Last year, NerdWallet conducted a survey of couples to dig into gender roles and money. Among the results — which showed that gender roles are indeed still alive and well — was this little nugget: one in five respondents reported that they and their partner have no savings goals.
That doesn’t mean they aren’t saving; just that they aren’t saving for anything specific. But that process of spelling out goals is key to reaching them. If you simply save blindly, you’re more likely to raid that cash for the wrong reasons. You may prioritize the wrong objective and choose the incorrect vehicle to house your money.
Here is a general guideline for the order in which to focus your savings efforts.
1. Start with your 401(k)
If your retirement plan at work comes with a matching contribution, you need to grab that first, says Johanna Fox Turner, a financial planner in Mayfield, Kentucky. It’s free money. Generally, the amount you need to contribute to catch that match will be fairly small: The most common arrangement is dollar for dollar up to the first 6% of salary deferrals, according to Aon Hewitt, which amounts to around $2,400 a year on a $40,000 salary.
2. Build up your emergency fund
Once you’ve captured all of your matching dollars, you want to start building an emergency fund. Having some cash in the bank that you can draw on in case of an unexpected expense — whether that’s an insurance deductible after a car accident or a blown water heater at your house — is the foundation for the rest of your financial life, because it keeps those costs from piling up on your credit card, costing you interest. But many people aim too high here, says Fox Turner, noting that the rule is three to six months’ worth of bare-bones living expenses, which is less than three to six months’ worth of paychecks. What’s the risk in saving too much? An emergency fund should be kept in a standard savings account where it is easily accessible, which means you’re unlikely to earn more than around 1% in interest. Excess money could be working harder for you elsewhere.
3. Max out tax-advantaged accounts
For many people, the best option at this point is a Roth IRA. It allows you to start building a tax-free pool of money early: Under the terms of a Roth, your contributions are made after tax, but the money grows tax free. The other perk here, says Fox Turner, is that you can take out your original contributions at any time without taxes or penalties. The downside: It has a low contribution limit of $5,500 and income restrictions (those who earn more than $116,000 if filing single or $183,000 if filing jointly won’t be eligible to contribute the full amount). If you’re not eligible for a Roth, a traditional IRA is a good substitute (here’s a good explanation of the difference between traditional vs Roth IRAs). Once you’ve maxed out your IRA, go back to your 401(k) until you reach the limit there, which is $18,000 in 2015. For help selecting a Roth or traditional IRA, check out NerdWallet’s favorite IRA providers.
4. Start planning for college
It’s a common question from parents: Save for college or retirement first? The answer is retirement, because your kids can get financial aid for college. No one is going to help finance your retirement. When you’re ready to start saving for college, a 529 account is a good vehicle in which to do it. Your contributions aren’t tax-deductible, but distributions for college are tax-free. The catch is that if the money isn’t used for education expenses — because, for example, your kid decides to learn on the job as a chef — you’ll pay taxes and a 10% penalty on the earnings. That’s why some advisors, like Fox Turner, recommend using the aforementioned Roth IRA as a multi-tasker, because it allows distributions for qualified education expenses.
5. Save for other goals
Retirement and college are frequently discussed financial goals, but they aren’t the only ones. You may want to save for a wedding, a downpayment on a house, or even next year’s summer vacation. These goals should be sprinkled in along with the above as needed, based on time horizon. “The further away the goal is, the longer it can afford to wait until you direct your attention to it,” says Patricia Jennerjohn, a financial planner in Oakland. (The exception to that rule: Saving for retirement in your 401(k), because if you don’t grab that match, you’re giving up free money.) Where you should put this money also depends on the time frame. Money you need in five years or less shouldn’t be in the market, but for timelines beyond that, you can look at a taxable account with an online broker or a robo-advisor.
More from Nerdwallet:
- How does your IRA provider rank among the best?
- Battle Bots: Evaluating Robo-Advisors
- Are you getting the most out of your savings account?
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