The 401(k) has grown increasingly popular over the past four decades, turning into most Americans’ primary retirement savings vehicle. By automating savings into a long-term, tax-advantaged account, the 401(k) is one of the main ways the average person builds wealth over time.
But what about financial needs outside retirement? How are you meeting your financial goals, such as buying a home or paying for your children’s college tuition? What happens if your car breaks down or you have unexpected medical expenses?
Theoretically, you could pull the money you need out of your 401(k) to cover emergency expenses — but there may be tax and penalties associated with early withdrawals. It’s not ideal. And with only 36% of Americans feeling their retirement savings are currently on track,1 there’s even more reason not to touch your 401(k) until you retire.
Fortunately, there are other ways to save that give you greater flexibility.
1. Create an emergency fund
Funding an emergency account should be every adult’s primary goal before they start looking at other savings opportunities. This is the money you can use to fix your car, replace your furnace, pay the hospital if you break your arm, and even live off of if you lose your job.
Calculate what you spend in an average month, and then make it your goal to save 3-6 months’ worth. We recommend putting emergency funds into a separate savings account so they aren’t mixed in with the money you use on monthly bills, clothing, entertainment, etc. Although a savings account won’t return you much interest on the money you save, it will keep the funds liquid and easily accessible, which is what you need in an emergency situation.
2. Set up a health savings account (HSA)
HSAs are one of the most tax-preferred savings accounts you can leverage. With its triple tax benefits, you can make pre-tax contributions, and those contributions grow and are distributed tax-free if used for qualified medical expenses. With recent studies estimating healthcare expenses for a 65-year-old retired couple are expected to exceed $300,000, setting aside savings to offset some of those costs is a smart idea.2
The ability to set up an HSA is limited to individuals and families covered under high-deductible health plans, so if you’re relatively young and free of health issues, setting one up is a great way to put aside money for medical expenses and to let that money grow tax-free.
Even if you must switch to a different health insurance plan as you get older, you can still keep your HSA and use it on qualified medical expenses; you just can’t fund the account anymore. Additionally, once you turn 65, you can use HSA funds for any purpose without incurring the 20% penalty normally levied when you make nonqualified withdrawals — which makes your HSA a great retirement-savings vehicle, too.
3. Set up a 529 plan
If you have or plan to have children, a 529 plan is one of the best ways to save for education expenses — and one of the most tax-efficient. It provides tax-free growth and tax-free qualifying distributions, so if you start saving money now and let it grow for 18+ years, that can result in significant dollars. Plus, many states provide an annual tax deduction if you, as a resident of that state, contribute annually to their 529 program.
529 plans can also pay for education expenses outside college. You’re now allowed to pay for K-12 expenses (up to $10,000 per year) and even some registered apprenticeships. And while we don’t recommend overfunding your 529 plan, if you do, there’s a long list of qualified beneficiaries you can transfer the account to.
4. Build a brokerage account
Another savings opportunity not to overlook is setting up a brokerage account, where you invest after-tax dollars into stocks and bonds.
While brokerage accounts don’t have the same tax advantages as retirement accounts, they do benefit from the more favorable capital gains rates instead of income tax rates. Brokerage accounts can be a great way to diversify your savings outside of your retirement accounts or accounts that levy penalties on unqualified expenses (such as HSAs).
Choosing your long-term savings options
The first step to choosing the right savings strategies for you is understanding what your goals are — and what they should be. How much will you need to save for retirement? Will you have kids? Do you plan to purchase a home? If so, how big of a down payment will you need? How much mortgage can you afford?
Talking with a financial advisor can help you determine your financial and life goals and what strategies to use to achieve them. Understanding all your options and how they can work together is a daunting task, but it’s much easier when an advisor can help guide you.
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