Where to save your next dollar

In a perfect world, we would all be completely debt-free, maxing out our 401(k)s at work, fully funding traditional or Roth IRAs, loading up a 529 plan to send our kids to college – and then looking for ideas on how to spend all the money that’s left over from our last paycheck.

Most of us don’t live in that world.

You have goals, needs, and obligations all competing for the limited amount of money you’re able to save each month. And if you can’t satisfy them all, how do you set priorities? Where should you save your next available dollar?

Here’s what I suggest, in order of importance:

  1. Emergency reserve. This is your moat, the money that will stand between you and the next big expense you’re not expecting. More than a third of your fellow Americans couldn’t come up with an extra $400 in an emergency without borrowing or selling something. Get about 30% of your annual income saved here before moving down the list.
  1. Credit card debt. Or anything else that’s charging you double-digit interest rates. And once they’re paid off, resolve to pay them in full every month from now on.
  1. Your retirement plan at work. With a full moat and zero balances on your credit cards, your next priority should be saving enough in your 401(k) or similar plan to qualify for anything your employer matches. You can’t afford to pass up free money. Keep in mind, matching contributions from your employer may be subject to a vesting schedule. Please consult with your financial advisor for more information.
  1. Roth IRA. The money you earn on your investments can be taxed today, tomorrow, or never. If you are allowed to make contributions to a Roth IRA and meet other criteria, you can create a pool of money that compounds tax-free over the rest of your life.
  1. Down-payment on a home. Or any other big purchase you consider a necessity but either can’t or don’t want to borrow for.
  1. Back to the 401(k) plan. If you’re getting the full employer match on your 401(k) or similar program, go back and boost your contributions here until you max out. And don’t forget the catch-up provisions on these plans and IRAs once you reach age 50.
  1. College savings plans. If you still have money to save and want to help your child or grandchild with the skyrocketing cost of an education, consider funding a 529 plan or Coverdell Education Savings Account. But don’t put this goal ahead of the ones above. Remember, it’s okay to borrow for college, but not retirement.
  1. Mortgage debt. With low interest rates and higher standard deductions, the tax advantages of paying down a mortgage or home-equity loan aren’t very compelling these days. While it feels great to be completely debt-free by the time you retire, it’s not an absolute necessity.
  1. Next big purchase. I realize the idea of actually “saving up” to buy something you want is pretty passé these days, but smart people still do it. It certainly beats having a car payment or putting another year’s holiday gifts on the credit card. And last time I checked, you can still pay cash for home improvements and appliances.

When it comes to saving money, you may not be able to do it all. But the next best thing is saving where it will have the greatest impact.

Any opinions are those of Mike Brown Financial Group and not necessarily those of RJFS or Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete.

Like Traditional IRAs, contribution limits apply to Roth IRAs. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free.

401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10%  federal tax penalty.

As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. The tax implications can vary significantly from state to state.