Coronavirus and Retirement: The Reality and What to Do
By Matthew J. Knee, Specialist at New Hampshire Financial Services, LLC
Many economists and retirement specialists, me included, expect the Corona Virus outbreak to cause a recession. Since many people made poor financial investment decisions in the last recession, I am writing to remind us that we are the controllers of our own destiny.
To quote the Greek philosopher Epictetus, “It’s not what happens to you, but how you react to it that matters”.
Let me start with three considerations. First, pause with gratitude if you have a retirement account – nearly half of American workers do not. If you do not have a retirement account, now is a good time to get one. Second, know that in the last recession the market fell 57% over the course of two years. It took the average account an average of thirty-six (36) months to return to the original account value before the markets fell. Third, in just over a month between the dates of February 10th, 2020 and today March 20, 2020 the S&P 500 has plummeted 32% and is showing no signs of slowing its decent.
This is likely to be the largest economic decline we are going to see in our lifetimes. I am not bringing this up to fear-monger, rather to explain the seriousness of the situation we find ourselves in.
There’s a joke often heard in the financial industry, for those who have been around long enough, that recession turns the American 401(k) into a 201(k). The nation’s 401(k) and IRA’s lost about $2.1 Trillion over the course of the 2008 recession. However, by implementing strategies to help you mitigate losses and capitalizing on the opportunities that recession creates – you can come out ahead of the curve.
It’s important to act and not to become paralyzed by analysis in these times. We have all heard the saying, “A deer caught in the headlights gets hit by the car”. We have been advising our clients to do the following.
Protect what they have
Stay the course with their savings plans – maybe even increase their contributions
Continue taking advantage of the tax-saving available over the next seven (7) years
Not to look at their account balances too often
Not to add more years to the mortgage if they are considering refinancing
To practice social distancing
To wash their hands with increased frequency
To do what they can to comfort the anxious and sick – though, maybe not in person.
Protecting what you have. There is a problem with percentages when it comes to investing. It is twice as hard to earn in the market as it is to lose as demonstrated below.
$100k + 50% = $150k
$100k - 50% = $50k
$50k + 50% = $75k
For many, most of their retirement savings is allocated in their employer sponsored retirement plan. Whether this is a 401(k), 403(b), 457, profit sharing plan, direct benefit pension plan, or other similar account. It's easy to feel restricted to the equity allocation options that these plans provide because you do not want to incur a taxable event, tax withholding, or a penalty for touching the money before the age of 59½.
You can contact your Human Resources department or plan manager and transition to a more conservative equity allocation or transition to a money market account to help stem the tide of decline.
Thankfully, you are most likely no longer tethered to staying in your employee sponsored retirement plan. Under current law, you can roll out of these plans into a ‘like account’ using an in-service distribution. This includes things such as an IRA that will allow you more control over the equity allocations without incurring a taxable event or penalty for moving the money before the age of 59½.
In the current economic condition, we have found fixed indexed alternatives to be a great resource for many. In short, these alternatives allow you to both protect your principal from negative market risk and grow with the market during positive years.
You can have your cake and eat it too.
To demonstrate, below we have backtracked how a $100,000 investment, with no additional contributions, performs over history since January 1st, 1999 to March 18th, 2020. The red line represents the S&P 500 naked. The green line represents the fixed indexed alternative vehicle. The blue line represents a 3% growth that would keep pace with inflation and maintain the same purchasing power over the term.
The core dilemma that many are facing lays in volatility potential and risk tolerance.
By eliminating loses and accepting slightly lower interest earning potential, you allow yourself to stay ahead and avoid gambling with your retirement dollars.
Stay the course with your savings and investing. Bear markets and recessions are not permanent, and our economy will recover from this – over time. Just because you have protected what you have already earned in your employer sponsored retirement account, IRA, or other account - does not mean that this is no longer an asset for you to use and capitalize on.
Continuing to save and invest allows you to follow the rules of dollar-cost averaging. Many investors are buying stocks and funds that they believe are on sale at the current time. Because of this, if you can, downward markets are a great time to increase your contributions to your savings plans.
The maximum annual 401(k) contribution is $19,500 in 2020, ranging up to $26,000 for those above the age of 50. Only 4.6 Million taxpayers out of 140 million get the maximum tax advantage for saving in retirement accounts. Your HR department will celebrate your joining the elite club of maximizers.
This said, if you don’t have three to six months’ worth of expenses saved in an emergency fund. You might find value in temporarily stopping your contributions to your retirement accounts and allocate those dollars to create a safety buffer.
Continue taking advantage of the temporary tax cuts. The tax is the tax is the tax. Your traditional IRA has a silent partner named Uncle Sam. Because your traditional IRA and 401(k) grows tax deferred with pretax contributions, a Required Minimum Distribution (RMD) is associated with your account. When a person reaches the age of 72, they are required by law to withdraw a certain amount from the associated retirement account and pay taxes on the withdrawal.
Politics aside, the Trump tax-cuts allow for individuals to take advantage of taxes being at a historically reduced rate for a limited period. Owners of traditional IRA’s and other pre-tax and tax deferred accounts need to explore the potential benefits of a Roth Conversion. A Roth conversion essentially buys Uncle Sam out of your partnership through an up-front tax payment.
The amount you convert is added to your current income and taxed at the appropriate rate. After a conversion the money in the Roth account is all yours – there are no more taxes to be collected on the principal or the growth. It is important to note that you do not need to convert the entire account at once. You have the ability to do conversions in segments so that you aren’t straddled with a large tax bill for a one time conversion.
If you aren’t working with an advisor, financial/tax professional to find out how you can best capitalize on these conversions during this period to gain long-term savings – it may be a great time to find someone that you can work with.
That said if you are already working with someone, you may want to ask yourself why they haven’t brought up this conversion strategy over the past three (3) years since the tax cuts were implemented. Are they a conflicted advisor?
Don’t look at your account balance too often. Studies show that people who check their accounts and participate in trades frequently tend to buy high and sell low when compared with those who re-balance periodically.
Evidence suggests that people who are open-minded and have neurotic traits are especially vulnerable.
Don’t add more years to your mortgage if you are refinancing. You want to make sure you are never in a situation where you have to sell stocks or liquidate investments to pay a mortgage when you or a family member loses a job, hours, or gig in a recession or after entering into retirement.
If you are in a position where you can make additional payments, when you refinance it may be beneficial for you to investigate a biweekly mortgage payment option. With a biweekly mortgage plan, one additional mortgage payment is made each year. That extra payment goes towards the principal of the loan.
Since this reduces the amount of the loan balance quicker, the biweekly mortgage plan will also reduce the amount of interest charged over the life of the loan.
This recession doesn’t have to be as bad as the last one.
It depends on how quickly you decide to prioritize your planning and implementing your strategy. Your retirement savings or distribution planning should be going under some healthy hygienic maintenance right now.
Remember, protect what you have, keep saving and investing, take advantage of the tax cuts, and don’t panic. But most importantly, do all you can to stay healthy and take care of your loved ones and our community.
As always, I hope you find my words informative and educational. If you are looking for more information, feel free to explore our website and browse our resources and blog section.
If you are looking for a more direct source of guidance, we also offer free no obligation consultations.