You’ve committed to ‘paying yourself first’. Good job! You’d definitely win a participation ribbon for doing that. Thanks for all of the awards, helicopter parents. But now you have a plethora of questions. TBH, I just used plethora because it’s a big word. Here is what you might ask yourself: Where do I put the money I’m saving? Which accounts should I have? How much should I put into each account?
These are all great questions and ones I usually get the most. Below is a list that details the order of accounts/buckets that I recommend you stash your money in. This doesn’t mean it’s the best, the worst, or the most correct. It just means, this is how I would do it.
- Emergency Fund
This isn’t really saving for retirement, but I included it in this list because it is important. If you don’t have an emergency fund with around 3 months of expenses, do this before you continue to the next few steps. This emergency fund is used for emergencies. Ground breaking news right there. I bet you would have never guessed that. But really, it’s used if you lose a job, when the water heater needs replacing, or when your dog has an emergency visit to the vet. Not because you accidentally spent too much on happy hour during the month. Some people split up the emergency fund with the ‘what-if’ fund. The emergency fund is strictly used for when you lose your job and the what-if fund is used for those one off crazy expenses. I love this idea. However, if you are having a hard-enough time saving anything, don’t worry about this, it’s just an idea.
- Max 401(k) match
If your employer matches any sort of contribution that you make into a 401(k) or 403(b), do this. This is ‘free’ money that is on the table. While there is no such thing as a free lunch, this is one of the closest chances you’ll get at it. Most companies match anywhere between 1-6%. This is your best option. If your company matches 5%, and you hit the match, you’re already saving 10%. Not only is the free money good, employer sponsored retirement accounts offer a great tax-advantaged way to save for retirement. I will explain in another post the difference between retirement accounts. But for now, know that it is a great way to save for retirement.
- Fully Fund a Roth IRA
Roth IRA’s are a great way to save for retirement. Since you put after-tax dollars into these accounts, you don’t get to deduct your contributions for your taxes. However, they are tax-advantaged in the fact that you will be able to pull out earnings and contributions tax-free (if you are at least 59 1/2). One downside, which was mentioned in my College Saving Strategies post, is that you can only contribute up to $5,500 per year. By having a Roth account, you get a good mix of tax-deferred and tax-free accounts in retirement, which allows you to create an optimal income distribution strategy during your retired years. These accounts are typically for young investors as there are income limits that prohibit you from contributing to a Roth IRA once you have a certain amount of modified adjusted gross income (MAGI).
- Brokerage Account/Finish Funding Your 401(k)
Now, this is where things get a little interesting. Just the fact that I listed the brokerage account on the same line as finishing your 401(k) will get some peoples blood boiling. And that’s okay. Remember, this is just my recommendation. But, to be fair, it all depends on each person’s situation. I would spend the remaining money splitting between a brokerage account and your 401(k), maybe even a 60/40 split leaning in the direction of a brokerage account. I like the brokerage account because of the flexibility. It allows you to pull money out at any time for any reason. You will have to pay taxes if you do this though. While there are no tax advantages, in terms of retirement, to this type of account, it does offer far better investment options than the 401(k), which could lead to greater returns. However, if you are committed to retirement and know you won’t need to pull the money out early, then I would continue to contribute to the 401(k) until you hit the max.
I hope this helps you out as you continue to save money. Remember, saving money isn’t all about retirement. While saving for retirement is important, it doesn’t have to be the most important. The strategy listed above is strictly my opinion for retirement dollars. What are your thoughts? How would you do it?