Everything You Should Know About Savings When Your Bad at It
Updated: Sep 8, 2021
The second building block for reaching your dreams is a strong savings habit. When you put money away, you are saying, “I believe in my future and I’m willing to take charge of it.” Saving puts into action the faith you have in yourself.
If you haven’t successfully put money aside in the past, that’s all right. Saving some amount is possible — no matter the size of your paycheck. Here in Part Two, we’ll show you how to make use of your money so you can:
Save for short-term goals
Save for an emergency
Finance your long-term goals and dreams
GROW YOUR SAVINGS
Regardless of how much you earn, your savings (your wealth) can grow if you start treating money as something that works for you. And, time is much more powerful than the amount you save or even the returns you earn on investments because of inflation and the time value of money.
Start Saving Early. It Pays!
Because of inflation, the same items you purchase today will cost more in the future.
But individuals who start saving and investing early in life have an advantage over those who start later. When you put away even small amounts, a very important financial concept is working for you: the time value of money.
When you put money into an interest-bearing savings account, the amount you save is the principal. The principal earns a rate of interest as determined by the financial institution. Interest is paid on a saved amount at regular times, such as annually, quarterly or monthly. When interest is paid, it is added to the principal. This new balance – principal plus interest – earns more interest during the next period, and so on. This process is called compounding, and its effect is like magic when you let it work for you over time.
The more frequently interest is calculated (or compounded), the more your money works for you to grow. Here is an example of why it pays to start saving early in life and to compare interest rates and frequency of compounding.
Aletta and her brother Cory both deposit $5,000 into high-yield money market accounts that pay an annual percentage rate of 6 percent. Compare the results after 10 years if interest on Aletta’s account is compounded once a year and interest on Cory’s account is compounded once a month.
Another way to take advantage of the power of compounding is to increase the principal amount so more interest is earned each period. Suppose that Aletta and Cory both establish the routine to add $100 each month to their money market accounts. Not only will the principal grow, but they will receive a considerable amount of interest after 10 years. Compare to the previous example the results after 10 years
WHERE DO I PUT MY PAY AND MY SAVINGS?
Both checking and savings accounts are offered by banks, savings and loan associations and credit unions. It is not necessary to have your savings and checking accounts at the same financial institution, although that may be more convenient and it may permit you to have a free checking account.
A checking account is a safe, convenient and inexpensive way to pay bills. This account is a service that financial institutions provide, so they often offset the cost of this service by charging fees. Make sure you understand what fees you will be charged, if any.
Once you start saving money, you’ll need a safe place to keep it. A savings account pays you money in the form of interest while you leave your money in the account.
YOUR CHECKING ACCOUNT
Before you open a checking account, shop around. Here are some questions to ask:
How much money do I need to deposit to open an account?
What is the minimum balance to avoid fees? Are there any monthly fees charged to the account (for instance, for falling below the minimum balance)?
Will I get more benefits if I keep a larger balance?
Is a debit card available?
How much do new checks cost?
Is there a fee for writing checks?
Is there a “basic” account with lower fees if I meet certain criteria?
Do any checking accounts earn interest?
If so, do they require a minimum balance?
What is the overdraft fee if I make a payment or purchase that my account cannot pay (a nonsufficient funds fee)?
Is overdraft protection available?
What are the automated teller machine (ATM) fees?
Is there a fee for working with a teller in person, online or by phone?
Is the bank insured by the Federal Deposit Insurance Corporation (FDIC)?
Is the credit union insured by the National Credit Union Administration (NCUA)?
Make Your Checking Account Work for You
Checking accounts make money management convenient. For example, you can ask your employer to pay you through direct deposit, so your paycheck is deposited directly into your account electronically. Your paycheck funds will be there on payday, ready for you to use. You will not have to go to the bank and there is no chance of losing your paycheck or having it stolen. Your money is easy to track because you will receive a statement from your employer showing how much was deposited to your account.
If you have a savings account, you can ask your employer to have part of your pay directly deposited into that account. If you start with an affordable amount, you won’t miss it and your savings will grow without effort on your part. An alternate way to “pay yourself first” is to have money transferred automatically from your checking account to your savings or investment account on a certain day of each month.
Automatic bill payment from your checking account also can relieve stress. If you have regular bills (for example, mortgage or car payments), your bank transfers the bill amount to the company or institution each month. You don’t have to remember to make payments, which saves time and worry. Most importantly, you can be sure your bill is paid on time, and that you avoid penalties for late payments.
But be careful. If you lose track of your checking account balance, or if for some reason you run low on money, you could overdraw your checking account. This could cost you a lot of money in fees. Give yourself reminders to record automatic payments on your spending plan or budget when they occur. Some banks also will send you reminders of upcoming automatic payments.
Automatic payments can work for you — or against you
ONE COUPLE PAYS A PRICE FOR AUTOMATIC PAYMENTS
When Tina and Tyler bought their first home, they chose the automatic payment feature so that their house payments went directly from their checking account to the mortgage company. At first it was great — no checks to write, no worries about late payments.
When their first child, Alicia, was born, Tina quit work for three months to care for the baby. With no second paycheck and extra expenses, money was tight. A little while later, one of them forgot to track a payment for groceries. Not only did the automatic payment bounce, but so did two other small payments. The mortgage company charged a $25 penalty because the payment was late. Also, the bank charged a $30 overdraft fee for each of the other payments. Tina and Tyler lost a total of $85.
After paying these charges, Tina and Tyler decided to drop the automatic payment on their mortgage until they got their finances back under control. For them, this convenience feature was no deal.
AUTOMATIC PAYMENTS SAVE THE DAY — AND MONEY
Jennifer, a recent college graduate, is accustomed to doing everything online. She uses direct deposit and makes as many bill payments online as possible. Jennifer generally
pays all her bills on time, but sometimes she loses track. As a result, she’s paid late fees.
So when Jennifer bought a one-year-old used car, she requested automatic payments. Her car payment money stays in her checking account, earning interest, right up until it’s due each month. (Her checking account pays interest if she keeps it above a certain balance.) Jennifer also signed up for email spending alerts and she frequently checks her bank account balances. By keeping close tabs on her accounts, she can ensure that her online payments, automatic payments and daily expenses aren’t getting her in trouble.
TIPS FOR USING A CHECKING ACCOUNT
Keep track of how much money is in your checking account. In addition to your online statements, maintain a spreadsheet, app or checkbook register to track your current balance as well as each deposit, payment and withdrawal.
Never make payments if you don’t have the money in your account. The bank’s nonsufficient funds (NSF) service charges can be as high as $35 for each overdraft. Overdrafts will hurt your reputation with the bank and with people to whom you owe money. The business receiving the payment may charge a fee as well.
Be careful about using your debit card when your account is running low. Depending on how a business verifies your card, you can get approval to spend more than you have in your account. Then the bank charges you $35 or more for overdrawing your account.
Don’t rely solely on the bank to track your balance. Follow the How to Reconcile a Checking or Savings Account tips on page 30. If something doesn’t add up or you spot an error, ask your bank or credit union representative to help you reconcile your checking account. Sometimes pending deposits or withdrawals will not be reflected in your balance right away, which can make you think you have more money than you do.
Promptly report any errors, and lost or stolen checks, debit cards or credit cards to your bank or credit union.
Keep your bank statements and other relevant payment paperwork for up to seven years. You may need this information to prepare and defend your tax returns or dispute an error on your credit report.
When you are ready to dispose of any paperwork from the bank (statements, canceled checks, etc.), shred it to prevent identity theft.
HOW TO RECONCILE A CHECKING OR SAVINGS ACCOUNT
1. Verify that all your posted withdrawals are accurate, including amounts for electronic payments from your checking account, ATM withdrawals and debit card charges. Often tips are not reflected in pending payments, so it’s a good idea to keep your receipts to track the full amounts.
2. Total the amounts of payments, checks and debits that have not yet posted to your account. Also, subtract ATM withdrawals, debit card transactions and/or automatic withdrawals (for savings or monthly bills).
3. Total the amounts of any deposits that have not yet posted to your account.
4. Subtract any bank fees.
5. The resulting balance should match the balance in your spending tracker.
6. If the numbers don’t agree, check your math and look for missing transactions (for example, additional payments that have not cleared or fees you may have incurred). Remember, you always can ask a bank or credit union representative for help.
Your Savings Account
Before opening a savings account, call several financial institutions or visit their websites to find out answers to the following questions:
How much money do I need to open the account?
What is the minimum balance I will need to keep in the account?
How much interest does the account pay? How often is interest applied to the account?
How do I withdraw money when the time comes to spend or invest it?
Is there a limit to the number of times I can withdraw money from my account each month without incurring a charge? (Remember, the whole point of having a savings account is to leave the money there, so a few reasonable limits on how often you can take money out should not be a problem.)
When I take money out of the account, is there an effect on the interest earned?
Is the bank insured by the FDIC? If it’s a credit union, is it NCUA insured?
After those questions are answered, you also may want to ask about certificates of deposit (CDs) and money market deposit accounts.
CERTIFICATES OF DEPOSIT
CDs are deposits you make for a specific period of time. At the end of that time period — called the maturity date — you get back the dollar amount of the CD (the principal) plus interest. CDs pay a fixed amount of interest, so the amount you can earn on a CD doesn’t change over its time period.
You can choose a CD with a maturity period of one month, three months, six months, one year, two years, three years, and so on. The longer the maturity, the higher the interest rate you generally earn in your account. CDs are great when you have a specific time frame to meet a specific goal. For example, say you plan to buy a new car in three years. You can choose a CD with a three-year maturity. If you need the money before the CD matures, you may have a penalty (such as losing three to six months’ worth of interest).
MONEY MARKET DEPOSIT ACCOUNTS.
Compared to regular checking accounts that sometimes pay interest, you may earn a higher interest rate on money market deposit accounts. However, you may need to deposit as much as $2,500. (Each financial institution requires a different minimum balance.) Like a regular savings account, a money market deposit account may limit the number of monthly withdrawals. A money market deposit account can be a good place to keep your emergency fund.
Money market and CD accounts might pay more interest more frequently than a regular savings account, but there is a trade-off for this higher interest rate. With a CD, the trade-off is that you have to leave your money in the account for a certain period of time. With a money market deposit account, the trade-off is that you have to keep a higher minimum balance to earn the higher interest. However, both options have the potential to grow your savings faster than a traditional savings or checking account.
KEEPING YOUR MONEY SAFE
When you select a bank for your checking and savings accounts, be sure the bank is insured by the Federal Deposit Insurance Corporation (FDIC). This insures your bank accounts (checking, savings, trust, CDs and IRAs) up to a total of $250,000. Other accounts, such as mutual funds, may not be insured. Credit union accounts are insured in a similar manner by the National Credit Union Share Insurance Fund (NCUSIF), which is administered by the National Credit Union Association (NCUA).
Saving vs. Investing: What Is The Difference?
There can be confusion about the words saving and investing. For example, someone might claim that a new car is an investment, which probably is not true since most cars lose their value over time and an investment ideally should increase in value. Think of saving and investing as methods of setting aside money for the future. The best method depends on your needs and goals.
Saving means putting aside money you don’t spend now so it can be used later. For short-term needs, individuals typically set aside savings in safe interest-bearing accounts that can be accessed quickly. Examples of liquid accounts that have little or no risk of losing value include a regular savings account, a certificate of deposit (CD) or money market deposit account. Use these accounts for money you want to be able to access quickly, with little or no risk that you’ll lose what you set aside.
Savings can be used to meet short-term needs (for example, an emergency or a down payment). You also can use savings to build up the minimum amount needed to make an investment.
To build up money for long-term needs, invest your saved funds in ways that have the potential to offer greater returns than interest-bearing accounts. Investments are meant to accumulate so they can be used for longer-term needs, such as your retirement or a child’s education.
Investing means buying something with the expectation that it will make money for you. The most common investment choices are stocks, bonds, real estate and mutual funds. These types of investments do not guarantee a return, so they have more risk associated with them. However, they are capable of earning more than low-risk savings accounts.
Investment accounts can be very volatile — they can lose (or gain) a great deal of value in a short period of time. Generally speaking, the longer you invest, the more the risks are reduced. As long-term goals approach, you should consider moving the money for those goals from riskier investments to guaranteed interest-bearing types of savings accounts.
In time, you will have both short-term and long-term financial needs; therefore, you will need money in both savings and investments.
Double Your Money: The Rule Of 72
As noted earlier, a key to investment success is time. The longer a sum of money earns compound interest or an investment increases in value, the larger it becomes. The other important factor is the rate of return. The higher the rate, the more quickly a sum of money will grow.
To see how fast your money can grow in different savings and investment products, use The Rule of 72, which is an approximation of how quickly your money will double.
Option 1. To see how long it will take to double a sum of money (for example, turn $500 into $1,000), divide 72 by the rate of return. The example below assumes an 8 percent interest rate.
72 ÷ by 8 (the interest rate) = 9 (years) So,
at 8 percent interest, $500 doubles to $1,000 in nine years.
Option 2. To determine the rate needed to double your money, divide 72 by the number of years in which you want to double your money. The example below assumes an investor wants her money to double in 10 years.
72 ÷ by 10 (the desired number of years) = 7.2 (the rate of return) So,
to double $500 to $1,000 in 10 years, the investment needs to have a 7.2 percent annual percentage rate.
The Rule of 72 shows that, over time, investors earn more on their money than savers. Using sample rates of returns in the table below, compare the outcomes of two different average returns from individual stocks or mutual funds compared to money market deposit accounts. Using an 8 percent average return on individual stocks or stock mutual funds and 4 percent annual interest rate on money market deposit account, compare the number of years it takes to achieve the same dollar value of returns.
The rate of return can make an amazing difference. Investors need to balance higher rates of return with increased risk.
TYPES OF INVESTMENTS
Stocks: Owning stock means you own part of a company. In general, if a company does well, its stock price increases. You also might receive some of the profit in the form of a dividend. Of course, if the company does not do well, the stock goes down in value. Also, stocks can be affected by outside factors, such as political and market events that have nothing to do with the company’s performance.
Stocks can be risky; however, over a long period of time — such as 20 years — many stocks do increase in value. To decrease risk, it’s a good idea to own stock in more than one company, in different industries (diversifying your investments) and to hold these stocks for long periods.
Mutual Funds: A good way for most people to diversify their investments is through mutual funds. A mutual fund pools your money with money from many other people. Instead of buying just a few assets, a professional fund manager purchases many stocks, bonds and/or other assets. This diversifies your investment so that you don’t have all of your eggs in one basket. Professional management and diversification are two of the main benefits of mutual funds.
Bonds: Bonds are issued by both companies and government entities (federal, state or local). When you buy a bond, you lend money to the issuer. The bond represents a legal promise to pay you interest for the use of your money (for example, for bridges and highways) and to repay you the original amount you paid for the bond (the principal).
Bondholders are less likely than stockholders to lose money. But the return on the bond investment usually is lower than potential returns on stock. However, the potential for your money to grow is greater than a basic savings account.
Treasury securities: Treasury securities include federal government bills, notes and bonds. The principal is safe as long as you hold the security to maturity (the time at which the government agrees to pay back the principal). However, if you sell the security before maturity, you risk losing some of the principal if interest rates have risen since your purchase date.
Real Estate: A real estate investment may include residential rental property, raw land, real estate investment trusts (REITs) or commercial businesses. Real estate is an attractive investment to many people. It can be seen and touched, and it offers pride of ownership.
However, an investment in real estate carries some distinct risks. It is possible for property values to go down as well as up. If you sell the property when it is worth less than the price for which you bought it, you could lose some of your investment principal. Interest rates may rise, causing your monthly payments to go up if you have an adjustable-rate mortgage rather than a fixed-rate mortgage. Also, real estate is subject to property taxes, even if it is not income-producing.
Keep in mind that real estate is not a liquid investment. That is, it may be hard to sell the property when you want to, leaving your money tied up when you need it.
APPLY SOUND SAVINGS AND INVESTING HABITS
Set Financial Goals
How do you take control of your life and move forward when you are busy keeping up with everyday life demands, such as paying the bills and taking care of loved ones? The answer is planning, and the first step in planning is setting goals.
These are goals you want to accomplish within one to three years. For example, you could save $200 each month for a year to establish a solid emergency fund. Common short-term goals might include:
1. Paying down debt
2. Establishing emergency funds
3. Taking a vacation
4. Buying cars or household items
These are goals you want to accomplish in three to five years. An example would be to save $10,000 over three years for a home down payment. Often people will consider these medium-term goals:
1. Further education or training
2. Beginning to invest
3. Charitable donations
4. Buying a home
These are goals you want to accomplish in five to 10 years. An example would be to save at least $5,000 each year to invest for retirement. Long-term goals also can include:
1. Educating children or grandchildren
2. Starting a business
3. Acquiring rental property
Improving your financial life requires planning, which starts with setting goals that are Specific, Measurable, Achievable, Realistic and Time-bound (SMART). It also helps to share your goals with a “financial buddy” to set specific dates to check in on progress and celebrate your successes.
Once you’ve set your goals, you can figure out what you need to save over each time period and chart your progress with a financial buddy. Before you get started, however, take some time to think about what you want and need that costs money.
1. Jot down a dozen or more items that could become your goals.
2. Prioritize these items, starting with the ones that are the most important to you.
3. Mark each goal with a time frame: short-term, medium-term or long-term. Then use the worksheet that follows to outline your goals, the amounts you will need to save over time and when you will conduct your progress checks with your financial buddy.
Make the Commitment to Save
The first step in setting aside money for savings is deciding that it’s possible. Far too many people think they just can’t save money. If you are one of those who never seems to have anything left from your paycheck after paying bills and living expenses, start thinking of saving as a necessity.
The secret of saving is to pay yourself first. When you collect your paycheck, set aside a certain amount for savings.
IF YOU THINK PAYING YOURSELF FIRST IS EASIER SAID THAN DONE, HERE ARE SOME IDEAS TO GET STARTED:
If possible, have your employer automatically deduct money from your paycheck and deposit it into your savings account. What you don’t see, you won’t miss.
Have your financial institution automatically transfer a set amount from your checking account each month into your savings account. Your financial institution usually can set the date of the automatic transfer for the day (or a few days after) your pay is deposited. It is fine to start small (say $10, $15 or $20 a week). You will be amazed at how quickly your money grows.
Try putting $1 a day, plus pocket change, into a large envelope or a jar. At the end of the month, you could have about $50 to deposit into your savings account. That’s $600 a year (not including interest if you deposit it in an interest-earning account).
Deposit a tax refund, pay raise or bonus into your savings account rather than spending it.
Include savings as a line item expense on your spending plan. Make saving a priority over spending for things such as movies or dining out.
Take advantage of product rebates. When you receive the rebate checks, deposit them into your savings account. (Most people fail to take advantage of this savings tool.)
Break costly habits and save the difference. For example, if you spend $75 a month on trendy new T-shirts, put the $75 into your savings account instead.
After paying off a loan, put the same amount each month into savings (if the money isn’t already going to paying off another loan).
Plug your spending leaks
The first step in setting aside money for savings is deciding that it’s possible.
It’s important to view investing as a long-term savings and wealth-building tool, not a get-rich-quick tactic. Controlling risk is key to your investment strategy. One of the best ways to manage risk is to spread your investments and savings across a variety of channels. This is important because if you have all — or even most — of your money in one place (whether it’s the stock market, real estate or even municipal bonds issued by your hometown), you’re at a higher risk to lose it all if something goes wrong.
There are three main ways to control risk: diversification, investing consistently and investing over a long period of time.
Diversifying means spreading investments across different industry sectors (e.g., technology and health care) and securities (e.g., stocks and bonds), and using a variety of investment products to protect the value of your overall portfolio in case a single security or market sector takes a serious downturn. This reduces risk, because even though one or more investments might falter, others will gain.
Think of it this way: If all of your wealth was in a single company’s stock and that stock suddenly plummeted 50 percent, you would lose half of your savings. Diversifying over several stocks, as well as real estate, bonds and other products, lets gains in one area offset losses in another.
Investing Consistently (Dollar-Cost Averaging)
One way to make the most of investments over time is to commit to investing a certain dollar amount on a regular basis. For example, let’s say you are going to invest $30 per month in Company XYZ’s stock. The value of the stock will fluctuate from month to month based on the company’s performance, the demand for the stock and other factors. Regardless of whether the stock is high or low, you buy as many shares of Company XYZ’s stock as you can with your $30.
One month, your $30 might buy you two shares, the next month it might buy just one share. But no matter what, you consistently invest your $30. This is called dollar-cost averaging. Since markets generally rise over time, you’ll often do well over the long term.
Investing Over Time
Research shows that investing for the long term reduces investment risk because, even though the price of a given investment may rise and fall within a short period of time, it generally will gain back any losses over the long term. Investing is a long-term strategy for long-term goals (typically five, 10, 20 years or longer).
Withstanding short-term price fluctuations often generates greater long-term rewards for stocks versus other asset classes. Over the long term, stocks, on average, consistently and substantially outperform cash and inflation.
USE INVESTMENTS TO MEET YOUR FINANCIAL GOALS
When you decide to take on investments, you will need to keep in mind the length of time to meet a particular financial goal.
For example, most stocks are growth investments that you buy in hopes of selling for a higher price later. But some investments, such as rental property and fixed-income securities (such as government bonds), are not meant to be sold, but are meant to be maintained as a consistent source of income.
The primary goal of growth investments is to sell the assets at a higher price than you paid for them. Some investments qualify as both growth and income investments. Compared to income investments, growth investments typically offer more potential for bigger gains … and losses.
Some common growth investments include:
Mutual funds that let you invest in a variety of stocks, often for a low initial investment. Mutual fund shares can be purchased through a broker, by mail or online. Fees and commissions will vary.
Exchange-traded funds are similar to mutual funds because they pool money from many investors to buy securities. ETFs are bought and sold through brokers, usually with high fees.
Stocks hopefully can be sold for a higher price than you paid for them some time in the future. Stocks can be bought through a registered broker or by using online brokerage firms.
Income investments provide regular earnings such as monthly interest, quarterly dividends or rent payments. Steady, predictable income is the goal for income investments. Choose wisely to create a balanced portfolio.
Some common income-producing investments include:
Bonds, in which you lend money to a government entity or corporation with a promise that you will be repaid on a certain maturity date. Risks vary depending on the type of bond you purchase.
Real estate investments, in which monthly rent payments provide regular income with the potential to sell the property later for more than you paid. The best way to purchase real estate is through a qualified real estate agent.
Dividend stocks, in which regular payments usually are paid to stockholders quarterly, either in cash or shares of stock. Depending on the performance of the stock, you may be able to sell it later for more than you paid. Registered brokers or online discount brokers can facilitate stock purchases.
Business ownership that can generate regular income payments. You get to keep all the profits after taxes and business expenses, but about 50 percent of new businesses fail in the first five years.
SAVE FOR EMERGENCIES
Nobody can predict the future so it makes sense to put aside money for a rainy day. Keep this emergency fund money in an account that is separate from your general savings. If you mix your emergency fund with your general savings account, it becomes too easy to dip into the emergency fund.
Using the money in your emergency fund is better than taking out a loan or cashing in your investments to pay for an emergency. If you take out a loan, you will have to pay interest. If you cash out an investment, you will lose interest and possibly some of the original investment.
Remember these points when building an emergency fund:
Aim to set aside enough to cover your basic living expenses for at least three months. (Saving even $500, however, can help you better cope with unexpected expenses.)
Keep the money in an easily accessible savings account or money market deposit account. Do not keep the money in a long-term investment asset, such as a CD with a long maturity date or in a stock or a mutual fund
Use the money only for true emergencies, such as unexpected medical bills. If you lose your job, you may need your emergency fund for food, utilities, mortgage payments or rent and necessary transportation.
Here’s how much I will need to keep in my emergency fund
Grocery bill for 1 month $ x 3 months = $
Gas/oil, electric, and water for 1 month $ x 3 months = $
Mortgage or rent for 1 month $ x 3 months = $
Car payment and gas or bus fare for 1 month $ x 3 months = $
Other Expenses Other debt payments for 1 month $ x 3 months =$
Total amount I will need to keep in my emergency fund:
Saving for Retirement Shouldn’t Come Last
Many people look forward to retirement as the time when they will be able to kick back and do the things they love. That could mean traveling, starting a business or just living comfortably. No matter what your retirement dreams are, it’s a good idea to start planning — and investing — for retirement now. With years to go before retirement, you can set aside savings from each paycheck in an investment account such as a 401(k), and let time and compound interest work their magic.
The best way to build your retirement account balance is through automatic savings. For example, your employer, at your request, can transfer a portion of your paycheck directly into your retirement savings account. You can request that your bank or credit union automatically transfer money from your checking account into your retirement account on the day of the month you choose. Dollar-cost averaging is a great investment strategy to use for automatic retirement savings.
Tax-Advantaged Retirement Accounts
To make it easier to grow your retirement nest egg, the federal government enables you to put your retirement investments into certain accounts that have special tax advantages. These accounts, such as IRAs, are available from mutual fund companies and stock brokerage firms. Financial institutions, such as banks, credit unions and savings and loan associations, also offer and maintain these accounts. Be sure to ask about costs, such as annual fees and sales charges, before opening a retirement account.
Often, you can choose the assets you want to put into a retirement account. You can choose among cash, CDs, money market funds, annuities, mutual funds, stocks or bonds. (In general, you cannot invest in collectibles such as coins, stamps or antiques for a retirement account.) Ask your employer, financial planner, insurance agent, stockbroker or your financial institution about investment options.
One smart way to invest for retirement is to use accounts that let your money grow without generating a tax bill each year
Individual Retirement Accounts (IRA)
If you have a job, you can put away as much as $5,500 each year ($6,500 if you are 50 or older) in an Individual Retirement Account (IRA). If you have a nonworking spouse, you can open a spousal IRA and contribute from your earnings up to the same limits.
The money you put into an IRA often can be deducted from your taxable income, so you pay less in taxes each year. Your IRA money is not taxed until it is withdrawn. This is a big advantage because you end up having more money earning compound interest year after year.
You can withdraw your IRA money without penalty after you reach age 59½ . Under certain conditions, such as buying a home, you may be able to withdraw funds out of certain IRAs without paying a penalty. If you withdraw your IRA money and do not meet the certain conditions, you will face a large penalty. You will have to pay $1 for every $10 that you withdraw (10 percent). In addition, you will have to pay income taxes on the withdrawn money.
The Roth IRA
The money you contribute to a Roth IRA is made with “after-tax” dollars. The difference is that regular IRA contributions lower your taxable income while Roth IRA contributions do not. The amount of money you can put into a Roth IRA is the same as a traditional IRA, but you can’t fully fund both types of IRAs. Roth IRA withdrawals work as follows:
After age 59½, you can take out the money you put in — plus the interest earned on the account — without paying taxes on any of that money.
Interest earned on Roth IRA contributions can be subject to income tax upon withdrawal if funds are withdrawn within the first five years from the date of your first contribution. Such a withdrawal is an “unqualified distribution.” Only qualified distributions are completely exempt from taxes.
You can withdraw the original money you put into a Roth IRA before reaching 59½ without paying a penalty or taxes. (Of course, withdrawing funds prior to retirement reduces your potential earnings for retirement.)
The rules for Roth IRAs are different if you convert another investment or savings account into a Roth IRA. It is best to talk with a tax advisor or financial planner and visit www.irs.gov to get the latest information about a Roth IRA.
Employer-Sponsored Retirement Plans
This type of retirement plan is offered by employers. Usually, you sign up for the plan and tell your employer what percentage of your paycheck to transfer into your plan. (The maximum dollar amount you can contribute each year is set by the federal government.)
Many employers sweeten the pot by matching a percentage of your contributions. For example, an employer might contribute 25 to 50 percent for every dollar (25 to 50 cents) you contribute to the plan. This is equal to getting a bonus, so it pays to put in as much as you can afford.
A 401(k) offers you a number of advantages:
You do not pay taxes on the money you contribute; in other words, you make “pretax” contributions.
You pay taxes on those contributions only after you withdraw them from your plan — usually after you retire.
The money you contribute to a 401(k) plan usually can be invested in a selection of investments that ranges from reasonably safe to risky.
After you contribute money to a 401(k) plan, leave it there. It’s true that some 401(k) accounts permit you to borrow from them, but borrowing slows down the rate at which your account grows. If you borrow from your 401(k), you will have less money with which to retire.
Borrowed 401(k) funds must be paid back with after-tax dollars. Because you must pay income tax on 401(k) withdrawals after you retire, you end up paying income tax twice on borrowed funds: once when you borrow, then again when you retire. If you leave your job and cannot repay borrowed funds within a short time period, you will pay taxes on the balance. If you’re younger than 59½, you also will pay a penalty of $1 for every $10 you borrowed from this fund.
Nonprofit organizations offer 403(b) retirement plans, which are similar to 401(k) plans. These plans are sometimes referred to as tax-sheltered annuities.
As with a 401(k), you do not pay taxes on your contributions or on the amount of money the plan earns until you withdraw funds after you retire.
Also, similar to the 401(k), you choose how your contributions are invested. There are limits on how much you can contribute each year. Taking money out of a 403(b) plan before you retire has the same 10 percent penalty that applies to the 401(k) plan.
THRIFT SAVINGS PLAN (TSP) AND 457 PLANS
The TSP covers federal government workers and service members and 457 plans cover state and local government workers. Contributions by you (and your agency, if applicable) are pretax.
Tax-Advantaged Ways to Pay for Education
The U.S. government not only provides tax-advantaged ways to
save for retirement, it also provides tax-advantaged ways to pay for
education. These include Coverdell Education Savings Accounts,
which apply to a child’s entire education; 529 plans, which are
helpful for traditional college; and the American Opportunity Tax
Credit, which can be ideal for adult education. Be sure to consult a
financial planner or tax professional on all these options
COVERDELL EDUCATION SAVINGS ACCOUNT (ESA):
A Coverdell ESA provides a tax-deferred method to save for elementary, secondary and postsecondary education expenses, including tuition, books, supplies, room and board, private school enrollment fees and other qualified expenses. You can set up a Coverdell ESA for any child under the age of 18, and contribute a maximum of $2,000 per year per child until his or her 18th birthday. A Coverdell ESA can be transferred without penalty to another family member. The contributions are not tax deductible, but earnings accumulate tax free. The rules regarding the Coverdell ESA — including the contribution limit — may change over time.
Established in 1996 and named for Section 529 of the IRS code, 529 plans provide tax incentives to set aside money for college. Each state offers its own plans — and its own type of tax incentives. The plan’s beneficiary, usually a child or grandchild, can withdraw funds tax free for qualified educational expenses at any college in the country. The 529 plans are either savings plans, which can grow on a tax-deferred basis, or prepaid plans.
AMERICAN OPPORTUNITY TAX CREDIT (AOTC):
The AOTC provides a tax credit up to $2,500 per student for four years of college or other eligible postsecondary training. The tax credit applies to tuition, fees and course materials, minus grant aid, for families below certain income levels. For more information about the AOTC, visit the U.S. Department of Education at www.ed.gov and type “AOTC” in the search box.
PROTECT YOUR SAVINGS AND INVESTMENTS
Financial planning encompasses many aspects of managing your financial life. One key area is how to protect yourself and your finances from fraud. This section will explore ways to help you identify common types of fraud and what you can do to protect yourself.
Work with a Financial Professional
Taking care of your finances is like taking care of your health. You need to do regular checkups. But just like going to a doctor for your physical, not everyone wants to do their own financial planning, In fact, many of us prefer to have the assistance of a licensed financial practitioner.
Use these tips to help you identify a qualified, knowledgeable financial professional:
working with an advisor
Ask for recommendations from family and friends, then interview at least three financial planners before making a choice.
Ask for the planner’s credentials and licensing in the areas such as investment advice, securities or insurance.
Ask about the person’s work experience in financial planning.
Find out how the advisor keeps on top of the latest trends; regulations change all the time, so current knowledge is important.
Find out what you can expect regarding the extent of written advice offered, number of meetings, whether you are expected to purchase investments through the planner, etc.
Ask for references from other clients.
Discuss how the financial planner will be paid — by commission, fee and commission or fee only.
Common Types of Financial Fraud
Fraud can strike individuals and families of all education and income levels. Some common types of fraud include:
Identity theft in which someone steals your personal information and uses it without your permission.
Tax refund fraud in which an identity thief uses a legitimate taxpayer’s identity to fraudulently file a tax return and claim a refund.
Debit and checking account fraud in which fraudulent telemarketers steal money from your checking account.
Credit card fraud in which thieves steal your credit card information to use for their own gain.
Credit repair fraud in which a credit repair company promises to help you clean up your credit history for a fee.
Online fraud in which fraudsters use your social media accounts, email or seemingly legitimate sites to steal your identity and account information or sell you bogus products.
PROTECT YOURSELF AND YOUR ASSETS FROM FRAUD
You can’t be on guard all the time, but take these steps to minimize your risk.
Guard your Social Security number: Don’t give anyone your Social Security number unless you know the source and have initiated the contact.
Shred documents with account numbers: Shred or tear up any documents with any identifying account numbers or personal information.
Use a postal mailbox: Don’t leave your mail laying around. Place bill payment envelopes inside a postal mailbox instead of in a home mailbox.
Opt out of prescreened credit offers: You can stop prescreened credit offers from arriving in the mail by calling 1-888-5OPTOUT or visiting www.optoutprescreen.com.
Update computer security software: Install firewalls and anti-spyware on your computer to prevent viruses or downloads designed to steal your personal information.
Watch your wallet: Keep track of credit cards and debit cards, and never lend them out — to anyone. Leave your Social Security card, bank account numbers, passwords and PINs at home instead of storing them in your wallet.
Check your statements: Review bank statements, credit card statements and all other bills for unauthorized use.
Also check your credit report every year.
STEPS TO TAKE IF YOU FALL VICTIM TO FRAUD
Fraud crimes often are underreported because the victims of fraud feel shame or embarrassment, or doubt their own judgment. In fact, the U.S. Department of Justice reports that only about 15 percent of fraud victims report the crimes to law enforcement. If you are a victim of fraud, take these steps:
1. Save all paperwork related to the incident.
2. File a fraud alert with any one of the three main credit reporting companies (TransUnion, Experian or Equifax). Whichever company you file with must notify the other two.
3. File a fraud report with the Federal Trade Commission either online (www.identitytheft.gov), by phone or in writing.
4. File a police report with your local police.
5. Notify your bank or credit issuers.
6. If you believe someone may have used your Social Security number fraudulently, notify the IRS immediately
Highlight on Social Media:
Take these special precautions when using social media sites to protect yourself from fraud:
Privacy settings. Default privacy settings on many social media websites or apps typically are broad and may permit sharing of information to a vast online community. Modify the setting before posting any information on a social media site or app.
Biographical information. Limit the information made available to other social media users. Consider customizing your privacy settings to minimize the amount of biographical information others can view.
Account information. Never share account information, Social Security numbers, bank information or other sensitive financial information on a social media website or app.
Friends and contacts. When choosing friends or contacts on a social media site or app, think about why you use it. Decide whether it is appropriate to accept a friend or other connection request from a financial service provider, such as a financial advisor or broker-dealer.
Site features. Familiarize yourself with the functionality of the social media site or app before broadcasting messages. Who will be able to see your messages — only specified recipients or all users?