Starting The Year Right - Savings Priorities
Welcome to Saving Money with Andrew!
This is the first issue of Starting The Year Right, a series on setting goals this year. This week we’ll kick off with some thoughts on savings priorities.
Why do people save? For the foreseen and the unforeseen. Primarily, most of us save money for a specific purpose, such as retirement, college, a new car, etc.
But people also save for the unforeseen, and that’s even more important. Most Americans experience some kind of financial misfortune at some point in their lives, whether it’s unemployment (in June, almost half of the US adult population did not have a job for one reason or another, with total unemployment as a share of the labor force over 10%), an unexpected health expense (61% of Americans have received a large and unexpected medical bill), or something completely unexpected like a global pandemic.
In my family’s case, we assess our savings at the beginning of each year, and we set our savings priorities based on a few key principles:
Managing Risk
The #1 priority is always making sure to have cash available to withstand a sudden financial shock, such as a large unexpected medical expense or a period of lost income. It’s hard to know exactly how much one should have in an emergency fund, but recommendations such as three to six months of basic expenses are common.
Taxes
Next, consider prioritizing accounts that provide a tax benefit. For example:
Retirement Accounts - Each dollar saved in a traditional 401(k) saves 40 cents on taxes, assuming a 40% tax rate (federal + state).[1] IRAs are also a great option if you are eligible. For couples with joint income below $66,000 (or individuals below $33,000), the Saver’s Credit offers as much as a 50% federal tax credit on every dollar you contribute, in addition to other tax benefits.
HSAs and FSAs - If you have access to an HSA each year (through a high-deductible health plan), contributions are tax-deductible, saving 40 cents on the dollar, again assuming a 40% combined tax rate. And withdrawals are tax-free as long as used for qualified expenses. We also contribute to a dependent-care FSA to pay for preschool expenses. We aren’t eligible for a health-care FSA because of our HSA, but a health-care FSA is a great option for those with traditional health insurance through their employer.
College Savings - We try to contribute to a 529 college savings account each year. In our state, contributions are tax-deductible from state taxable income (saving us 10 cents for each dollar in our state) and withdrawals are tax-free as long as used for qualified educational expenses.
What’s Left?
With anything left, we try to save in simple, long-term passive index funds. We don’t own individual stocks, and our focus is generally on minimizing fees (we use Vanguard).
What If This All Feels Out Of Reach?
Many of the options above are out of reach for lots of people. Maybe you struggle to save anything at the end of the month. Maybe you have massive student loan or credit card debt and there’s very little left to save.
If that’s the case, focus on first building a small emergency fund for at least a month or two of expenses. Then, if you have any high-interest debt, particularly credit card or student loan debt (and you’re not on a repayment plan with loan forgiveness), consider paying that down first as quickly as possible.
Once you’re able to save more, think about the options above. You might consider opening an IRA with a place like Vanguard to take advantage of the Saver’s Credit if you’re eligible. Between the tax deduction and the credit offered by the Saver’s Credit, the tax benefit can be worth more than 50% of your contribution.[2]
Get the year off to a good start by taking a bit of time to think about where to focus your saving throughout the year. Every little bit counts!
And now…Andrew’s pick of the week:
Ted Gioia’s annual best albums of the year lists are a fantastic source of new music recommendations, particularly for someone like me who spends long stretches just listening to Billy Joel, Steely Dan, and prog rock playlists on Spotify on repeat.
Gioia’s 2020 list is no exception. One great discovery from the list (not exactly obscure, it’s a Grammy Album of the Year nominee!) is Jacob Collier’s Djesse Vol. 3, featuring All I Need, which is also nominated for Best R&B Performance. Enjoy!
I hope this has been helpful. If you liked it, please share it with a friend! Also, please send me your feedback, requests, and success stories.
Finally, a small disclaimer. This newsletter is not intended to be financial or investment advice, just interesting things I’ve come across that might be worth considering. Before making a big financial decision, you should consult your own accountant, investment adviser, or whomever you normally rely on for financial advice.
[1] To put it simply: if you put $1000 in a traditional 401(k), it won’t be taxed at all, whereas if you did anything else with the $1000, you’d be on the hook for $400 in income tax, so that $1000 is really worth $600 to you after taxes.
[2] For example, if you contribute $100 to a traditional IRA and your combined federal and state tax rate is 20% and you receive a 50% Saver’s Credit, those two tax benefits are worth $70 to you ($20 in savings from the tax deduction and $50 in Saver’s Credit). So it’s like it only cost you $30 to save $100 for your retirement.