, starting, or even increasing your retirement plan contributions during the coronavirus recession will allow you to buy shares in companies you love while they are on sale. This, too, shall pass, and those who invested wisely will be rewarded.