Rationally, we all know the stock market goes up and down. But after a 10-year run of solid performance, the downswing of 2020 hits particularly hard -- especially if you're retiring soon. And even though the market has recovered somewhat from its low point earlier this year, your 401(k) balance is probably still smaller than you'd like. Here are four ways to handle those declines in your retirement account.
1. Delay retirement and increase contributions
Extending your career for a year or two, if you have that option, is the most straightforward response to declines in your 401(k). It helps, too, that you're probably spending less on gas, dining, and entertainment as you practice social distancing. If your job is secure enough, you can redirect those savings into your retirement account by way of higher contributions.
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If you are 50 or older, you can contribute up to $26,000 annually in your 401(k) in 2020. That's $1,000 per paycheck if you get paid every two weeks. At that contribution level, working for an extra year would add $26,000, plus any employer-matching contributions, to your retirement balance. Over the course of 20 years, $26,000 will almost triple in value, assuming a 5% average annual return.
Another perk to retiring later is a higher Social Security benefit. If you're over the age of 62, every month you put off your Social Security claim means an increase to your monthly benefit.
2. Downsize and stick with your original timeline
If continuing to work isn't an option, you could downsize and proceed with your original retirement timeline. Downsizing might involve major actions, like selling your home and buying a cheaper one. Or it could mean trimming away some of your discretionary spending. Maybe you'd planned for a healthy travel budget in retirement, for example. That would be an easy place to cut back -- especially in the short term.
Can you envision being happy long term with a retirement lifestyle that's leaner than you had planned? If the answer is yes, you can take a lot of pressure off your savings. Say you have $1 million in your 401(k), and it's earning 5% annually. Assuming inflation of 2%, if you spend $50,000 a year, your money should last 30 years. But if you could reduce those annual withdrawals to $45,000, you can stretch your savings for an additional five and a half years.
3. Claim Social Security and work part-time
You could also claim Social Security and transition to a part-time job. If those two income sources together are enough to pay the bills, you could delay taking any distributions from your retirement account, which would give your balance time to recover from the losses incurred this year.
You are subject to an income cap if you claim Social Security benefits before full retirement age (FRA). FRA is based on your birth year. For everyone born after 1943, FRA is somewhere between 66 and 67. In 2020, the income cap is $18,240. Any wages earned above that amount will reduce your monthly Social Security benefit.
Once you reach FRA, you can work as much as you want, and your earnings will not change your benefit.
4. Review your asset allocation and sit tight for now
On March 23, 2020, the S&P 500 was down about 30% for the year. One month later, despite ongoing economic fallout from the coronavirus pandemic, the index had recovered enough to show only a 10% drop for the year. That doesn't mean there won't be more declines in the future, but it does remind us that there is value in riding out market turbulence. You'd be kicking yourself if you'd sold out at the end of March, right?
Economic uncertainty will continue, at least until COVID-19 is under control and communities start to reopen. In the face of the unknown, sometimes the best strategy is to check your asset allocation and then, if you're comfortable with the composition of your portfolio, do nothing.
Revisit your 401(k) investments and your reactions to the market volatility in the first quarter of this year. Were you losing sleep and constantly stressed out? Those are signs you're invested too aggressively for your risk tolerance. You might reduce your equity funds and increase your positions in more stable assets, such as bond funds or target-date funds that have already passed their target retirement year. On the other hand, if you were able to ignore most of the market drama, your current allocation is probably within your comfort level.
A little of this, a little of that
You can also combine these strategies. Continuing to work, full- or part-time, can support additional retirement contributions or at least keep you from taking withdrawals. Either will improve your long-term solvency. And it's always a good idea to review your spending and cut out the fat. Make those moves now, and you'll minimize the effect this year's volatility has on your long-term financial stability.
