Saving money is always a good thing. It creates financial security and helps us achieve goals that are important to us. But saving money comes with challenges. Most of us save in a random way, without a specific purpose, without an understanding of exactly how much is needed to achieve our goals, or knowing where we should save money. It’s not uncommon to lose sight of big picture goals in our desire for immediate consumption. Our long-term goals are frequently derailed by competing goals that pop-up from time to time. So let’s take a look at the top ways we can become Savings Superstars.
The Reality of Starting Early
It’s no surprise that the earlier you begin saving towards a goal, the more likely you are to achieve it. In addition, the earlier you start saving, the less money you’ll actually have to save to accomplish the goal. The reason lies in the power of compound interest, which, magnified over time, makes even the loftiest financial goal achievable. The first rule in saving money is to start early.
1. AUTOMATIC SAVINGS
A top factor that will assist you in reaching your financial goals is an automated savings plan. Whether you’re saving to purchase a new car, pay for college education, and plan for retirement, having an automated savings program is key. Establish payroll deductions or direct debits from your bank accounts into specific financial accounts established to accomplish your goals. If you plan on manually moving money each month into the appropriate financial account, you are sure to miss a payment and be conflicted by competing goals.
2. RETIREMENT ACCOUNTS
401k plans have revolutionized retirement savings, allowing money to be automatically deducted from your paycheck before it’s taxed, and before you can spend it. It’s of no surprise that 401k and 403b plans have amassed trillions of dollars in only a few decades. An appropriate savings rate for retirement will differ from person to person, but it’s imperative that you save more than the 4-6% that an employer will typically match. A savings rate of 10% is a minimum target, with 15% being a good target, and 20% a reachable goal.
3. IRAs/ROTH IRAs
It’s important not to overlook the benefits of contributing to IRAs and Roth IRAs when building your retirement plan. If you spouse is not working or doesn’t have access to a corporate sponsored retirement plan, you are able to contribute directly to an IRA account for your spouse. If your income is below certain levels, contributing directly to a Roth IRA is a great savings vehicle. Assets in Roth IRAs grow tax-deferred and withdrawals are tax free! If your income is too high to contribute directly to a Roth IRA, you may be able to get money into this tax-favored account via “back door” Roth contributions. If you’re maximizing your 401k and 403b contributions and have capacity to save more, IRAs and Roth IRAs are great solutions.
4. BROKERAGE ACCOUNTS
The most overlooked savings account is simply a brokerage account where you save after-tax money. Of course, maximizing 401k contributions is almost always preferred; but if you have excess cash flow, be sure to set-up a regimented savings in this type of account. Otherwise, those extra dollars in your bank account are likely to be spent.
5. 529 COLLEGE SAVINGS ACCOUNTS
So why are we talking about college savings accounts in a retirement blog? Two of the main competing goals people face is the goal of planning for retirement and saving for children’s college education. It’s not uncommon for one goal to derail the other at various points in life. Although you may be in your peak earning years as your kids head to college, paying out of pocket for these expenses and trying to maintain a healthy savings rate for retirement can be difficult. This reality speaks to the importance of saving money early, for both goals, and to do so in an automatic way.
Similar to item #6 above, you may be wondering what taxes have to do with retirement savings. The answer is everything. Having different ‘tax buckets’ in retirement provides flexibility when you begin withdrawals and increases your probability of success. Early in the process of retirement planning, the primary goal is to defer taxes, with the 401k plan being the primary tool. As you begin thinking about drawing a retirement income, having assets in different tax buckets allows for tax efficient withdrawals. Coordinating a withdrawal strategy from different investment accounts with decisions related to starting Social Security and Pension Income have a direct impact on the overall success of your retirement plan and need to be thoroughly evaluated.
At the heart of savings has to be a willingness to defer gratification with the understanding that the goal you’re saving for is more important than current consumption. Leveraging the above tools will magnify your probability of success in reaching your goals. When following them, you become