Prioritize Your Savings
You’ve figured out your budget, and you are ready to start saving. How do you prioritize your savings? Do you start with your emergency fund? Maybe you payoff debt? Or, do you max out your 401k?
On today’s episode of Monday Morning Money, we’ll give you our take on how to prioritize your savings.
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Here is How to Prioritize Your Savings
Step 1 – Your Emergency Fund
Start at the beginning. Your first priority should be to have an emergency fund. Start with accumulating $1,000. Then work towards 3-6 months worth of take home pay. It should be accessible when you need it. But the account you set up needs to have a very clear purpose: Emergencies only.
Step 2 – Get the Free Money
Many employers will give you some of their money if you will save yours. When you are talking about 401k’s, this isn’t something new. But many employers are now matching your contributions to a health savings account.
This is free money. Your only cost: Delaying the use of it for a few years (or in some cases, decades). It is a great way to boost your long term savings.
Step 3 – Pay down Higher Interest Debt
Some types of debt are worse than others. (Rarely is debt a good thing). Prioritize paying off the debt with a higher interest rate. To us, this means any obligations which charge 5% or more. This could include credit cards, student loans, and car loans.
Try to pay these off early. It can save you a significant amount of interest. And, it will increase the amount you can save for other purposes.
Step 4 – Max out your Health Savings Account
Health care will be one of your biggest expenses in retirement. A Health Savings Account (HSA) is a terrific tool to help you pay those costs in a tax advantaged way.
If you qualify, a family can contribute up to $7,000 per year and an individual can contribute $3,500 per year. Your contributions are deductible. The account grows on a tax deferred basis. And qualified distributions are tax free.
Step 5 – Max your 401(k) or Payoff Your Mortgage
Being debt free is a liberating feeling. And, it would be hard to argue with anyone who wanted to make paying off a mortgage a priority. But, we can offer a convincing argument in favor of applying the excess cash flow to your 401(k) too.
It comes down to how far away your retirement is. The longer you have, the greater opportunity for compounding returns. But if you have less time to your retirement, the priority shifts.
In my mind, the cutoff is ten years. If your retirement is more than 10 years away, put that excess in your 401(k). If retirement is sooner, put the extra towards your mortgage.
There are no wrong answers here.
Bonus tip: Check to see if your employer offers the Roth 401(k)….If so put the extra cash flow in a Roth type account!
Step 6 – Max Out your Roth IRA
If you still have extra cash you want to save, look to maximize your Roth IRA account. Tax free growth. That’s a good enough reason in and of itself.
What About College Savings?
It depends. If you are a parent, college savings comes right after paying down your higher interest debt. For a grandparent, it depends on how well prepared you are for retirement. If you’ve saved enough to have the retirement you want, saving for college can fit in just about anywhere.