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Retirement planning

The 411 on 401(k)s in the Wake of Coronavirus

4 Minute Read

Making ongoing contributions to your 401(k) is a wise commitment to prepare for your future retirement. But during a time of economic uncertainty and market volatility, it’s natural to wonder whether you should adjust those contributions.

Currently, employees with access to 401(k) plans at work can contribute up to $19,500 per year to the plans, and all contributions are tax-advantaged. In most cases, contributions are deducted from taxable income, and taxes are paid upon distribution in retirement. For Roth 401(k) plans, taxes are paid before contributing, and there are no taxes paid upon withdrawal.

If your employer matches your contribution, the advantages are even greater. Say your employer will match your contribution up to 6 percent of your income. If you earn $100,000 and contribute 10 percent or $10,000 per year, and your employer contributes an extra 6 percent or $6,000 per year, you’re investing $16,000 for retirement, but only about two-thirds of it came out of your pocket.

As the market dips, it may be tempting to consider decreasing contributions or taking a break altogether. Typically, the right solution depends on your unique situation.

If you’re nearing retirement

As you move closer to the end of your career, you may not have a lot of time left to wait for a bear market to rise again. That doesn’t mean you should stop contributing altogether, but you may need to make some adjustments.

Instead of halting your contributions, consider reallocating your 401(k) investments to include more cash or cash equivalents. By continuing to contribute regularly, you’ll still have a bigger nest egg available when you retire. And as the market recovers, you will still have some holdings that can continue growing during your retirement years.

If you have more than five years left before retirement

During a market downturn, the stock prices for many top companies are on sale. That means you can benefit from ongoing investment because you’ll get more shares for your money—and as the market recovers, you’ll be in a better position to capitalize on that growth.

Even if the markets look grim now, history shows that the market always rises over time. While stock market downturns vary in length, they are generally much shorter than periods of market growth. Between 1926 and 2019, the U.S. market experienced 12 bear markets. Bear markets are characterized by a drop in market indexes by 20 percent or more.

According to an analysis by First Trust Advisors, these bear markets ranged from six months to 2.8 years. Every time, the market has recovered and continued to grow—and the periods of growth have been much longer. This was the case in the bear market of 2010 to 2020, which lasted 10.8 years.

By continuing to invest when the prices are low, you’ll get more for your money and own more shares, allowing you to benefit even more when the market picks up again.

If your employer offers a matching contribution

Getting a matching contribution from your employer is like free money available for the taking. If that’s available to you, always try to contribute enough to earn the full match.

For instance, if your employer will match a contribution up to 5 percent of your salary, but you are only contributing 3 percent of your salary, you’re leaving money on the table. Do whatever you can to contribute enough to get the full match; it’s an opportunity for your employer to continue paying you a salary for the years when you’re no longer working.

If your employer suspends its matching contributions during a period of economic uncertainty, try to contribute your regular percentage if possible. Your retirement portfolio will benefit, and if your employer reinstates matches, you’ll be ready.

If you need the money for current expenses

During a difficult economic time with high unemployment, some workers may need to take home more of their pay. For instance, if your spouse has been laid off, you may need to cover more of the household bills.

If you need more of your income right now, consider reducing your 401(k) contribution temporarily to maintain financial solvency. But keep in mind that your 401(k) contributions are tax-deductible. By continuing to contribute some portion of your income to your 401(k), you are reducing your tax liability, which also helps you keep more of your money.

And even though your 401(k) contributions are set aside for retirement, that money still belongs to you. If you need it, you can make withdrawals before you reach retirement age. Typically, taking money out of a 401(k) before the age 59 ½ incurs a penalty of 10 percent of the withdrawal, as well as a 20 percent federal tax.

During 2020, new rules included in the CARES Act allow people who are facing financial hardships related to the coronavirus pandemic to withdraw funds from their 401(k) plans without paying the 10 percent penalty for early withdrawals. The funds taken out are taxable at your regular tax rate, but you have three years to pay those taxes.

An early withdrawal should be a last resort because this means you’re losing the opportunity for those funds to grow and compound over time.

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