Whether you want to save for retirement or save for a new car, you might not know where the best place is to store your savings. Maybe you feel that navigating the financial landscape can be challenging and scary. Or maybe you just haven’t thought about what savings options there are. Whatever your reason, there are a variety of saving choices all with different advantages and disadvantages. Once you understand your options and how they work you can start to take advantage of them and make your money work for you! I am by no means a financial expert, but hope this quick tutorial will help you start to explore all your different options!
1. 401(k)
A 401(k) is typically offered by employers as a way for employees to defer some of their income into savings. If you or your spouse have a 401(k) at your company, this is a great place to start saving. You can invest in a variety of mutual funds, stocks, and bonds offered through your 401(k).
Your employer can transfer money from your pay check to your 401(k) (once you authorize it) with every pay check so you can save without having to do anything! Many employers also offer some sort of “match” meaning if the employee puts some money in the 401(k) the employer will put in the same amount of money and “match it.”
A 401(k) is a great option because the employee deferrals and gains from their investment are not taxed and deferrals aren’t taxed until distribution (when you take money out of your account).
Most 401(k) funds cannot be distributed until after the person is 59 ½ without some sort of penalty, but you can roll over a 401(k) from a different company without any penalty.
2. Individual Retirement Account (IRA)
There are two main types of IRA: Roth and Traditional. With both of these IRAs you can’t withdraw the money until you are 59 ½ without a penalty. They also have a maximum you can contribute being $5,500 a year if you’re under the age of 50.
- Traditional- There is no income limit on who can contribute to a traditional IRA. The downside to a traditional IRA is that your earnings and distributions are taxable when you withdraw.
- Roth – A Roth IRA does have an income limit, meaning if you or your spouse’s combined income is over a certain amount you are not eligible to contribute. But if you do qualify for a Roth, qualified distributions are typically not taxable.
3. College Saving Plans
If you have kids there are some great ways to start saving for college. Two main ways to do that are with an Education Savings Account or a 529. Both of these accounts have to be used for education expenses but can include tuition, fees, books, etc. The money in both accounts can also be used for another member in your family. If money is withdrawn from either type of account for non-education expenses, a federal tax and penalty is involved.
- Education Saving Plans- You can only add $2,000 a year per child’s account. ESPs also have an income limit.
- 529- These are normally run by states so the rules and types of investment range. Many offer some type of benefit; for example in Oklahoma, whatever money you put into the 529 for that year is able to be deducted on your state income tax. Most don’t have a limit on how much you can contribute and have no income limit.
4. Savings Account / Money Market
These are offered through a variety of different banks or companies and each vary with the bank.
- Savings Account- typically savings accounts have a lower opening deposit and a lower minimum balance. Many also don’t have a limit with how many times you can withdraw funds from your account. The big thing with savings accounts is that the interest rates are typically lower than money markets (think 0.01% currently).
- Money Markets- Tend to have a higher opening deposit and monthly balance, but that varies with the institution. Most only let you withdraw money from these accounts up to 6 times a month. The good thing is that the interest rates are normally higher (think 0.8% currently). Many financial gurus use these as a place to put your “emergency fund” where you can hold your money and gain some interest but don’t plan on using the money on a regular basis.
5. Mutual Funds
If the stock market scares you a little bit, mutual funds are a great way to get your feet wet. Mutual funds are made up of stocks, bonds and money market funds and are all grouped under the same mutual fund name (Ex: Large Cap Funds meaning stocks from all large companies). Each mutual fund is also managed by a professional manager. These are typically less volatile than stock from a single company.
There are a variety of types of mutual funds with all different types of companies’ stocks in them. The returns on mutual funds vary from year to year but average out to a 10% annual growth over the long term. This is higher than saving accounts which is what makes mutual funds attractive. Since a mutual fund does have a manager, most of them withhold a small annual fee.
6. Certificate of Deposit (CD)
CDs are offered by banks and are relatively low risk but have a low return rate. Basically you give the bank a certain amount of money and if you agree not to touch the money for a defined amount of months or years, the bank will give you a slightly higher interest rate (think 1.5% currently). The gains from CDs are taxable income.
I hope this helps show you some different types of investment options. This is just a quick overview and there are other rules and restrictions that could apply that I didn’t discuss. Like with anything, I recommend talking to a professional including your financial advisor before you start investing. Once you get the hang of investing it can be fun watching your money grow!