Simple Saving Priorities: Where to put Your Money
After you’ve passed the piggy-bank stage, some financial difficulties are good to have. For example, it’s a happy problem to need direction as to where to put your savings. Congratulate yourself that you have an income today, you’re saving some of it and you’re reading this blog!
Some frequently asked questions at Wealth Gathering involve how to allocate savings. Which goals do you save toward first, second and so on? What types of accounts are best for achieving your goals?
Today’s blog also addresses only moderate-income households. The priorities shown here apply to those with an Adjusted Gross Income (AGI) of less than $122,000 for individuals or $179,000 for married couples because these limits are the phase-outs for Roth IRA eligibility. With higher incomes, saving priorities are a bit different and will be the subject of a later blog.
Priorities: What to do and Why
Here’s the best way to prioritize your savings:
- Prep Your 911 Fund: Calling 911 won’t help if there’s no answer, so set up an emergency fund for the unexpected. Without money in the bank, you’re one surprise away from bankruptcy, whether it’s a layoff, lost pay due to illness, car trouble or worse. Your cash cushion provides the ability to sleep at night!
To set up an emergency fund, calculate 3 to 6 months of expenses (not income). This is 3 to 6 times your monthly Survive spending. If you spend $5000 to Survive every month, then $15,000 to $30,000 goes in your emergency fund. If you dip below the 3-month mark, divert all savings to your 911 Fund until you reach the minimum requirement.
Your 911 Fund must be totally liquid and safe, so it goes in the bank. True, interest rates are low—but if you’re calling 911, you can’t wait several days for help to arrive. Some online banks provide good returns (search www.bankrate.com).
- Get the Match: Do this step only if your employer offers a retirement plan with a match. Often a company matches every dollar you put in a 401(k) or 403(b) plan up to a percentage of your salary (typically 3% to 5%). Declining this option is like turning down a bonus. Your employer says, "Do you want this extra money?" You reply, "No, I’ll take less income and more taxes."
At first, only contribute the amount required to get the full match. If no match is offered, go to the next priority.
- Kill the Debt: Nothing destroys a sense of freedom like being shackled to a load of debt. If you’re worried about bills and chained to your job (or two) by debt payments, it’s a sure sign that the debt owns you and you’re not free.
While debt-elimination is critical, this is not step 1 because someone who is debt-ridden and lacks a 911 Fund is one bill away from bankruptcy! Debt-elimination isn’t step 2 because matching represents additional income. Credit card interest might be 20%, but you get approximately a 125% return on matched contributions because of the match plus tax savings.
- Get a Roth IRA: You ask, “Should I put money in a Roth or my employer’s plan?” Roth IRAs are the best deal because they grow tax-free, and after age 59 1/2 you can withdraw the money tax-free. You can also limit your fees and have more investment choices instead of being restricted to employer offerings.
A Roth is the only type of tax-sheltered account where you can withdraw invested moneys (but not earned interest) penalty-free. A Roth can also be a second-layer emergency fund or savings vehicle. However, since they’re investment accounts, Roth IRAs can lose value. If you plan on withdrawing early, invest conservatively.
To complete this step, invest up to the yearly limit, which is $5,000 per person and $6,000 if you’re over 50.
- Revisit 911: Make sure there’s enough in your emergency fund. Consider building it to the 6-month mark, especially if you’re self-employed, the primary bread winner or a person with irregular income or job insecurity.
- Take Your Pick: Way to go! If you’ve still got Freedom dollars left, you have many options:
- Max out your employer retirement plan contribution
- Start a college savings account for your kids
- Enjoy some guilt-free Freedom
- Give extra to meaningful charitable causes
Keep these steps handy. They make a good savings roadmap for practicing wealthy habits on the road of financial freedom!