How Should I Prioritize My Savings?

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How Should I Prioritize My Savings?

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We all know we should be spending less money than we make and building up savings, but there are a lot of different types of savings. How do you know what should be a priority?

Saving money is great, but you want to be saving money in a smart way that will help you to reach your financial goals. Saving for the wrong things at the wrong stages of life can have bad consequences.

Of course, everyone’s financial situation is unique. But in general there is a basic order that you should follow when it comes to prioritizing your savings. Let’s take a look at the typical way you can know how you should be saving your money.

→ Related reading: How to Create a Budget that Works

Priority 1: Emergency Savings

Your first financially priority should be to build up a sufficient savings fund for emergencies. Most experts recommend that your emergency savings account has enough money to cover 3-6 months of living expenses, but the specifics can vary depending on your situation. If you are self-employed or a family living on a single income, you’ll probably want to be more conservative and have at least 6 months of expenses saved up.

No one wants to think about something bad happening, but there are plenty of scenarios where you would need some savings to fall back on. Unexpected layoffs aren’t uncommon, unfortunately. Emergency medical bills, a car that dies on you, or major home repairs can all happen at any time.

I would recommend getting your emergency fund in place before moving on to any other savings or investments, especially if you have a family. It’s not only important to build up the emergency savings, but it’s equally important that you don’t touch this money unless it is a true emergency and it’s necessary. If you’re always dipping into your emergency savings, you will be in a constant position of trying to put money back into that fund.

My wife and I use online savings accounts with Capital One 360 (of course, there are plenty of other online savings accounts you can use). You can create multiple savings accounts for different purposes. Name one of them “emergency”, put enough money in it, and leave it there unless it is a true emergency.

Priority 2: Pay Off High-Interest Debt

How Should I Prioritize My Savings?

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If you have high-interest debt, like credit cards, you should pay that off as soon as possible. I would prioritize this ahead of any savings, aside from the emergency fund. Low-interest debt like a mortgage, car loan, or student loan would not fall into this category.

When it comes to paying off debt there are a few different approaches. One option is to start with the debt that carries the highest interest rate and work your way down. Dave Ramsey, a popular financial author and educator (especially in Christian circles), recommends a different approach. He says you should list the outstanding balance of each debt and start by paying off the smallest debt first. The reason he suggests this approach is because it gives you motivation to see debts being erased, even if they are small. You’ll be encourage and more motivated to keep eliminating debt. You can read about Dave Ramsey’s snowball approach here.

Priority 3: Retirement Savings

How Should I Prioritize My Savings?

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After you’ve saved up enough for emergencies and paid off high-interest debt, now it’s time to start thinking about retirement. If you’re young it may seem boring and unnecessary to save for retirement already, but the earlier the better. If you start early you’ll have much more time for compounding and growth, and you’ll be in a much better spot as you get closer to retirement.

Not all retirement savings is equal. There are several different options, so let’s look at how you should prioritize your retirement savings.

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401(k) Up to the Employer Match

If you have a 401(k) plan through your employer, most likely that employer will provide some sort of match to your contributions. The specifics will vary from one employer to the next, but something like a 4% match or a 6% match would be pretty common.

My first recommendation for retirement savings is to make sure you are contributing enough to get ALL of the employer’s match. So if your employer matches contributions up to 5% of your salary, be sure that you are contributing at least 5% of each paycheck. If you’re not doing this, you are essentially passing on a raise from your employer.

The money that you contribute to your 401(k) is tax deductible, which is another huge benefit. Between the employer match and the tax benefits, contributing to a 401(k) is a must.

Roth IRA

If you still have money to set aside for retirement after your 401(k) contributions, the next priority should be a Roth IRA. Unlike the 401(k) contributions, the money that you invest in a Roth IRA will not reduce your taxable income. However, the Roth IRA comes with an even more powerful benefit: you won’t pay taxes on the growth or when you get the money out of the Roth IRA in your retirement. The limitations and eligibility change sometimes, but currently you can contribute up to $5,500 per year if you are under 50 years old, or $6,500 per year if you are over 50. That contribution limit is a combined total that applies to all IRAs, but Roth and Traditional. You can split the $5,500 however you want ($5,500 in Roth and $0 in Traditional. $0 in Roth and $5,500 in Traditional. $3,500 in Roth and $2,000 in Traditional. Or any other combination up to the maximum).

One of the few negatives of the Roth IRA is that there are some income restrictions that don’t allow you to contribute if you qualify as high income. For single filers you will need to have income less than $135,000 or less than $199,000 for married couples filing jointly. Check with your accountant, but those numbers are current as of the time this article is published.

Traditional IRA or Additional 401k Contributions

The next option for retirement savings is to invest in a Traditional IRA or to make additional contributions to your 401(k). Employees can contribute up to $18,500 in a 401(k) per year, not including the employer match. Again, check with your accountant, but that number is for 2018. It was $18,000 for 2017.

As mentioned in the previous section, total contributions to IRAs are capped at $5,500 or $6,500, depending on your age.

Priority 4: College Savings

How Should I Prioritize My Savings?

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If you have kids, it’s never too early to start saving for college. Tuition is ridiculously expensive these days, so if you don’t start early you will be behind. You can use a 529 plan, which has some benefits. The IRS doesn’t give you a tax deduction for your 529 contributions, but the distributions are tax free.

One word of caution here is that you will face some penalties if the money is not used for qualified education expenses. While you want to have something saved up, it’s best not to go overboard and put more than is needed in a 529 plan, as it will just lead to penalties later.

Priority 5: Personal or Family Goals

How Should I Prioritize My Savings?

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If you’ve made it through all of these things and still have more money that you can save, you can start thinking about some other goals for you and your family. Maybe you want to save for your weddings, a vacation, major home improvements, a new house, a vacation home, or something else. You could put this money in a conservative account, like a savings account, or you could be more aggressive and put it in a mutual fund. My preference is to use a conservative savings account if I plan to use the money within the next 12 months, and put longer-term savings in mutual funds. My wife and I use Vanguard, but there are plenty of other companies you could use if you prefer.

Should I Pay Off My Car Loans and Mortgage Early?

How Should I Prioritize My Savings?

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A lot of people wonder if it is a good idea to pay off other debt like a car loan or mortgage. My answer is “yes!”. Most car loans and mortgage loans are not high interest, so this is really a matter of opinion or preference. But there is a lot of benefit to being debt free.

If you’re talking about a car loan, you can start saving for your next car once your current car is completely paid off. Not having expenses like a car loan or a mortgage every month will obviously reduce your monthly expenses, and it can help to reduce stress and make you more stable financially. As someone who is self employed and has an unpredictable income, I can tell you that not having debt makes me feel a lot more comfortable about the financial security of my family.

Of course, not everyone will feel the same way. I don’t think it is a bad decision to prioritize other savings an investments over this type of low-interest debt if that is what makes you feel more comfortable.

FREE DOWNLOAD

Free Budget Spreadsheet

Download a free budget spreadsheet for use in Excel and OpenOffice, plus a PDF version that you can print.

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About the Author Marc

I've been working in internet marketing full-time since 2008. I started VitalDollar.com to share from my experience and to help others who want to improve their own financial situation. You can read my full bio here.

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  • Troy Taft says:

    Looking back, savings has turned out to be a pretty big deal in my life so far. These priorities are pretty close to mine. I have felt the value of this.

    One note: I found that I need to be careful with how much I put into IRAs. My understanding is that there’s a pretty hard limit of about $5,500. Your Roth IRA and Traditional IRA, together, would have to add up to that number and no higher (unless you are over 50 then it’s $6,500). If you’re a high-earner, you might not even be allowed to put much in one at all.

    Workplace 401k’s and 403b’s are a different story and they do go up to that higher amount. You can even get Roth 401k’s! Those are really awesome.

    Thanks for the great post. I agree it’s really important to consider our savings.

  • Marc says:

    Hi Troy,
    Thanks for your comment. Yes, you are correct, the IRA limit is a combined total. I changed the wording on the article to make that more clear.

  • Hello Marc,

    This is my first time on your blog and I’m so loving it.

    The emergency savings you talked about is something I love so much.

    I did it last year November and my result was incredible but along the line, I stopped. I think this is a huge reminder that investment shouldn’t make me dabble into my emergency fund so deeply. The embarrassment it could cause one is out of this world.

    I have 6 bank accounts now and I think it’s time to start naming them for different purposes.

    Thanks for sharing this valuable content.

    Emenike

  • Marc says:

    Hi Emenike,
    Thanks for visiting and for your comment. I use several different saving accounts and have them named for different purposes. That is a really great approach that works well for me and my wife, so I think it could work well for you too.

  • Harriet Vane says:

    Great post! I especially like the point about “passing on a free raise” if you don’t get the full employer match on your 401 (k). I’m a payroll administrator and it drives me nuts when people don’t max that out—it’s free money!

  • Marc says:

    Hi Harriet,
    Thanks for your comment. Glad to hear that you feel the same!

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