Investors might be eager to close the books on 2022, but before you do, take some time to make sure your portfolio is ready for the new year.
This year, your December financial checklist comes with a twist. Many market participants expect a recession in 2023, as policy makers continue to raise interest rates to cool the economy and tame inflation. As you review your finances, make sure you’re positioned to weather the storm. The good news? “We don’t think 2023 will be like 2008,” says Beth Handwerker, an estate and financial planner at James Investment in Beavercreek, Ohio. But even if the downturn isn’t deep, it still pays to prepare, she adds.
Here are some considerations for your year-end financial checklist:
Increase your 401(k) contributions
For 2023, the Internal Revenue Service has raised the limit for 401(k) contributions to $22,500, up from $20,500. Plan participants age 50 and older are allowed an extra $7,500 in catch-up contributions, up from $6,500 this year.
These increases are the biggest in at least 25 years; to take advantage of them, make sure to review your paycheck deductions. (Contributions are typically calculated as a percentage of pay, so if you got a raise recently, you may already be contributing more than you were before the pay bump.) Most companies will automatically stop your contributions before they exceed the annual limit, which would result in penalties. Still, it’s a good idea to double-check that with your human-resources representative if you’re planning to contribute the maximum.
Another item to check if you’re planning to max out your contributions is how your company structures its 401(k) match, says Matt Fleming, wealth advisor executive at Vanguard Personal Advisor Services. Sometimes, the company match will stop when you stop contributing to your plan, instead of offering a “true up” payment to make you whole at the end of the year. In that case, if you max out your contributions before year end, you’ll miss out on some of your match. To avoid this, lower your contribution rate so you don’t max out your contributions until the end of the year.
Pad your cash cushion
Financial experts generally recommend that you keep from three to six months’ worth of living expenses in a liquid savings account. (Retirees should hold more cash, up to two years’ worth of portfolio withdrawals.) Since the economy is on shaky ground, aim for the higher end of this range, especially if you work at a company or in an industry that could be vulnerable to a slowdown. But any amount of savings helps. A cash cushion can help you avoid taking on credit-card debt or tapping your retirement account in the event of a job loss or other unexpected expense.
High-yield savings accounts are a good option for your emergency cash, and today you can find some that offer more than 3%. “Recessions come and recessions go,” said Rob Williams, managing director of financial planning and wealth management at Charles Schwab. As long as you have a lengthy investing time horizon and some liquid cash set aside, then you can stick to your plan whether the recession comes or not.
Look into rebalancing
Rebalancing involves tweaking your portfolio to get it back to your target allocation. Say you aim for a portfolio that’s 60% stock and 40% bonds. If you do nothing all year as stocks go on a tear, like they did in 2021, then you’ll wind up with a higher allocation to stocks by year end. You should sell your winners (appreciated stock) and use the proceeds to buy more losers to get your mix back on track.
This past year was different, of course. Both stocks and bonds performed poorly, so there are no clear winners and losers. But it still pays to look at your asset allocation. While stocks were down about 20% for the year, they’re still up over the past five years. “The surprising thing for many people is they’re still stock-heavy,” says Christine Benz, director of personal finance at Morningstar.
If that’s the case for you, it’s a good time to buy bonds. “Typically in a recession, high-quality bonds do great,” Handwerker says. For example, in the financial crisis of 2008, Treasury bonds stood out as a bright spot. Stick to shorter-term, high-quality bonds, she advises. High-yield, or junk, bonds perform more like stocks and should be avoided heading into a recession.
If you’re age 73 or above, don’t forget to take your required minimum distribution from your retirement account by the end of the year. It’s the government’s way of finally getting its hands on its share of your retirement savings that has grown tax-deferred for decades. The penalty for inaction is steep: If the full amount isn’t distributed by Dec. 31, you’ll be subject to paying the IRS 25% of the amount not withdrawn, on top of the ordinary income taxes you’ll owe (the penalty may drop to 10% if the oversight is correctly quickly). Most brokerage firms offer the option to automate your RMDs so you don’t have to remember to take them.
Those who are philanthropically inclined can consider making a qualified charitable distribution, which is a donation made directly from your retirement account to an eligible charity that can satisfy your tax requirement.
You’re eligible to start making qualified charitable distributions at age 70½, even though RMDs start at 72. Says Vanguard’s Fleming: “It’s never too early to start thinking about IRA distributions.”
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