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Tag: 401k Consulting

401k Participant Update: Q & A with a 401k Advisor

By: ANTHONY MCCALLISTER, AIF®, J.D., Senior VP, Wealth Advisor

We have held many 401(k) group meetings, one-on-one meetings, and phone calls with 401k participants this year. Understandably, participants are concerned with the markets and their 401(k) accounts. What follows are a couple of the common questions we’ve been asked and our general responses. 

Question:

I am tired of contributing to my 401k and seeing it decline in value.  Should I stop funding my 401k until the market stabilizes?

Answer:

We generally believe it best to continue contributing to your 401k to take advantage of dollar cost averaging.  Contributing consistently is an important step in preparing for your retirement.  You control your payroll deductions directly from your paycheck, helping to make this a simple and effortless process.  Coupled with the principle of dollar cost averaging, this consistent payroll deducted contribution into your 401k throughout your working career can help you reach your retirement goals.  Dollar cost averaging is the investment of equal amounts of money at standardized points over time, regardless of the price of the underlying securities.  This can lower the impact of price volatility, as we are experiencing currently, and can lower the average cost of the investments being held.

Question:

My account has declined in value this year.  Should I move my account into something safe (i.e., the money market, stable value, guaranteed account, or other cash equivalent) until I see the market rebound and I feel better about it? 

Answer:

While everyone’s situation is different, we do not recommend trying to time the market; we believe it is better to focus instead on long-term investing.  Timing the market includes when an investor moves some or all of their stock investments to cash in an attempt to avoid a market decline and with the hope of later reinvesting into a market rebound.  While this sounds like a good strategy, this requires a participant to make two correct decisions: when to sell and when to buy.  In the previous 12 bear markets of the S&P 500 Index, the index had positive returns a year following entering the bear market in all instances but three.  The average one-year return was 23.9%.  But reviewing each of these 12 bear markets individually on a one-month, three-month, six-month, and one-year basis, the returns they experienced differ significantly, making timing when to enter back into the market very difficult.   (https://www.wsj.com/livecoverage/stock-market-today-dow-jones-bitcoin-fed-rates-06-14-2022/card/how-the-s-p-500-performs-after-closing-in-a-bear-market-yBwgfJwW8HGSNJaKg6LB).

It is very difficult to time when to leave the market to avoid market declines.  It is equally as difficult to determine when to reinvest an account at the opportune time in order to experience any market rebound.  We believe the best course of action is to maintain an appropriate, diversified mix of stocks and bonds, investing for the long-term in light of a dynamic plan for reaching your retirement goals.

In these difficult markets, we recommend holding fast to investment principles of resisting the urge to sell equities into declining markets, not attempting to time the market, focusing on investing with a long-term financial plan in mind, and continuing saving through dollar cost averaging.   Do not hesitate to contact your CapSouth Financial Advisor to schedule a time to discuss your individual situation and to review your accounts.

(See: https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/market-updates/on-the-minds-of-investors/is-market-timing-worth-it-during-periods-of-intense-volatility/).

CapSouth Partners, Inc, dba CapSouth Wealth Management, is an independent registered Investment Advisory firm. Any opinions expressed in the material are those of the author and are not presented as facts. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results. The S&P 500 Index is an unmanaged, capitalization-weighted index that measures the performance of 500 large capitalization domestic stocks representing all major industries. Indices do not include fees or operating expenses and are not available for actual investment. This article contains links to third party content (content hosted on sites unaffiliated with CapSouth Partners). CapSouth makes no representations whatsoever regarding any third party content/sites that may be accessible directly or indirectly from this article. Linking to these third party sites in no way implies an endorsement or affiliation of any kind between CapSouth and any third party, including legal authorization to use any trademark, trade name, logo, or copyrighted materials belonging to either entity.

Refunds to the Highly Compensated

Refunds to the highly compensated employees (HCE) in a qualified retirement plan can be frustrating to the participants and a challenge to the plan administrator.  Various options exist to improve this situation.  These include:

  • More effectively manage the deferral and refund process
  • Eliminate the issue of refunds caused by testing
  • Allow the participant to continue to individual retirement accounts

This article will discuss these options.

  1. More Effective Management 

If a plan is using the “current year” testing method, consideration could be given to using “prior year” testing.  Under the “current year” option, the data is not finalized until after the end of the year and the HCEs do not know the amount they can contribute until after the testing is completed.

Under the “prior year” option, the data from the previous year is used to provide the maximum deferral amount for each HCE.  This should eliminate excess deferrals that require refunds.

Another option is to notify the HCE at the beginning of the year regarding the estimated maximum deferral.  This is based on the prior year average deferral of the non-highly compensated employees (NHCE) and a review of the current deferrals of each of the HCE.  Of course, this amount may change during the year due to changes in the deferrals of either group.

  1. Consider a Safe Harbor Plan

A safe harbor plan allows the HCE to contribute the maximum allowable deferrals without regard to the average deferrals of the NHCE. There are various safe harbor options that a plan could consider.  These include:

  • Basic Safe Harbor Match (equal to 100% of amount contributed up to 3% of pay, plus 50% of amount contributed, up to the next 2% of pay);
  • Enhanced Safe Harbor Match (must be at least as generous as the basic formula, normally equal to 100% of amount contributed up to 4% of pay);
  • 3% Non-Elective Contribution (NEC); and
  • Qualified Automatic Contribution Arrangement (QACA):
    • QACA Match (equal to 100% of amount contributed up to 1% of pay, plus 50% of amount contributed, up to the next 5% of pay) or
    • QACA 3% NEC.
  1. Options for the Participant

Each HCE has several options to contribute to retirement accounts outside of the qualified plan.  These include:

  • IRA Deductible Contributions:  In most cases, HCEs do not qualify to make deductible IRA contributions.
  • Non-Deductible IRA Contributions:  Most HCEs qualify to make non-deductible IRA contributions.  The maximum contributions to IRA accounts for 2022 is $6,000 plus $1,000 for employees 50 and older. 
  • IRA to Roth IRA Conversions:  Each HCE should carefully consider the strategy of making non-deductible IRA contributions followed by a Roth conversion.  This works extremely well with participants who do not have an existing IRA account.  The non-deductible contribution is made, and the account is immediately converted to a Roth IRA.  The result of this process is that the money ends up in a Roth IRA growing income tax free just as it would have if the HCE elected to defer to the Roth 401(k) account inside the qualified plan.  If the participant has existing IRA accounts with zero basis, this option does not work as well.  In this case, the conversion would create additional taxable income.  This may or may not be an issue based on the current tax bracket and the projected future tax brackets. 
  • Some HCEs have outside businesses that generate taxable income.  In some cases, the HCE has the option of opening a SEP plan and deferring money to the SEP account.
  • Annuity contracts often allow investors to contribute unlimited amounts.  These contributions are after tax and form the basis in the annuity contract.  All the accumulated growth and earnings in the contract grow tax deferred.  Caution should be taken to avoid buying an annuity that has high internal fees and pays high commissions to the salesperson.  Always inquire as to the commissions to be paid, total expenses of the plan, and withdrawal options and penalties. 

Plan administrators should carefully consider the plan design to determine if changes could be made to manage this process more effectively.  HCE should seek guidance from qualified advisors to examine the various options available to assist them in making the critical long-term decisions regarding their retirement planning. 

by: Anthony McCallister, AIF®, J.D.

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To discuss this article further or to learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or call 800.929.1001 to schedule an appointment to speak with an advisor.

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice.

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