What are savings?

Savings represent that portion of your income or earnings that is put aside and not spent.

Life can be full of surprises, both good and bad. Building savings is a great way to ensure that you have extra cash available for emergencies, unexpected bills, medical expenses, and future goals.

Most importantly, saving is an important commitment to future prosperity and a lifetime of financial well-being.

Types of savings

• General

Often kept in a general savings account, which can be accessed for any reason. This is the most common type of savings.

• Emergency

Savings that are to be used only for emergencies, such as medical bills or to cover expenses if you lose your job.

Note: Paying for last minute Coachella tickets does not count as a financial emergency!

• Retirement

Typically kept in a dedicated tax-deferred investment account, such as an IRA or 401(k), to provide income after you retire.

• Dedicated

Savings fund built up for a specific reason, such as to fund the downpayment for a house, buy a new car, or pay for a family vacation.

Why are savings important?

• Peace of mind

Having savings means that you know you always have a little extra money in the bank should you need it. Just knowing that you have something to fall back on can relieve much of the stress of living from paycheck to paycheck.

• Safety net

If you have an emergency fund, you won’t be financially ruined if something unexpected happens. A healthy emergency fund can help ensure that your life stays on track even if you become ill or injured or lose your job unexpectedly.

• Planning for the future

Buying a house, having a family, and retiring are all significant life events that require financial planning. By beginning to save early in life, you can ensure a more secure future.

The power of compound interest

Savings accounts can be a powerful way to grow your money. This is because you earn interest on the interest already earned in previous years, called “compound interest.”

Reasons to put your money into a savings account:

• Security: although they typically offer interest rates of 1%–2%, these low rates are a trade-off for security. Investing is for growing wealth, while savings accounts are for preserving money you already have.
• Your balance grows each year without any new deposits.
• By depositing more, your savings grow even faster.
• Savings accounts are guaranteed unlike investment earnings.
• They are insured by the FDIC for up to $250,000.

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Example

Assume you deposit $1,000 into a savings account that offers a 2% interest rate compounded annually. If you do not withdraw any money, your balance will grow as follows:

• Year 1: $1,000
• Year 2: $1,000 * 1.02 = $1,020
• Year 3: $1,020 * 1.02 = $1,040.40
• Year 4: $1,040.40 * 1.02 = $1,061.21
• Year 5: $1,061.21 * 1.02 = $1,082.43

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If you contribute more to your savings account each year, the amount of interest you earn increases and compounds even faster.

What about retirement?

Of all the reasons to save, retirement is perhaps the most important; once you stop working, you may have to depend on these savings to cover all your expenses for the rest of your life.

There are many ways to invest for your retirement, whether through an employer-sponsored retirement plan, such as a 401(k), or a self-directed investment account.

You don’t have a time machine to invest in the past like Biff in Back to the Future II (So good, right?), but you can always start saving early to make your later years  more tolerable!

Good to know

How much you can invest each year is limited. The annual contribution limits for 2017 and 2018 are as follows:

	401(k)	IRA
2017	$18,000	$5,500
Additional Catch-Up Contributions for those over 50	$6,000	$1,000
2018	$18,500	$5,500
Additional Catch-Up Contributions for those over 50	$6,000	$1,000

 

• You can’t withdraw money until you reach age 59½.
  • If you do, you will have to pay a 10% tax on the amount withdrawn.
• Retirement investment accounts, like all investment accounts, are not FDIC insured.
  • Investments cannot be insured by the FDIC because their value may go up or down. Any investment has inherent risk, including the risk of losing money.

Tax benefits of retirement saving

Depending on what type of account you have, traditional or Roth, each has different tax-deferral benefits:

• Traditional accounts
  • You don’t pay taxes on the income you contribute to the account each year, which reduces your annual tax bill.
  • You do have to pay income taxes on your withdrawals when you start using that money after retirement.
  • This is best for people who will be in a lower tax bracket after retirement.

• Roth accounts
  • You pay taxes on income in the year you earn it, even your retirement contributions.
  • You don’t have to pay any income tax later on withdrawals.
  • Better for those who will be in a higher tax bracket after retirement due to investments or other income sources.

Tips for saving

1. Document your spending

Make a list of monthly bills and expenses to see how much of your income you need to spend to maintain your standard of living.

2. Cut costs

Determine where you spend money unnecessarily and cut down.

3. Open a savings account

Open a dedicated savings account to keep your savings separate from your spending money. Choose an account with minimum fees and maximum interest rates.

4. Pick a percent

Decide on a specific percentage of each paycheck that you will devote to savings based on your budget. Try to save as much of your income as reasonably possible

5. Automate

Set up an automatic transfer amount from your checking account to your savings account each pay period. When your paycheck is deposited, a set amount of money should automatically go to your savings account.

6. Forget about it

Let your savings account grow on its own. Resist the temptation to dip into your savings for frivolous expenses.

Key takeaways

• Saving is a great way to ensure peace of mind, plan for the future, or fund special expenses.
• Be sure you put your savings into an interest-bearing savings account to take advantage of the power of compounding.
• Savings in qualified retirement accounts, such as 401(k) plans and IRAs, can’t be used before age 59½ but offer great tax benefits.
• Make saving easier by documenting monthly expenses, deciding how much you can afford to save, and automating transfers to your savings account each month.

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Fun facts

• Many employers will match contributions to 401(k) plans up to a certain amount, which could double your retirement savings each year.
• Cutting down on TV time can help. Advertisements can be very effective and lead viewers to unnecessary purchases, so avoiding them can help you steer clear of the temptations.
• People tend to spend more when they’re stressed, so habits that keep your stress level down can empower you to save more.

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[toggles heading=’References’]

https://www.fdic.gov/deposit/deposits/faq.html

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https://money.usnews.com/money/blogs/my-money/articles/2017-02-28/how-to-combat-emotional-overspending

http://www.investopedia.com/articles/pf/08/emotional-spending.asp

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