April is National Financial Literacy Month, so Wellview will be sharing financial fitness-related blog posts each Friday this month. Regardless of where you fall on the financial literacy scale, this is a good time of year to take a few minutes to learn something new and/or to consider your finances and come up with some ways to tweak or improve them (a financial spring cleaning). Please note that these blog posts are for educational purposes and we are not offering individual advice. For personal recommendations and support, please reach out to one of our Accredited Financial Counselors (AFC) or a Certified Financial Planner (CFP).
Financial literacy “unfun” fact: Approximately 40% of Americans have less than $300 in savings.
I often compare the stages of financial coaching to a three layer cake: the first layer is basic budgeting (income and expenses), the second layer is savings, and the third layer is investing. Last week we discussed the importance of and helpful tips around income, expenses, and budgeting. This week’s topic is “savings,” and generally speaking, this shouldn’t be tackled until you know how much you make and how much you are spending (the first layer).
There are 5 types of savings accounts:
- Emergency savings accounts: this is the savings account that you use so that you don’t have to finance life emergencies on a credit card (at a higher interest rate).
- Revolving savings accounts: this is where you move money that will be coming due in the near future or “earmark” savings for purchases that you know are coming up (due to timing of paychecks to expenses or due to the expense being a periodic expense). It’s “revolving” because money goes in and out frequently.
- Big purchase savings accounts: this is where you save for larger purchases that are on your radar (e.g. a family vacation, a new refrigerator, or a downpayment on a home).
- Retirement savings accounts: these are longer term savings accounts that will be discussed in greater detail in two weeks.
- 529 savings accounts: these are accounts set up on behalf of your child(ren) to save for future college expenses. While these are great investments and have tax benefits, you want to make sure you are funding the other four savings accounts first before you commit to these accounts.
Emergency Savings Account
You’ve completed your budget and now know (1) what your monthly expenses are, and (2) how much money you have left over after you deduct your expenses from your income. This leftover money is what you will be moving towards savings, and the first savings account you want to fund is your emergency savings account. The rule is to set aside three to six months of expenses to cover any sort of unexpected emergency.
One caveat: I have worked with many participants who have crushing debt (credit card and loans), and setting aside a lot of money for something that may or may not happen, when their credit card debt is 25%, just doesn’t seem right to themt. I completely understand that and tend to agree with Dave Ramsey in that having even $1,000 set aside is a good starting point for emergencies. After you have that first $1,000 set aside for emergencies, you can focus on reducing debt, then return to funding the emergency savings account once some higher interest debt is paid off. But (believe it or not) in order to pay down your credit card debt, you will have to set money aside for emergencies. Why? Because if you do not, you will constantly be putting emergencies on your credit card and never paying it off or down. They are two sides to the same coin. So, to start, and based on your own unique situation, make sure to have at least $1,000 set aside for emergencies. Ideally this will grow to three to six months of living expenses.
Revolving Savings Account
Last week we talked about periodic expenses, which are the expenses that come up, but not monthly (annual dues or subscriptions, insurance every six months, etc.). Now that you have identified these bills, when they are due, and how much you need to set aside each month to cover them, you need to earmark those funds in a revolving savings account. Some people like to set aside a specific account for these future bills, while others just kind of know that they will need $200 to pay future bills at the end of the month, or that $1,500 in their savings account is for bills that are due in six months. This is a personal preference and one that may develop over time, but the essence is that we need to have money saved for future, planned, periodic expenses.
Big Purchase Savings Account
Once you have your emergency savings account funded and you are setting money aside for future bills in a revolving savings account, it’s time to consider a big purchase savings account. If you have a high level of savings, this may be embedded within one of your savings accounts, but a big purchase savings account represents your plans for buying a larger ticket item in the future. It’s for new furniture, or a family vacation, or even holiday expenses for the end of the year. It’s for a downpayment or whatever you want to purchase that you want to pay cash for and not finance. Ideally, you will take the cost of the item, divide it by how long you have to get it (or you can determine how long you have to wait for it by how much you can save each month), and save that monthly amount until you can purchase said item. Some participants like to open a new account and watch this grow over time, while others just have these expenses earmarked in a larger savings account. Depending on how much time you have to purchase the bigger purchase, you can create this account as a slightly higher earning savings account (e.g. a money market account or even a certificate of deposit) or even an investment account (more on that next week). The option is up to you and wholly depends what works for you and your timeline.
Retirement Savings Account
These are worthy of their own blog post which you will get in a few weeks. For the purposes of general savings, there are tax benefits for starting to save for retirement as soon as you can, however, please do not beat yourself up if you haven’t started saving for a future event just yet. We are all doing the best we can at any moment, and a lot of us are just trying to get through each day and month, let alone address something that will happen several years down the road. When we know better, we do better. The sooner we start saving for retirement, the better. However, we can’t change the past; we can only focus on the present moment and what is under our control in the future.
529 Savings Account (or “plan”)
These are kind of like retirement accounts in that they are longer-term savings accounts with a tax advantage when you are saving for education expenses. In a nutshell, your contribution will come after taxes (meaning, you’ve already paid taxes on the amounts you are depositing), however any earnings and withdrawals used for a qualified “higher education expense” are not taxed. Almost every state offers a 529 savings plan, and you don’t need to be a resident of that state to buy into their plan. To make things even more confusing, each state has its own rules about contribution limits, state tax advantages, etc., so this is one savings option that you will need to research.
The main point I want to make with 529 savings accounts is to prioritize an emergency fund, some sort of savings account or system for revolving/periodic expenses, a fund for known future purchases, and your own retirement savings before you start investing a lot into a 529 savings fund. Unless, of course, someone else offers to fund it on your child’s behalf. In that case, go for it! While it’s a wonderful savings tool, we need to make sure our oxygen masks are on and working before we take care of everybody else.
I hope you’ve learned something new or have reflected on your own savings this week. If you have any questions or need support addressing your savings needs, please do not hesitate to reach out to one of our Accredited Financial Counselors. We are here if and when you need us!
Source: Spend Me Not
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– Tanya Runci, AFC, BA, MA, ADE, NBC-HWC
Health Advisor | E-Mail Tanya