Retirement savers are playing catch-up. Blame the bear market, which sacked nest eggs for losses last year, causing account balances to shrink, especially in the first half of 2022. The good news? Unlike NFL football, the clock doesn't run out in the retirement savings game.
Comebacks are possible if you have the right game plan — and stick to it. Here's a roadmap to recovery.
You can't control what the market does. But you can control the way you react to volatility and temporary portfolio losses, says Rob Williams, managing director of financial planning and retirement income at the Schwab Center for Financial Research (Charles Schwab).
What you don't want to do, Williams says, is "swing for the fences" and try to make all your money back fast by betting on the hot stock of the day. "You might get lucky, but the risk is too high," Williams said.
What you do want to do is execute a sound plan that boosts your odds of getting your retirement savings back on track. That means you'll have to make many financial moves that when taken together will add up and help you steadily replenish your 401(k).
Retirement Savings: Max Out And Catch-Up
A smart fix is to sock away as much as you can in tax-friendly retirement accounts like 401(k)s and IRAs.
"Pay yourself first," said Emily Irwin, senior director of advice at Wells Fargo. With both retirement account balances and the market down, now is the time to spend less so you can free up more dollars for savings and investments.
The upside? You'll be able to invest more in growth-oriented assets like stocks at depressed prices, which will enhance returns when the eventual recovery occurs.
So, if possible, max out your retirement savings (and at a minimum invest enough to get your company's 401(k) matching contribution). The IRS, in an effort to offset rising inflation, boosted max IRA contributions by $500 to $6,500 in 2023 for people below age 50; individuals 50 or over can save $7,500.
And 401(k) investors have an even bigger opportunity to play catch-up. In 2023, savers younger than 50 can sock away $22,500 in 401(k)s, up $2,000 from last year. And the catch-up contribution for folks 50 or older rose $1,000 to $7,500. That means people 50 or older can save $30,000 a year in a tax-deferred
401(k).
"This is a gift from the IRS," said Christian Thwaites, partner, at financial advisory firm Cerity Partners.
And the gift keeps giving. Catch-up contributions are a way to play offense again. The numbers add up quickly. For example: Investing $2,500 a month (the $30,000 annual max) over 10 years at a 10% return will result in a nest egg of $510,128.
Or invest $2,500 a month (the $30,000 annual max) over 5 years and a 10% return will build a retirement savings account of $196,956.
Reinvest Idle Cash In Regular Installments
Are you sitting on a big chunk of cash because you got spooked by the market volatility and sold in a panic? If so, start putting that money back to work in stocks, which generate larger returns over time than less-risky assets like cash.
Wells Fargo's Irwin recommends investing the money over the course of three, six or 12 months, rather than investing a lump sum. By layering in, you'll avoid the buyer's remorse if you put all your money in on the wrong day.
"Use dollar-cost averaging instead of going all-in," Irwin said. "Set a dollar amount or a percentage of cash you want to invest over a certain time period. Regardless of what the market is doing, go in with a set amount and stay the course."
Take Advantage Of IRS Tax Changes
Retirement savers should also take advantage of inflation adjustments the IRS made to the tax code, Irwin says. Uncle Sam boosted the standard deduction for the 2023 tax year from $25,900 to $27,700 for married couples filing jointly.
That move reduces the amount of income a couple pays tax on by $1,800.
That's real money. So, if you need the extra income, adjust your tax withholdings so you get access to the extra cash, Irwin says. "Let's get the money now," Irwin said. And if you don't need more cash flow, treat the tax break as a raise and save or invest the money.
"Pretend like it never existed and use the money for some targeted goal, such as replenishing your emergency fund or retirement investment account," Irwin said.
Consider An IRA Roth Conversion
Run the numbers with your financial advisor to see if doing a Roth IRA conversion makes financial sense. With a Roth conversion you'll pay taxes upfront on the value of a traditional IRA and then get tax-free withdrawals on the new Roth IRA at age 59 ½ and after you've met the five-year holding period.
Why does a conversion make sense now? Because the market value of your IRA is likely lower due to the sharp decline in stock and bond prices. As a result, the dollar amount you'll be taxed on in the Roth conversion is smaller, which equates to a smaller tax bill.
What's more, the shares you convert to a Roth IRA will benefit from the eventual rebound in asset prices. And with the Trump tax cuts set to expire in 2025, you'll lock in lower tax rates now.
"It's a little bit of a (positive) perfect storm," said Irwin.
Generate Income With Bonds
The days of 0% interest rates are over, thanks to the Fed raising its funds rate seven times in 2022 from 0% to 0.25% back at the beginning of the year to 4.25% to 4.5% on December 14, 2022 to fight inflation. That means retirees can once again generate decent income to pay the bills with the help of higher-yielding bonds, says Duane McAllister, co-head of municipal bond investments at Baird Advisors.
"You're getting a much higher income level than you were a year ago," McAllister said. Plus, interest earned on muni bonds is not taxed by the federal government and are often free from state taxes, too, depending on where you live. The tax-equivalent yield on a muni bond earning 5.5%, for example, would be nearly 9% and even higher in states that charge high income taxes, McAllister says.
When it comes to taxable bonds, investors can now earn yields as high as 4.4% on U.S. Treasury bonds; investment grade corporate bonds now fetch 5% to 6%; and junk bonds yield even more.
I Bonds issued by the U.S. Treasury also currently sport an attractive yield of 6.89% (through April 2023). These bonds must be purchased directly from the TreasuryDirect website. Investors need to understand the rules regarding how much they can invest annually in I Bonds and penalties for early withdrawal.
Rebalance Your Out-Of-Tilt Portfolio
The steep losses suffered by stocks in 2022 might have left you with a lower weighting in stocks than
your financial plan calls for. Now is the time to rebalance your retirement savings portfolio to get your mix of stocks, bonds and other assets back in line with your long-term goals, says Brad Bernstein, managing director and senior portfolio manager at UBS Wealth Management.
"Everyone's asset allocation is out of line after all the market volatility," Bernstein said.
Eliminating losers from your portfolio that you're not confident will bounce back is also a useful strategy from both a rebalancing and tax standpoint. You can offset $3,000 in gains with losses for the 2023 tax year and carry over additional losses in future tax years.
When rebalancing your portfolio, you should also review your holdings to see if you are properly diversified. Make sure you're not betting too much of your portfolio on a single sector, such as tech or health care, or an investment style like growth, or an individual stock. If that's the case, reduce the concentration of your portfolio by trimming some overweight holdings and investing the proceeds into areas of the market that you have less exposure to.
Avoid Panic Selling, Stay In The Game
What you don't want to do after a market free fall is self-sabotage your retirement. "The worst thing to
do is to panic and sell," says Schwab's Williams.
Still, there are crunch times when you have no choice but to tap your 401(k) as a last resort. In fact, in a sign of financial strain, an investor survey by Vanguard found that "hardship withdrawals" from employer-sponsored retirement accounts recently reached an all-time high.
Those early withdrawals result in a tax hit and possible 10% penalty. If you've taken an emergency distribution, put together a "plan to replenish what you've removed," says Dan Cronin, founder of Lifestyle Wealth Management. Move on from short-term troubles and get back on track as soon as you can.
"Investing and saving for retirement is a long-term game," Schwab's Williams stresses. "Stay in it."
