The COVID-19 pandemic resulted in unemployment levels unseen since the Great Depression. If your household is experiencing reduced income due to job loss, furlough, or reduced hours, the immediate reaction might be to reduce spending to the bare minimum in order to “Weather the Storm.” SAVVI understands that reaction, so we built our COVID Relief Planning Assistant to offer smart, personalized advice on ways to cut back or access savings, loans or retirement accounts while keeping long-term goals in mind. Our COVID Relief Planning Assistant is free for users who need guidance at this critical time.
After a loss or decrease in income, you might consider cutting back (401)k (or other retirement savings plans) or health savings account contributions, but it may actually make sense to continue contributing to these plans, or to shift balances, in order to optimize your outcomes during the crisis. The COVID Relief Planning Assistant’s “Weather the Storm” goal can offer guidance, but here we’ll share a couple quick tips that may help you keep more of your current and future savings.
Keeping the Match
If, after your income reduction, your household still has access to an employee sponsored retirement plan, you may have cut back or suspended contributions to free up cash flow for necessary expenses. This may mean losing tax benefits, or even “free money” from your employer via matching contributions, but committed expenses like your rent or food certainly take precedence. In some cases, however, you may be able to meet your expenses and keep contributing.
The CARES Act legislation, designed to help Americans affected by the crisis, permits you, if your plan allows, to take out up to $100,000 of your retirement account balance before age 59 1/2 without the usual 10% penalty, and if you want you can pay back the distributions within three years after you're back to work. This includes IRA accounts. Current 401(k) participants can take loans of up to $100,000 or up to 100% of the account balance with no repayments due for one year, if your plan allows, and interest does accrue on the loan. Generally speaking, these hardship withdrawals or loans should be avoided unless absolutely necessary, particularly because a withdrawal may mean selling assets at a now depressed valuation. But if it means keeping a significant matching contribution, you may consider using this provision to access needed funds from one account, while continuing to contribute to another account to capture the matching contribution.
With lower income may also come a lower tax bracket. This could be an ideal time to do a Roth Conversion. A Roth Conversion allows you to convert an existing deductible Individual Retirement Account (IRA) into a Roth IRA, taking an account that will be taxable in retirement, paying taxes on the converted funds and in doing so creating a tax-free account for your retirement years. Perhaps one of the more important factors in your decision on whether or not to convert to a Roth IRA is how you will choose to pay income taxes at the time of conversion. If you’re financially capable of paying the income taxes “out of pocket,” you should consider a Roth conversion. In fact, by paying income taxes from out-of-pocket sources, you keep your IRA balance intact, therefore allowing the converted Roth IRA to fully take advantage of tax-free growth over time. If you choose to pay taxes from your IRA principal, converting may not provide the best long-term result. You may find that a lower income places you within income limits to contribute to a Roth. You may consider allocating distributed funds from one traditional plan as a contribution to a Roth IRA, or perhaps using a “backdoor” Roth strategy of contributing to a traditional IRA and then converting it. Regardless of the strategy to get funds into a Roth IRA, you’re creating a greater tax-free nest egg for your golden years.
The retirement plan provisions of the CARES Act essentially allow you to “shift” balances among retirement plans by taking distributions from one and contributing to another. We already discussed the value of shifting balances to capture an employer-matched contribution; shifting balances also may be of assistance if you and your spouse have an age difference. If you do not anticipate needing this portion of your nest egg earlier in retirement, you may shift funds to your younger spouses plan to extend the time before RMDs (required minimum distributions) are required. On the flip side, if you need access sooner, understanding the 59 ½ age for penalty-free withdrawal, you may decide to allocate funds to an older spouse’s plan.
Another powerful step that can help at this time is continuing to contribute to a Health Savings Account (HSA), if you have one. Since HSA funds are intended to pay for out-of-pocket medical expenses not covered by insurance, you are permitted to make tax-exempt yearly contributions up to a maximum of $3,550 for individuals and $7,100 for families in 2020. If you are age 55 or older, you may make additional contributions of $1,000 in 2020. The accounts are owned by the individual and are fully portable from job to job. The tax advantages of the HSA are substantial. Contributions to and withdrawals from an HSA are tax free, provided the funds are used to pay for qualified medical expenses. The investment earnings within the account also grow tax free. Any funds left over in your HSA at the end of the year can remain in the account, and you can start all over with your contributions. If you use little of the money in your account and continue to make deposits, you could end up with a substantial nest egg by the time you reach retirement. Prior to age 65, non-medical distributions are taxed as part of gross income and are subject to a 10% penalty. After age 65, however, you are permitted to withdraw funds from an HSA for non-medical reasons by simply paying the income tax due. Even after a job loss, you’re going to incur health expenses. Leveraging these benefits is as valuable now as prior to losing your job or your reduction in income.
While it may seem counterintuitive to save into retirement and health savings plans at this time, the short- and long-term benefits make a meaningful difference. With help from SAVVI you can meet your critical monthly expenses, and by leveraging new but temporary rules provided by the CARES Act, create a more sustainable retirement plan for your future.
If you've been financially impacted by the Coronavirus crisis, click here to take advantage of our free interactive tool. The questionnaire will help you determine if you qualify for assistance to maintain financial stability in this time. If you qualify, you will also have access to a free comprehensive financial plan from SAVVI. Your SAVVI plan will take into account the effects of the current crisis, while helping you achieve your long-term goals.
SAVVI Financial LLC (‘SAVVI’) is an investment advisor registered with the Securities and Exchange Commission. SAVVI does not guarantee investment results and past performance is no guarantee of future results. Information provided is for educational purposes and does not constitute investment advice, which is only provided to registered users who have a valid Investment Agreement in place with SAVVI. No information on this presentation should be construed as an offer to buy or sell any security or insurance product. SAVVI is not a certified accountant, lawyer, tax professional or HR professional. Nothing in this document may be considered as tax, accounting, employment or legal advice. Please consult with your accounting, tax, human resources or legal professionals before taking any action.