The 4 Essential Savings Accounts You Need — & When To Tap Them
If you feel like you’re behind on your savings and the very thought of catching up gives you anxiety, you are not alone. Many Americans are financially unprepared for the unexpected: 57 percent have less than $1,000 in savings, and 39 percent have no savings at all.
While there is no “silver bullet” for personal finance and your needs will vary depending on your age, income, and life stage, there is a one-size-fits-most strategy to building your savings and your financial security. Here are four essential accounts to get you started.
1. Emergency Savings
Financial experts almost universally agree that an emergency fund is the top priority for many people — especially beginning savers. Emergency savings help you avoid racking up credit card debt or dipping into other investments when you need cash quickly in the event of job loss or an unexpected financial emergency. Many of us don’t have this safety net: The Charles Schwab Modern Wealth Index found that only 30 percent of millennials have an emergency fund to cover at least three months of expenses.
The amount of money you should set aside for emergencies varies from person to person, but plan for three months of expenses at a minimum. Realistically, six months is a better cushion, says Doane University professor Timothy G. Wiedman, D.B.A., PHR, SHRM-CP. Consider the demand for your skills, your credentials, and the job market in your area to decide, at worst, how long unemployment might last. Whether you’re able to put away five percent of each paycheck or $5 a week, start building this fund now.
Account type: Jim Marrocco, CFP®, CFA at Thinking Big Financial in New York recommends using a high-yield savings or money market account for your emergency fund because these accounts don’t fluctuate in value. They also have slightly higher returns than regular savings and are liquid for easy access in case of emergency.
Use this for: Recurring living expenses during unemployment, including rent or mortgage payments, groceries, utilities, transportation, and insurance premiums. This fund can also help cover unplanned medical expenses, costly car repairs, or major home maintenance — if your roof caves in or a hurricane leaves your basement flooded, for example.
2. Retirement Savings
If you have a retirement plan through your employer, contributions to this account should be a high priority. If you don’t, you can still save for retirement using an IRA. According to the Bank of America Merrill Lynch’s 2017 Plan Wellness Scorecard, 82 percent of millennials are contributing to their 401(k) plans, as are 77 percent of Gen Xers. This is a positive trend, as investing early on allows compound interest to work in your favor. These accounts also offer tax advantages, and if your employer offers a contribution match, that’s free money toward your retirement.
If money is tight, contribute at least enough to your 401(k) to receive the full employer match, says Charles Schwab Foundation President Carrie Schwab-Pomerantz, CFP®. Once you are able, increase your contributions to the maximum amount allowed. The more you set aside, the more secure you’ll be down the line.
Account type: This depends on what your employer offers as well as your current age and savings priorities. Do your research or consult a financial planner to decide whether a 401(k), IRA, or another type of account is right for you.
Use this for: Don’t! Leave your retirement accounts alone and let them grow. In most cases, you’ll incur tax penalties if you tap these savings before you retire.
3. Short-Term Savings
A short-term savings account helps cover large, planned expenses, from a holiday trip to a new work wardrobe. These are “fun” goals that require time and commitment to save for and that would likely be difficult to cover out-of-pocket.
Account type: Like your emergency fund, your short-term savings should live in a high-yield, relatively accessible account. You can even create individual accounts for each goal, though experts recommend focusing on fewer priorities to save more quickly.
Use this for: Discretionary spending, including travel, seasonal shopping, and new furniture or appliances for your home.
4. Long-Term Savings
Build long-term savings for large purchases you expect to make two to 10 years down the line — a middle ground between your annual vacation and your retirement fund. The type and timing of your intended purchase will dictate how much you need to save and where to put that money.
Account type: A mix of high-yield savings and investments depending on your goals. Dan Kellermeyer of New Heights Financial Planning says, “Investment accounts should be used for savers who don’t need that money for at least five or 10 years. If you want to save for a down payment on your house in three years, an investment account may bring much higher returns, but you risk actually losing money in the market.”
Use this for: A down payment on a car or home, additional education, or an investment in your future business.
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Once you’ve got the essentials, you can explore health savings accounts, tax-advantaged college savings plans, and additional investment opportunities. Keep in mind that your financial priorities are unique, and though the above four accounts are recommended for most, how you approach them will depend on your individual needs.
To maximize your savings potential, find a strategy for managing your money — there are many apps that help you actively organize, contribute to, and keep track of your savings accounts in addition to your day-to-day spending. Finally, look into identity theft protection. Financial institutions are not immune from hackers and data breaches, and these services will alert you to any unusual activity so you can take action and minimize the risk to your hard-earned dollars.
Emily is a writer and editor living in Salt Lake City. She has written about money topics for sites like DailyWorth and Learnvest. Follow her on Twitter here.
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