How To Protect Your 401k
So you have a 401k and are taking advantage of your employer match and youre wondering how to protect my 401k from a stock market crash.
Most advisors will tell you to leave your money alone and ride the waves saying, eventually the market will recover and so will your investments. But this could be devastating for your retirement if you dont have much time left in the market.
If you could prevent the loss in value that comes with a stock market crash by getting out at the right time, and getting back in when the prices are low, wouldnt you want to?
While timing the market will never go perfectly, you can experience greater returns if you use the right tools.
Who Should Withdraw From Their 401 Early
Just because you qualify for a hardship-related withdrawal doesnt mean you should take one without weighing all your other options.
The experts we spoke with were all in agreement that withdrawing from your 401 shouldnt be your first move. However, they also indicated that if youre truly in need, then you should take advantage of the CARES Acts allowances.
It should be a last resort option. People shouldnt get carried away and start using their 401 assets just because they can, Pfau says.
Keep Contributing To Your 401 And Other Retirement Accounts
Steadily contributing to your 401 is another way to protect it from future market volatility. Cutting back on your contributions during a downturn may cost you the opportunity to invest in assets at discount prices. Meanwhile, maintaining your 401 contributions during a period of growth when your investments have exceeded expectations is equally important. The temptation to scale back your contributions may creep in. However, staying the course can bolster your retirement savings and help you weather future volatility.
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Penalties For Home And Tuition Withdrawals
Under U.S. tax law, there are several other scenarios where an employer has a right, but not an obligation, to allow hardship withdrawals. These include the purchase of a principal residence, payment of tuition and other educational expenses, prevention of an eviction or foreclosure, and funeral costs.
However, in each of these situations, even if the employer does allow the withdrawal, the 401 participant who hasn’t reached age 59½ will be stuck with a sizable 10% penalty on top of paying ordinary taxes on any income. Generally, youll want to exhaust all other options before taking that kind of hit.
“In the case of education, student loans can be a better option, especially if they’re subsidized,” says Dominique Henderson, Sr., owner of DJH Capital Management, LLC, a registered investment advisory firm in Cedar Hill, Texas.
What To Do When You Overcontribute To 401k
The IRS limits the amount contributed to a 401K to level the playing field for tax advantages. Since 401K plans are funded with pre-tax dollars, the more someone earns, the more they can afford to put away. Therefore, the IRS also enforces tax penalties for over contributing.
If you notice that youve overcontributed to your 401K, you should:
However, if the excess amount is not refunded back to you before April 15th, then you will have to pay taxes on the amount twice . Additionally, you will be subject to an excise tax of 6%.
Also, to make sure that youre not sitting on your hands and losing tax advantages, you should look into funding other retirement vehicles like an Individual Retirement Account .
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Open A Savings Account
Open a savings account at the bank of your choice if you do not have one already. Check to see if you can have money automatically deducted from your paycheck and put into your savings account. If you’re saving money for a particular purpose or goal, such as a downpayment on a new house, higher education expenses or a six-month emergency fund, it can be useful to create a separate account in addition to one you may already have.
Exhausting All Other Options
Investment advisors emphasize that people should exit a 401 only when they deem it absolutely necessary and have exhausted all other options. Remember, the 401 is above all a retirement account. It is wise to consult an investment professional before taking such a dramatic course of action.
“Many employees, as they are exiting their employment through retirement or a job change, rightly seek out advice from financial professionals,” noted Wayne Titus III, who is managing director at Savant Wealth Management in Plymouth, Michigan. “These may include a range of professions, from insurance agents, brokers, tax preparers, or CPAs.”
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Are You Investing Enough For Retirement
Periodically, you may decide to invest more for retirement. This can be easily done using the following steps:
Mistake #: Buying Too Much Of Your Companys Stock
If your employer’s stock shares are an investment choice in your 401, you may want to consider keeping your allocation to no more than 10 percent. Youre not being disloyal even the mightiest of companies think Enron and WorldCom can falter. With your salary already tied to your companys fortunes, you dont want a sizable part of your retirement savings to be similarly dependent.
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The Risks Of A Rollover
Before people roll over their 401 funds to an IRA, however, they should consider the potential consequences. “Consider the costs inside the 401 funds versus the total cost of an IRA,” including advisor fees and commissions, urges Terry Prather, a financial planner in Evansville, Ind.
Prather raises another, noteworthy scenario. A 401 typically requires a spouse to be named as the primary beneficiary of a particular account unless the spouse signs a waiver provided by the plan administrator. An IRA doesn’t require spousal consent to name someone other than the spouse as the primary beneficiary.
“If a participant is planning to remarry soon and wants to name someone other than the new spouse as the beneficiarychildren form a prior marriage, perhapsa direct rollover to an IRA may be desirable,” Prather says.
Reason To Forego 401 Contributions #: Youre In Debt
When youre dealing with the debt demon, it takes a certain measure of intensity to get it paid off. If youre being charged hundreds of dollars in interest each month, thats a big incentive to zero out your balances once and for all. The money thats coming out of your paycheck and going directly to your 401 could help you reach your debt-free goal that much faster.
If youre not sure whether it makes sense to temporarily suspend your contributions, consider how much youre paying in interest versus the kind of returns youre getting on your investments. If youre shelling out 15 or 20 percent to a credit card company but youre only seeing a return of 5 to 8 percent on your 401, youre basically going in the hole. Using the money to accelerate your debt payoff frees up more cash in your budget that you can then use to play catch up with your retirement savings.
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Key Considerations With 401 Loans
- Some plans permit up to two loans at a time, but most plans allow only one and require it be paid off before requesting another one.
- Your plan may also require that you obtain consent from your spouse/domestic partner.
- You will be required to make regularly scheduled repayments consisting of both principal and interest, typically through payroll deduction.
- Loans must be paid back within five years .
- If you leave your job and have an outstanding 401 balance, youll have to pay the loan back within a certain amount of time or be subject to tax and early withdrawal penalties.
- The money you use to pay yourself back is done with after-tax dollars.
Although getting a loan from your 401 is relatively quick and easy, the benefit of paying yourself back with interest will likely not make up for the return on investment you could have earned if your funds had remained invested.
Another risk: If your financial situation does not improve and you fail to pay the loan back, it will likely result in penalties and interest.
What Happens When You Borrow
The rules about 401 plans can seem confusing to workers. While employers arent required to offer the plans at all, if they do, they are required to do certain things but also have discretion over how they run the plan in other ways. One choice they have is whether to offer 401 loans at all. If they do, they also have some control over which rules to apply to repayment.
According to Michelle Smalenberger, CFP, Your employer may refuse to let you contribute while repaying a loan. Smalenberger is the cofounder of Financial Design Studio, a fee-only financial planning and wealth management firm. When an employer chooses what plan they will offer or make available to their employees, they have to choose which provisions they will allow.
If you cant contribute while repaying, remember that your employer is giving you a benefit by allowing the loan from the plan in the first place, Smalenberger adds.
And if you cant make contributions while youre repaying your loan, be aware that a higher amount of your paycheck will go to income taxes until you resume contributions.
If your employer does allow plan loans, the most you can borrow is the lesser of $50,000 or half the present value of the vested balance of your account, minus any existing plan loans. You must repay the loan within five years. And taking a loan puts you at risk of facing the obligation to repay it withina narrow time limit, typically 60 days or less, if you are laid off or quit.
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How Much Can You Contribute To A 401
Both forms of 401s have the same contribution limit: $19,500 for 2021 and $20,500 for 2022. The catch-up amount, which is for those aged 50 or older, allows these employees to contribute $6,500 more per year in 2021 and 2022.
Typically, there’s no limit to the amount of income you can earn to participate in either a traditional 401 or Roth 401. But the rare 401 plan might state that you can no longer make elective salary deferrals once you reach the total annual compensation limit. This is $290,000 for 2021 , even if you haven’t reached the yearly contribution limit.
Also, combined employee and employer contributions to a 401 must be the lesser of all of an employeeâs compensation or $58,000 in 2021. This increases to $61,000 in 2022.
Work With An Advisor For A Tailored Allocation Strategy
In addition to the above options, you can opt to have a financial advisor recommend a portfolio that is tailored to your needs. The advisor may or may not recommend any of the above 401 allocation strategies. If they pick an alternate approach, they will usually attempt to pick funds for you in a way that coordinates with your goals, risk tolerance, and your current investments in other accounts.
If you are married and you each have investments in different accounts, an advisor can be of great help in coordinating your choices across your household. But the outcome wont necessarily be betterand your nest egg wont necessarily be biggerthan what you can achieve through the first four 401 allocation approaches.
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Reasons To Skip Out On 401 Contributions
Investing in a 401 is a fairly hassle-free way to build your retirement savings but there are certain times when you should forego investing in a 401, like if you have more pressing financial problems, such as debt. While you will eventually be able to save for retirement, if you have issues that need addressing right away, it might make sense to put that off. For help figuring out how to prioritize 401 savings and other financial issues, consider working with a financial advisor.
Cashing Out Your 401k While Still Employed
The first thing to know about cashing out a 401k account while still employed is that you cant do it, not if you are still employed at the company that sponsors the 401k.
You can take out a loan against it, but you cant simply withdraw the money.
If you resign or get fired, you can withdraw the money in your account, but again, there are penalties for doing so that should cause you to reconsider. You will be subject to 10% early withdrawal penalty and the money will be taxed as regular income. Also, your employer must withhold 20% of the amount you cash out for tax purposes.
There are some exceptions to the rule that eliminate penalties, but they are very specific:
- You are over 55
- You are permanently disabled
- The money is needed for medical expenses that exceed 10% of your adjusted gross income
- You intend to cash out via a series of substantially equal payments over the rest of your life
- You are a qualified military reservist called to active duty
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Retirement Savings Can Benefit
As you make loan repayments to your 401 account, they usually are allocated back into your portfolio’s investments. You will repay the account a bit more than you borrowed from it, and the difference is called “interest.” The loan produces no impact on your retirement if any lost investment earnings match the “interest” paid ini.e., earnings opportunities are offset dollar-for-dollar by interest payments.
If the interest paid exceeds any lost investment earnings, taking a 401 loan can actually increase your retirement savings progress. Keep in mind, however, that this will proportionally reduce your personal savings.
How Does A 401 Work
A 401 is available in many workplaces as a benefit to employees. If your employer offers it, it’s worth considering it’s one of the easiest ways to start saving for retirement. Upon starting a new job, some employees are automatically enrolled in a 401 plan. Others may have to wait until a certain length of time is over to enroll in the plan.
When you enroll, you can specify what fixed percentage or amount of each paycheck you want to set aside in your employee 401 account. You can also choose which investments you want to put that money in and what portion of the money you want to go toward each investment. The spread of your money across different types of investments is known as your “asset allocation.”
HR departments often take care of the management of the plan. If you’re traditionally employed, your employer will deduct your contributions from your paycheck then, they will funnel them into the investments you chose, in your desired asset allocation. You’ll never even have to handle the money.
With a traditional 401, any contributions you make are excluded from your taxable income in the contribution year. In other words, they are eligible for a tax deduction that year. Also, contributions and earnings grow tax-deferred. This means you won’t pay taxes until you take distributions from the account.
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What To Do After Maxing Out Your 401 Plan
Eric is currently a duly licensed Independent Insurance Broker licensed in Life, Health, Property, and Casualty insurance. He has worked more than 13 years in both public and private accounting jobs and more than four years licensed as an insurance producer. His background in tax accounting has served as a solid base supporting his current book of business.
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If you’ve already reached your 401 contributions limit for the year , that’s a problem. You can’t afford to fall behind in the funding-retirement game. Also, losing the contribution’s reduction in your gross income isn’t going to help your tax bill next year, either. These pointers will help you decide how to handle maxing out your contributions and hopefully avoid a large tax burden.
Max Out 401k Employer Contributions
Your employer may offer matching contributions, and if so, there are typically rules you will need to follow to take advantage of their match. An employer may require a minimum contribution from you before theyll match it, or they might match only up to a certain amount. They might even stipulate a combination of those two requirements. Each company will have its own rules for matching contributions, so review your companys policy for specifics.
For example, suppose your employer will match your contribution up to 3%. So, if you contribute 3% to your 401, your employer will contribute 3% as well. Therefore, instead of only saving 3% of your salary, youre now saving 6%. With the employer match, your contribution just doubled.
Since saving for retirement is one of the best investments you can make, its wise to take advantage of your employers match. Every penny helps when saving for retirement, and you dont want to miss out on this free money from your employer.
If youre not already maxing out the matching contribution, you can speak with your employer to increase your contribution amount.
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