Everyone’s nervous about their investments right now. It’s time for a plan review and course correction, if necessary.
- Roger Wohlner
- Publish date:
Some of your clients might be feeling nervous about their 401(k) plan during this period of market volatility arising from the COVID-19 pandemic. Financial advisers should be working with their clients to ensure that these accounts remain invested in a fashion that will help clients realize their retirement goals.
Especially for nervous clients, this is a good time to review where their 401(k) and similar retirement accounts fit into their overall financial and retirement plans. This conversation will vary by client depending upon their age and other factors.
Even for those clients nearing retirement, their retirement accounts need to balance protection against downside risk with the opportunity for growth to fund a retirement that could last 20 to 30 years or longer.
Periods of market volatility are a good time to review a client’s overall situation, and their 401(k) plan is a key component of the retirement planning strategy for many clients.
The 401(k) account review should be a part of any overall financial review session that you are doing with a client. Clients want to feel comfortable that this account remains properly invested. The more nervous among your client base may need a higher degree of reassurance than some others.
How have their investment options fared versus other funds in their peer group over time and during this market downturn? This is an important question if the plan is a high-cost one, or if the investment options are just marginal.
Does the account need to be rebalanced due to the recent levels of market volatility? Even if the client has set the account to auto rebalance periodically, this might be a good time to manually rebalance the account back to its target allocation to ensure that the client is taking the appropriate amount of risk for their situation.
The 401(k) should be looked at in the context of the client’s overall portfolio for those with significant investments outside of their 401(k) plan. This might include taxable accounts and well as IRAs. The need to rebalance will likely extend to other parts of the client’s portfolio and their 401(k) should be included in this overall rebalancing review. Depending on a number of factors such as the quality of the investments offered in the plan, the client’s tax situation and their liquidity needs, certain asset classes may need to be over- or underweighted inside the 401(k) to achieve the desired overall asset allocation across the client’s total portfolio.
For clients who are not maximizing their contributions to their 401(k) plan, this is a good time to suggest that they increase their contributions. With the valuations of many investment options, especially those that are equity-based, off their highs reached in early 2020, this can be a good time to maximize contributions.
Consider a Roth Option
If your client’s plan offers a Roth option, this might be a good time to consider converting some of the money held in the traditional 401(k) option within the plan to the Roth option. The circumstances in 2020 present a good opportunity to consider a Roth conversion for several reasons.
Tax rates remain at low levels as a result of the tax reform that went into effect for the 2018 tax year. These low rates make a conversion cheaper. Add to this the fact that account valuations are generally lower at this juncture due to the decline in the markets. The latter factor allows your clients to potentially convert a higher percentage of their account for the same tax liability.
Additionally, the rule changes contained in the SECURE Act regarding most non-spousal beneficiaries of inherited IRAs make a Roth 401(k) that can be rolled over to the Roth IRA when your client leaves their employer a compelling option for some clients.
Loans and Distributions Under the CARES Act
The CARES Act allows employers to offer increased loan limits with liberalized repayment options compared to the normal loan provisions. It also allows for distributions for employees impacted by the COVID-19 pandemic that waive penalties for those who are younger than age 59½. There are provisions to spread the taxes on these distributions over a three-year period, as well as provisions to recontribute some or all of the amounts taken as a distribution to avoid taxes on those amounts. Employers must opt to accept either or both of these provisions for their plan.
Unless there is a true financial need on their part that can’t be met elsewhere, neither option is likely the best one. They may view this as a source of funds to be tapped, or they may be fearful of where the markets and the economy are headed and want to get some of their money out of their 401(k). In most cases this is not in their best interest and as their financial adviser you should lay out why this is the case and encourage them to stay the course.