Tracking your spending down the penny, picking the perfect asset allocation for your investments….it’s easy to get bogged down with the details. But before you go down this path, remember to step back and take a look at the big picture.

One thing is for certain: when it comes to money, gone are the days where a checking account, a savings account, and a pension are adequate. Instead, we are faced with choices. LOTS of choices. Kind of like student loan repayment plans. And we know how much fun that can be.

The sheer number of options can be overwhelming. Unfortunately, this can be a huge stumbling block to taking action.

Let’s take the example of saving money. Sounds easy, right? Everyone knows they need to do it.

Remember, knowing and doing are two completely different things.

So, how much are you supposed to be saving? Where are you supposed to keep this money? And what was this money for again?

If you’ve ever been confused about something as simple as saving money, understand that you’re not alone. It is a deceptively simple concept, but much more difficult to execute in real life. Not only must we have the willpower to save, but we must also know where to put it.

I’ve broken down savings into 5 major categories, each category with its own unique purpose. Within these categories, there are different buckets, and you have the power to choose which buckets you’d like to fill. Your buckets will be unique to you and your situation.

CATEGORY 1: CASH

Purpose: An emergency fund, a down payment, a car, your next vacation….there is no end to all the different uses you will have for plain old CASH.

Ah yes, cash is king. If you’re lucky enough to have a good amount of cash on hand, you might even feel torn about keeping it in a simple savings account, earning little interest.

How quickly your mindset changes when there’s a job loss, a medical emergency, or when your house needs expensive repairs! All of sudden, you are SO THANKFUL that the cash is available, ready to use for exactly these types of situations.

Another popular purpose for cash is when you’re actively saving for a financial goal, such as a down payment for a house, the next vacation, or that new tech gadget you’ve been eyeing. If you’re planning on spending this money within the next 5 years, it’s best to put it into a savings bucket that is not exposed to the stock market or any other type of investment that carries risk.

Here are the main buckets where you should keep your cash (i.e. not under the mattress):

  • Savings account at your bank: This is the savings account that typically comes with your checking account. Don’t expect to be earning much in interest if you’re at a brick and mortar bank- we’re talking fractions of a percent. Next to actual cold hard cash stashed away in your house, this will be the most accessible way you can get to your money if you need it in a pinch.
  • High yield savings account (online banks): Many online banks will offer high yield savings accounts with interest rates much better than what you’ll see with your regular savings account (for example, 2% versus 0.02%). You can link these accounts with your primary bank checking account. The money will be a bit less accessible since there is a delay when transferring money between accounts.
  • CD (Certificate of Deposit): You are loaning the bank your money, and they will return it to you, with interest, depending on the term of the CD (anywhere from 3 months to 5 or more years). Typically, the longer the term, the higher the interest rate. There is usually a penalty if you want to withdraw the money before the CD matures. One strategy is to build a CD ladder- you can read more about that here.
  • Money Market Account (MMA): MMA’s are offered by banks, and these accounts work very similarly to regular savings accounts. However, they usually require higher minimum balances in order to offer higher interest rates. They are also FDIC insured. (Note: A money market account (MMA) is different from a money market fund (MMF). A money market fund is an investment product, offered by brokers and mutual funds, that is not FDIC insured. Money in an MMF should be considered a part of your investment portfolio.)

As you can see, the liquidity of your money in a savings account differs depending on which bucket you use. Interest rates should be taken into account as there can be quite a variation.

You also have to realize that the point of a savings account isn’t to make your money grow.

You simply want your money in a safe place, ready to be deployed at a moment’s notice. Having your cash in a high yield savings account will slow down the impact of inflation. If you’re wanting to make your money grow, invest it.

CATEGORY 2: KIDS AND SAVINGS

Purpose: Whether it’s saving for college or a general savings account for your child, it’s a good idea to be prepared and start early!

As I’ve come to realize after three children, kids can get expensive. Not only do you need to feel emotionally prepared to bring children into the world, but being financially prepared is also important. One reason that becoming a parent can hit your wallet pretty hard is because of the cost of education (this post goes into college savings in more detail). In order to reduce money stress during those college years, parents are looking at ways to save for college ASAP.

Here are some buckets that you can use for your children:

  • 529 plan: If you are certain that you want your child to attend college, the most popular option is saving money in a 529 plan. You contribute to the account, choose your investments, and you will eventually have the ability to withdraw money from this account tax-free for qualified educational expenses. In the meantime, your money will grow tax-free until you decide to withdraw. There is no income cap in order to contribute, and although the contribution limits vary depending on the plan, the limits are pretty generous. You can choose virtually any 529 plan- it is not restricted to your state’s plan.
  • Coverdell Educational Savings Accounts (ESA): These are similar to 529’s, but there is an income limit, and you can only contribute a maximum of $2000 per year. Whereas 529 plans are reserved for college, these accounts can be used for K-12 education (although as of 2018, some 529 plans also allow funds to be used for K-12 education).
  • UTMA (Uniform Transfer to Minors Act) and UGMA (Uniform Gift to Minors Act): These accounts are not specifically earmarked for education. Theoretically, once your child hits his/her age of majority (usually ages 18-21), they own all of the assets within the account. Since these are considered the child’s assets, this will count more heavily against them (vs. a 529) when applying for financial aid.
  • Kids Savings Accounts: There are some savings accounts that are geared towards children as they learn the basics of money management. These can be used as wonderful learning opportunities, setting them up for personal responsibility as they navigate the world of banking and money management. Check with your own bank to see if they have this as an option.

The soaring cost of education has made saving for college a must for many families. But we must also remember that our kids need to understand how money works, too.

I constantly have money conversations with my kids in order to normalize the subject. Increasing their financial IQ will no doubt benefit them down the line, leading to lifelong smart money habits and choices.

CATEGORY 3: RETIREMENT

Purpose: Have enough saved so that you don’t resort to penny pinching and constant financial worries during your golden years.

Remember when retirees could rely on pensions and Social Security for income while in retirement?

Well, pensions are disappearing. And Social Security is expected to become insolvent by 2034, unless there is some major legislation that changes the current trajectory.

The idea of retirement is also changing. On one hand, there are retirees that return to work because they need the health insurance and the extra money. On the other hand, there are those who are on track to retire from the traditional workforce decades early, saving enough money in a relatively short period of time in order to give themselves the freedom to pursue other ventures (the FIRE movement).

One reason that retirement planning isn’t straightforward is because there are so many retirement buckets. Some buckets allow you to deduct the money up front, and you pay taxes later when you make your withdrawals. Others provide no tax deductions when you contribute, but then you get to take the money out tax-free.

The common theme: they all allow your money to compound and grow tax free. Do NOT underestimate the power of compounding.

The following are employer-sponsored retirement accounts, meaning that you will only have access to these buckets if you have an employer. One of my financial mistakes was not taking advantage of these accounts when I had the chance- don’t repeat what I did!

  • 401(k): The most well known employer-sponsored retirement account. Usually offered by larger employers/companies.
  • 403(b), 457(b), and 401(a): Similar to a 401(k), but usually offered by public educational institutions and state and local government agencies.
  • TSP (Thrift Savings Plan): Another employer-sponsored retirement account, this time for civil servants and those in the armed forces.
  • Defined benefit plan: These are traditional pensions. It is up to the employer, not the employee, to invest this money and provide the benefits upon retirement.
  • SEP-IRA (Simplified Employee Pension) and SIMPLE (Savings Incentive Match Plan for Employees) IRA: You are likely to see these plans available in smaller businesses. The employer drives the contributions in both of these plans. With the SEP-IRA, the contribution amounts can vary year to year, depending on cash flow. With the SIMPLE IRA, the employer can match up to 3% of the employee’s contribution, or contribute a fixed 2% of the employee’s compensation.

What if you don’t have access to an employer-sponsored plan?

  • IRA (Individual Retirement Account/Arrangement): There are two main types: Traditional and Roth IRA. These are NOT employer-sponsored, meaning anyone who is making earned income can contribute. An unemployed spouse can also have an account opened in his/her name, which is referred to as a spousal IRA.
  • Are you self-employed? If so, you have a whole suite of options, which include the SEP-IRA, the SIMPLE IRA (described above- you are now considered the employer AND the employee), and the Solo 401(k).

There are a lot of acronyms and seemingly random numbers when it comes to retirement accounts- no wonder people get confused! Adding to the complexity are all of the specific rules and regulations with each type of account. One individual can also have multiple accounts, amassing a collection of retirement accounts as they move from one workplace to another.

Ultimately, it is your responsibility to keep track of your retirement accounts and ensure that you have enough. The question of “How much is enough?” is a common one, and it doesn’t have an easy answer. The best you can do is to take a good, hard look at much money you’re spending now and making your best predictions going forward.

CATEGORY 4: HEALTH SAVINGS ACCOUNT (HSA)

Purpose: A tax-friendly way to pay for medical costs. Sometimes treated like a separate retirement account.

This account gets its own category since it’s in a class of its own. Why?

Because it’s triple tax free!

Other tax-deferred plans have a point where you will have to pay taxes, whether you are using after-tax money to make your contributions or getting taxed upon withdrawal.

Not so with the HSA. With this particular account, you will get the tax deduction up front (lowering your taxable income), tax-deferred growth, AND tax-free withdrawals as long as you are using it for qualified medical expenses.

One strategy that is being used is treating this like a separate retirement account. You can pay for your medical costs up front, keep your receipts, and let your contributions stay invested in this account. Once you hit age 65, you’re free to use your HSA for non-medical expenses without a penalty, although you will still pay income tax. If you were to use it for non-medical expenses before the age of 65, you would be hit with a 20% penalty.

The HSA is not available to everyone. You must be on a high deductible health plan (HDHP) in order to open an HSA. An HDHP is also not the right choice for everyone, so this is the first decision you need to make before deciding to open an HSA.

CATEGORY 5: OTHER INVESTMENT BUCKETS

Purpose: Investing your money outside of your tax-advantaged accounts, because you were such a rock star at using up all of the available buckets mentioned above!

Once you’re done checking off your savings buckets and tax-advantaged buckets, you’ll be searching for other places to park your money for investing purposes so that your money can grow. Remember, investing is NOT gambling as long as you’re doing in a smart, intentional way.

  • Taxable (brokerage) account: You will find similar investment choices that you would find in your other tax-advantaged accounts, like retirement accounts, college savings, and your HSA. These include stocks, bonds, mutual funds, and ETF’s. However, unlike these tax-deferred accounts, you will be paying taxes along the way. The upside is that these accounts are very flexible- there are no rules and regulations regarding how much money to contribute or required minimum distributions to worry about.
  • Real estate: You either get really excited about real estate, or you immediately think to yourself, “No way….I’m not touching that with a 10 foot pole.” With experience and luck, real estate can lead to a lot of financial success and wealth building. The caveat is that you need to have the desire to add real estate as a part of your investing strategy.
  • Businesses: Make no doubt about it, owning a business or investing in a business is another way to diversify your investments.

You also need to keep in mind that if you have a retirement account, a college savings account, or an HSA, you’re already investing. Too often, people equate investing with opening a taxable account and picking your own stocks. Stock-picking is not synonymous with investing!

You have to look at ALL of your investments as one big investment portfolio. You simply have different buckets, and again, it will be up to you as to which buckets you’d like to fill.

CONCLUSION

I will fully admit, it took me many years into adulthood before I even knew which buckets I owned, or how much I had in each bucket.

Why did it take me so long?

I thought that not living paycheck to paycheck was good enough. I thought that saving money was good enough.

I was wrong. It is NOT enough. Those were good starting points, but if I wanted to get serious about my money, I needed to know exactly where I was keeping my money, how much I had, and whether this aligned with my financial and life goals.

Once you see what you have, you can start comparing it with what you want. Are you close to reaching your goals? Or are you still wondering what kind of goals you should be setting for yourself?

Get personal with your savings. Look at your buckets and see if that’s where you want your money. Take a look at other available buckets and see if they make more sense for you and your own personal situation. Taking these steps will be key to helping you move forward and take action with your money and life goals!

What are your favorite savings buckets? Are there any that I should add to this list? Comment below!

]]>

Leave a Reply