Don't panic and withdraw unneeded funds from your 401(k)
Filed under: Retirement
One of the worst mistakes you can make right now is to withdraw money from your 401(k). Not only will you lock in the stock losses, but you'll pay a 10 percent penalty plus income tax on the money you take out.
Even if you are over the age of 59 1/2, when you no longer need to pay the 10 percent penalty, you still would have to pay income taxes.
You may think pulling your money out of your 401(k) will protect it from further declines. But if you are older than 59 1/2 and in the 25 percent tax bracket and withdraw funds, your cash will be reduced by another 25 percent. If you are younger than 59 1/2 and withdraw funds, you're looking at an additional 35 percent reduction.
Yes, your portfolio is likely hard hit unless it was 100% in a cash position. With the current market devastation, there really hasn't been a safe investment that was untouched. Both bonds and stocks were hard hit. In a recent study done by EBRI, it found that the average 401(k) of a person 56 to 65 lost about 25% of their investment if they were investing for about 20 years. If they were only investing for about 7 years, they probably saw a loss of about 29 percent. But, if you move that money to cash right now, you'll be locking in those loses and never recover from them.
Better than moving to cash would be to invest in a well-diversified portfolio of mutual funds. If you need ideas, one of my favorite mutual fund columnists, Paul Farrell, gives you a number of lazy portfolios from which to choose. I recommend you pick one and structure your 401(k) holdings to match the types of holdings in that portfolio.
For those of you who feel comfortable managing your own stock portfolio, you probably already realize we're in market that's at bargain basement prices. Yes, it's possible the market will still go down a bit more, but the bigger question for long-term investors is what is the best thing to buy now that will recover in two to three years. A good way to find out what your favorite investing gurus are doing is to visit GuruFocus.com and see what the top stock pickers are buying and selling. You'll find some great ideas. Put together your list of favorites and watch their stock prices. Immediately after a guru buys a stock you'll probably see a jump in price, so let the price float back down to normal before jumping in.
So how should you manage your 401(k) to maximize its lifespan and get the most from the recovery, which could still be a couple of years away? I recommend several steps as you get closer to retirement:
- As long as you're more than 10 years from retirement, you can build a more aggressive portfolio with a good mix of growth and value stocks. Your mix can be as high as 80% (or more if you can stand the volatility) in stocks and 20% in bonds. With that much time to go you have the time for the market to recover from its recent crash.
- When you're between 5 and 10 years from retirement, you should start moving to less aggressive stocks (blue chips and stocks that pay dividends) and increase your ratio of bond stocks. As soon as you're less than 10 years away from retirement, start shifting your portfolio to safer investments. Unfortunately in this recent downturn both bonds and stocks were hit. My favorite is a Ginnie Mae (Vanguard GNMA) bond fund that actually went up in value by 7.2% in 2008. (In the interest of full disclosures, I do own this fund). So with careful picking, you can find decent bond funds that won't lose big. Some of the biggest losers were bond funds that focused on commercial paper. So every bond fund is not a safe fund. Get to know your options.
- When you're between 2 and 5 years from retirement, your portfolio should be at about a 50%/50% ratio of safer stocks to bonds. Research has shown this mix can extend the live of your portfolio, so you won't run out of funds in retirement. In my book, Working after Retirement for Dummies, I talk about this research in greater depth and show you how to mange retirement fund withdrawals.
- When you're 2 years away from retirement, you should start moving the money you'll need for 2 years into a cash fund, such as a money market fund. That helps to protect you from having to sell an asset in its worst position.
Once you're in retirement, you should keep enough money in your money market to cover at least 2 years of cash needs. That should get you through any major market crash without being forced to sell into loses. As you sell bonds or stocks to convert into cash, sell the assets that have gains. By always keeping a cash cushion that matches at least 2 years of cash needs, you should always be able to find an asset that can be converted at a gain 2 years out. If it's a really bad period, you can wait 6 months to a year to find a good conversion if you have a 2-year cushion. Remember, as long as you keep that money in the 401(k), you don't pay taxes on the gain until you take it out.
A big mistake many retirees make is to move 100% of their portfolio into cash and bonds. Every portfolio needs growth assets. Most people live 20 years in retirement, so be sure to leave some growth assets in your portfolio throughout most of your retirement. At a very minimum, you should maintain at least 20% of your portfolio in growth assets until your very near your projected lifespan. How do you figure that? One of my favorite is the Life Expectancy Calculator at MSN.
Lita Epstein has written more than 25 books, including Working after Retirement for Dummies and Trading for Dummies.
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Reader Comments (Page 1 of 4)
3-03-2009 @ 8:05PM
Nc0gnet0 said...
This is bad advice, pure and simple! I can't beleive we still have people spouting this nonense!
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3-03-2009 @ 8:08PM
joseph said...
THAT IS ABSOLUTELY BULLSHIT, POOR, IDIOTIC ADVICE!
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3-03-2009 @ 8:18PM
Big-T said...
It's so easy to spend other's money for them but these same people are no place to be found when you lose your money. This advice is poor.
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3-03-2009 @ 8:29PM
miratuvida said...
Of course they do not you to move your money. If you do they will not make money off of you.
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3-03-2009 @ 8:33PM
carllovelace said...
What? Don't withdraw your money. Hell, why not buy into the theory of "Averaging Down". Don't sell your stocks. Instead "Buy More". In fact, Buy all you can. Go get a HELOC on your home and Buy, Buy, Buy. If you have any friends, borrow all the money you can from them and Buy with their money. Borrow from your relatives. "You'll show them who the dummy is when the market turns." Buy. Buy. Buy. What are you waiting for; Buy. Buy. Buy.
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3-03-2009 @ 8:34PM
Dave Reinhardt said...
Lisa,
Your article was well written but most of us conscientious Seniors already know pretty much all you spoke about. It was the Governments regulators responsibility towatch the Institutions that caused this problem and those regulators were not doing their job very well. I had sent a e-mail to Congressman Coble and Senator McCain requesting they consider some relief for Seniors in the way of tax free status
on the deferred income we had invested which is left for the next five year up to $250,00 of what was in the 401K or IRA accounts as of $January 2008. We deserve some help to. Up until the election there was talk of some kind of assistence however that has been forgotten I guess. Your support towards this effort from you and your financial colleagues would go a long way.
Thanks for taking the time to read this.
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3-03-2009 @ 8:37PM
spectre said...
Here is the best advice for those in Wall Street; "Diverse all your life savings to AIG! and leave it there. It will grow to a thousand fold downward" LOL!!!
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3-03-2009 @ 9:25PM
Patrick said...
Quit worrying about what the politicians in Washington or the stock market is doing. Take control of your future, run your own home business, develop multiple streams of passive income, and replace your lost 401K funds with tangible ongoing gains, no matter what the economy does.
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3-03-2009 @ 8:54PM
David Reinhardt said...
Lita
Responsibly active Senior 401 K/ IRA participents are fully aware of these points you make. What we need is support from you for relief from Congress just as they have given with Tarp and the Stimulos for others. We don't have 5 to 10 yrs to regroup. This was not our doing the Governments so called regulators were suppose to be watching the store. Those regulators are responsible for this as much as anyone. Tax relief for the next 5 years on all amounts on record in our 401Ks and IRA'S for the next five years for fully retired or those eligeagble in the near 2 to three year period would. Again support from you an your colleagues would go a long way.
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3-03-2009 @ 9:05PM
Donovan said...
If your smart, you'll pull every cent you (can't afford to lose) out of your 401K. Better to pay the tax's on what you have left. As opposed to losing perhaps several thousands of dollars, you will never be able to recover. Especially, if your thinking about using these funds for your retirement in the near future. Many people do not have another 20 to 30 years to wait and see what their 401K will eventually be worth. This is no time to gamble with your money.
Sorry Lita, This time your advice, is not only bad advise for consumers. It could be financially devastating as well.
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3-03-2009 @ 9:08PM
David Reinhardt said...
Lita
It should have read after the words IRA's for "accounts dated Jan 2008" instead of the next five year
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3-03-2009 @ 9:17PM
chilco99 said...
Will any of you EVER trust these idiots with your savings again? Not me! I will invest in a 69 cent mason jar and a good shovel.
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3-03-2009 @ 9:19PM
tom said...
This is real bad advise!! It clearly is the opposite of what I have done with my IRA money and over the past year I have made money, NOT LOST IT!! I may have not made a lot, but its still all there. People within a couple years of retirement should be TOTALLY in cash insturments. It people like those that wrote this article that have now gotten so many in financial retirement trouble!!
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3-03-2009 @ 9:19PM
Chuck U. Farlie said...
This is the worst advice I have ever heard !!! Do yourelves a favor and dont buy in to the 401 k ripoff that everyone is telling you that you`d be a fool to pass up. Take your money that would have gone into a 401 k and stash it somewhere safe. Not in a bank account, not in a fund or stock . Safe deposit box is good place. Take the cash and put it somewhere only YOU know where it is. Sure no interest but you get taxed for interest dummy just as you would with a 401 k. You see whats going on now and I was one who did`nt fall for the 401 k scam and I`m glad I did`nt. And by the way the same idiots who told me I`d be stupid to pay for my house outright are the same idiots who told me about the 401 k scam I`d should`nt pass up. Hmmm no mortgage , no 401 k...who`s the idiot now? All these financial idiots are only out there to steal you blind and if you give them your money in hopes of having a stressless lifestyle after you retire you are in for a rude awakening and you deserve it if you give them permission to blow your money. NO ONE CAN TAKE ADVANTAGE OF YOU WITHOUT YOUR PERMISSION !!!! Remember that folks.
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3-03-2009 @ 10:13PM
Chad said...
Who care about 401K? If I don't care about 401K, I just leave it be. Bank counts are not safe, "Greedy" people gamble now become losers.
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3-03-2009 @ 10:22PM
Rich Joaquin said...
very bad advice. you say the market will up turn ii 10 to 15 years. I've already $150 Grand. I am 71 years old.will not ever see it happen so safety deposit box was my next stop.feed good advice and not be so stupid
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3-03-2009 @ 10:27PM
engineer04 said...
If you are close to retirement age by say five or ten years, it could take that long for the mkts to recover anyway- so there is no reason to stay in stocks waiting for them to increase again value. You'll be waiting till the cows come home. And then some. Safest bets for people with stretch IRA's and basic IRA's who have the added benefit of being able to access without huge penalty- for gods sakes- invest in T-Bills (the five or ten year ones) which avg 3.24% interest. Or index annuities that will never lose you money but will garner gains when the mkts recover.
And do NOT listen to overconfident CFA's who are fighting their own internal co. battles over how to keep customers these days. They've given some pretty bad advice lately, and many if not most need to find a different line of work. Its pretty awful- in the bigger scheme.
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3-03-2009 @ 10:53PM
Collateral said...
What 401K?
Only the "no brainer" would think that "401K still exist". Quit being dumb! Libs!
Can't you see Obama and "tax cheater" treasure secretary are purposely destroying your 401K by pumping "papers" into the market and "help" the financial market to go "South"???
And ...further more! So goes your 401K!
Wake up! AoL and other main stream media e.i CNN, MSNBC , ..e.t.c are bunch of Political Activist ....
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3-03-2009 @ 10:55PM
Mike said...
I am in the process of pulling all of my money from my 401. I will then pay the penalty and buy a new home that has declined about 60% in value. This will make up for all the losses if the housing market comes back. If the housing market does not come back the stock market damn sure is not coming back. This is alot better gamble in my books.
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3-03-2009 @ 11:14PM
Frankie D said...
I took a huge hit on a spec. house I finally sold in 1992. I managed to pay the bank loan and keep my credit. But tnen being a buyer in a down market I bought a commercial property for 55k that the former buyers had paid 250k for and gone bankrupt. I think you have a great plan Mike. The only difference today is that the govt. is trying to keep real estate values up. But the deals are still out there!