Congratulations! You’ve finally reached the point where you earn a few more dollars than you spend each month.
What should you do with that extra cash? Where should it go? Those are the questions we’ll help answer.
Why does it matter where you save?
You work hard for your money—why wouldn’t you expect your money to work hard for you?
That matters to us, and “where to save” is one of the most common questions we help clients answer in our meetings. Being smart about where you save means YOU keep more of those dollars (versus paying tax). You also set yourself up for future success, putting the money in the best place for when and how you’d like to use it.
What are common things people save for?
We generally see people want to use this money 1) in the near term (think a new car or maybe a home downpayment) or 2) over the longer term (retirement).
That’s the first question you need to ask yourself—what am I trying to accomplish—what is this money for? We like to ask the question: is this money for you (ex: retirement), your family (ex: kid’s college fund), or your causes (charities)?
Once you know what bucket it lands in, it will help us figure out where best to save. After all, the two most important things are: 1) Is the money available when you need it, and 2) Can you access it in the most tax-efficient way (so you get to keep more of it)?
Before we get right to answering the question, let’s provide some context.
How income is taxed
The income tax system we have in our country is progressive. That means that each incremental dollar of earnings has a higher tax rate as you earn more.
The graphic below shows an example of an individual with $100,000 in wages. The first dollars they earn on the left are tax-free. The last dollars they earn on the right are taxed at a 22% Federal tax rate.
As you can see, the more you earn, the less of that dollar you get to keep (and the rest goes toward taxes). Knowing where you are for income helps determine where best to save. Just as the next dollar of income is affected by those tax rates, the next dollar you save is also impacted.
The other big-picture consideration is access to that money. Generally, you want to avoid fees and penalties. At best, all of what you save is available when needed.
For example, saving into your 401k retirement account at work is an excellent idea for the long term. However, if you need that money for a new car, you’d pay penalties and income tax to access those funds.
Here’s a breakdown of where to save based on when you need the money:
Near-term needs
- Checking account
- Keep at least a month’s worth of spending in your checking account.
- That helps reduce money stress for many people we work with.
- High-yield savings
- While the checking account above doesn’t earn much interest, many high-yield savings accounts earn 4% or more today.
- We’d suggest another two to five months’ worth of spending here. If you spend $5k a month, you might have $10k to $25k in this account.
- Electronically link this account to your checking account so that you can move money back and forth easily (and quickly!)
- Taxable investment account
- This account works for both near and long-term needs. Money is available without penalty. The only tax you’ll owe is on what you earn, and that’s a good thing!
- If you’d like the money for the near term, maybe you invest in a money market fund or bonds (lower risk). Otherwise, long-term money can go towards investing in companies.
Long-term needs
- Employer plan match
- If your company offers a 3% match on your first 3% of contributions, that is a 100% investment return! Do everything you can to match at least what your employer offers.
- HSA (Health Savings Account) & Roth IRA
- HSA: We love saving here because of the triple tax benefit. Contributions are tax-deductible, the account can grow tax-free, and drawing from the account is tax-free (as long as the draws are for qualified medical expenses). While this is money you set aside for health expenses, it can also be used for retirement as you age. That flexibility is valuable.
- Roth: This is one of our favorite places to save. There are limitations to allowed contributions based on how much money you make, however.
- Taxable investment account (same as above)
Sometimes people will save in this priority and still have funds left over. In that case, it may make sense to go back through the list and save more in certain areas. Rather than just matching your employer’s contribution in the 401k, you can contribute up to $23,000 to that account (in 2024).
Other strategies to consider
- Consider your current mix of asset buckets. If you have a lot of tax-deferred savings such as pensions and 401k’s, add more in tax-free accounts such as Roth.
- Save based on where your tax rate is today and what you think it will be in the future. For example, if you’re early in your career, your tax rate will likely be lower now than in the future. Pay lower tax rates today! If you already earn a lot of money, deferring tax today will make more sense. Our general rule of thumb:
- If you’re at the 22% Federal tax rate and lower, pay tax now.
- If you’re 32% or higher, pay tax later.
- If you’re in between, split where you save.
- There are lots of other considerations, too. Future required minimum distributions, increases to Medicare premiums, your charitable intent, and passing wealth down to family members.
Congratulations if you made it this far—you are already on a great path to learn about your options and improve your financial life.
We hope this helped you decide where best to save your next dollar! If you’d like help working through where to save, our team can review what may be best for you.
