Markets have been unstable for months, causing investors to be on edge – with good reason. Already this year, the stock market has fallen and wiped out more than $3 trillion in retirement savings. Alicia Munnell, director of the Center for Retirement Research at Boston College, calculates that 401(k) participants have lost approximately $1.4 trillion from their accounts since the end of last year. Additionally, individuals with IRAs which are mostly 401(k) rollovers have lost approximately $2 trillion this year.
This market downturn is the most severe since March 2020, when the Covid-19 pandemic began. Typically, 401(k) investments take two years after such a market decline to regain those losses. The falling markets reflect investor concerns about inflation and growing recession risks. However, many Wall Street professionals believe that last year’s run-up in sticks was a bubble and investors were looking for a place to park new money. Perhaps these losses are just wiping out the gains which occurred from 2020 to 2021 and people are not actually any worse off than prior to the pandemic? But when investors see an increase, it is permanent to them and makes losses painful.
Is it Possible to Protect Your 401(k) From Market Volatility?
Preparing for market declines ahead of time is possible. Just like gambling your money, putting your money in the stock market or any investments can be risky. Often, retirement decision making is emotional and even with educated decisions, we cannot always predict the outcome.
However, there are many strategies to mitigate risk – strategies that are both simple and complex. You should treat your retirement savings the same as short-term expenses like medical costs and long-term expenses like your mortgage. Meaning, you should continue to contribute to your retirement to ensure the funds continue to grow over time.
Also, it is important to diversify assets across various types of investments and areas of the market and avoid keeping concentrated investment positions. Maintaining the right asset allocation is necessary to protect your 401(k) from a crash and to maximize returns. Asset allocation should depend on your age and how soon your plan to retire. The longer you have until retirement, the longer time you have to recover from market falls and even crashes. Financial advisors specialize in asset allocation to include a comprehensive approach that includes goals, risk tolerance and time until retirement.
Refrain From Withdrawing Early
Never panic and withdraw money too early in an economic downturn. Withdrawing money early from a 401(k) will result in IRS tax penalties. Even if you are near retirement age, the market could rebound sooner than you expect. Nervous investors who pulled money from the market in March 2020 missed out on the bull market which followed with highs by November 2020.
Additionally, choose the right accounts for your money. Retirement accounts are popular because they offer tax advantages that taxable brokerage accounts do not offer. You get a tax break each year if you contribute to 401(k) or a traditional IRA. You will pay taxes on the withdrawals; however, you can choose a Roth IRA, which will not give you a tax benefit for making contributions, but withdrawals in retirement are tax-free. Additionally, do not put any money in a retirement account if you plan to spend that money before you are 59 and ½. The IRS imposes an early withdrawal penalty of 10% in most situations. If you want to take distributions before age 59 and ½, you can convert to your account to a Roth IRA. You will avoid Required Minimum Distributions (RMDs) and taxes on earnings, but you will pay taxes on the amount you are converting in that year. For tax planning, you can decide at year-end whether or not to convert to a Roth IRA and you can also plan to spread your Roth IRA conversations over years to help minimize taxes.
Always Have a Plan
Finally, make sure to plan for what happens if you become incapacitated or you pass away. It is important to have Durable Financial Power of Attorney documents in place to ensure someone you trust can make these important decisions on your behalf if you are no longer able. Also, there are steps you can take to avoid probate when you are deceased including naming beneficiaries on accounts and creating trusts to hold the assets and have control over what happens to the assets when you are gone.
If you have further questions or concerns about your retirement savings or overall estate planning, please contact KJK Estate, Wealth and Succession Planning Attorney Susan Friedman (SLF@kjk.com; 216.736.7272).