Everyone has dreams and life goals. For you that may be homeownership, sending your kids to college, comfortably retiring or all of the above. Reaching these goals takes time and a well-thought-out saving strategy. Saving for long and short-term goals is more complicated than just depositing your paychecks into your checking account and while there are several different potential paths that could help you reach your ultimate goal, there are certain strategies and vehicles that can help you get there faster or more efficiently.
It helps to have a timeline for your savings goals. For example, if your son or daughter is 14 and you want to help them pay for college that savings goal is more pressing than eventual retirement, which may still be several decades in the future. Knowing when you want to reach your financial goals can help you prioritize your savings. For you, that may mean foregoing your maximum matching contribution to your 401(k) temporarily until you reach your college savings goals. Or maybe refinancing your mortgage so you have more money each month to put toward that college savings plan.
Also, consider what you can borrow for and what you can’t. While it’s not always a great idea to finance something you can pay for outright, there are certain purchases that most people can’t make solely with liquid capital. A house is a perfect example. You may not have $200,000 cash available to pay for a house outright, but you may have the income to support a monthly mortgage payment of $1,000.
Retirement, on the other hand, is a savings goal for which you won’t be able to find financing. In certain circumstances, and depending on where you’re at in life, it may make more sense to focus your efforts on goals you can’t finance in some other way.
One of the biggest mistakes consumers make when it comes to saving is choosing the wrong investment vehicle. As mentioned earlier, there are much better ways to save for retirement or college than the checking account you use to deposit paychecks and pay monthly expenses. Certain savings tools also have tax benefits designed to incentivize saving for long-term goals. The following are just a handful of potential saving options that can help you reach your goals:
401(k) – Workers looking ahead to retirement are often best served by putting their retirement savings into their company’s 401(k). Most employers offer matching funds, often up to six or nine percent. This means if you earmark 6 percent of your income to go into your 401(k) the company will match your contribution. In essence, you’re getting paid 106 percent of your salary, which means not maximizing your contribution up to the matching limit is pretty much leaving money on the table. These contributions also aren’t taxed like the rest of your income, which is why they are sometimes referred to as a “pretax” 401(k). Likewise, any growth or dividends accrued in the 401(k) are tax-free until withdrawn. You will eventually need to pay income tax on 401(k) withdrawals, as this will be considered income during retirement.
529 Plan – Many states and some educational institutions operate special savings accounts known as 529 plans. Earnings grow tax-free. Any funds withdrawn from a 529 plan are tax-free so long as they’re spent on qualified educational needs. The money can be used for non-education-related expenses but the earnings portion of that money will be taxed and there’s generally a 10 percent penalty fee as well. The principal portion, or the money you put in that wasn’t generated by the investment’s growth, won’t be taxed, even for non-qualified purchases, because those dollars were already taxed before they went into the 529 plan.
Certificates of Deposit (CDs) – If you’re saving for something other than retirement or education, like for a home remodel or a big vacation, you may want to consider CDs. A CD is what’s known as a “promissory note,” or in essence an amount the bank is promising to pay you at the end of the CDs term. In order to get the full value of the CD you have to leave the money untouched for the full term. CDs generally have a fixed interest rate, or annual percentage yield (APY). For example, let’s say you purchase a $10,000 CD with a 2.25 percent APY and a five-year term. After the five years the ending balance of your CD will be $11,176.78. However, there are penalties if you withdraw the money early, most commonly the forfeiture of any interest earned up to that point.
Paying off debt is always a good idea, but that doesn’t mean you shouldn’t also be thinking about the future or contributing to a 401(k). If you’d like to learn how to tackle your debt and focus more on saving for the future, get in touch with the credit and debt professionals at American Financial Solutions. We would love to discuss your financial goals and help you map out a path to reaching them. Give us a call today at (888) 282-5844.