Chapter 10: Money for Later
Mr. Simms (bank interviewer): “Do you have any experience?”
Robbie Hart: “No, sir, I have no experience but I'm a big fan of money. I like it, I use it, I have a little. I keep it in a jar on top of my refrigerator. I'd like to put more in that jar. That's where you come in.”
– The Wedding Singer (1998)
Borrowing pulls money from the future for spending today. You pay interest for the privilege, reducing your lifetime money pile and making bankers a little richer. Saving does the opposite. You put money in the jar, pushing it from today into the future. You earn interest and grow your pile.
The concept of saving is simple. The problem is finding the money to put aside. For this you need some income, and you need discipline. Then you need to figure out the best jar to put the money in, which involves taking advantage of tax breaks the government put in place to encourage saving.
To some people, saving comes easy. They cherish frugality. They don’t mind living well below their means, with fewer things, in smaller houses, driving older cars. If you’re one of those people, you can skip this section.
For others, saving seems impossible. There is never money left after paying the bills. Every month brings a new unexpected expense. Your account balances always hover around zero. If this is you, here are a few tips for getting started and ramping up your savings.
Most everyone can afford to save. Saving 20% as suggested by the 50-30-20 rule may seem crazy out of reach today. Don't worry about it. Save a small amount even if you’re paying off a pile of debt. To quote track star Jim Ryun, “Motivation is what gets you started, habit is what keeps you going.” This step is about building habits.
Start with amounts that you won’t notice. If you pay for things with cash, throw any change in a bowl every night. If you use a debit card, check out cards that “round up” your purchases to the nearest dollar and put the change into a savings account. The original “round-up” card was from Acorns, but others have sprouted, including on-line bank Chime and Keep the Change from Bank of America.
You shouldn’t have to pay any fees for these services, which are only going to become more commonplace. And these apps pay stingy interest, so plan on moving the money to your high-yield savings account once you accumulate more than $100. Acorns is a little different, because instead of a savings account you get a brokerage account. More on those in Chapter 13. 
Next, set up an automatic transfer from your checking account to your savings account every payday. Even if it’s just $5. In six months, increase it to $10. Better yet, see if your employer can split your paycheck and send a specified amount directly to your savings account.
Your most important savings are for retirement. You might say, “Oh, that's far away.” As we'll see in later chapters, that's exactly why you should do it today. Time is huge when it comes to retirement saving. So take advantage of retirement savings plans at work.
If your employer offers a 401(k) or 403(b) plan start by making sure to get the full amount of any company match. Not all employers offer a match and there are many different formulas. A common one is for the employer to contribute half of the amount each worker contributes, up to a maximum of 3%.  If a worker saves 3% of their pay, the employer will add another 1.5%. If the worker contributes 6%, the employer will add the maximum of 3%.
With a modest saving program up and running, it’s time to step things up. Try to push savings to 5% or 10% of money coming in. However, don’t do this if you are still paying off high-cost debt. Pay down debt first. As you reduce debt, the freed-up money that previously went to paying interest is available for savings. Build up an emergency fund first, then work on increasing your retirement and other savings.
Another way to raise the bar is to dedicate pay increases to savings. Say you get a 2% annual raise. Immediately increase your savings by the same amount and continue to live on the budget you were used to. If you can’t do the full 2%, split the difference and save 1%.
Sometimes good things happen, and we have financial windfalls: bonuses, gifts, tax refunds, raffle or other winnings, and inheritances. Use these windfalls to boost savings instead of spending. Take all or part of them and immediately transfer them to your savings account. You won’t miss spending them.
The question of where to put the money that you save mostly hinges on taxes. The government provides significant help when you save for three things: retirement, education, and health care. There are some smaller incentives, but those are the biggies.
Let’s start with retirement. We’ve already covered some of this in the chapter on money at work, but here is a more general overview.
Your retirement savings should be in a retirement account. If you have a defined contribution plan such as a 401(k) or 403(b) plan at work, contribute to it. Otherwise use an Individual Retirement Account (IRA). These are all so-called qualified retirement accounts. Qualified accounts have more restrictions but also more tax benefits and better protections than non-qualified accounts.
The basic idea behind retirement accounts is this: you owe taxes on money you earn from work, but when you put that money into a retirement account the investment income is not taxed. Your money grows tax-free. There are two basic ways to accomplish this: pay taxes before you contribute to an account or pay taxes when you take the money out.
The two are mathematically equivalent if your tax rate is the same when you withdraw as it is when you contribute. This is why one of the early choices you may face in your career is whether to save in a “traditional” or a “Roth” account. How do you know which is better? If your tax rate is lower in retirement, a traditional account will end up being the better choice. If it’s higher, a Roth account will be better. Of course, you don’t know what it will be in advance. So you have to make some assumptions.
When you are early in your career and your salary (and tax rate) are low, a Roth account is probably a good bet. If you’re a high earner, your tax rate may be lower in retirement, so go with a traditional account. To be safe, you may want to contribute to some of each. But don’t get hung up on this decision. The most important thing is to start contributing as much as you can as early as possible.
The government provides a good deal on retirement accounts, so you probably won’t be surprised that the deal comes with some strings attached. Here are the major ones:
- There are limits to how much you can contribute. These usually change every year. For example, in 2021 the most you can contribute to a 401(k) or 403(b) account and get the tax break is $19,500. For an IRA the limit is $6,000. If you’re self-employed there are other options with higher limits.
- There are also restrictions on taking money out early. One is the magic age of 59½ (don’t ask). You can face penalties for taking out money before then unless it is for certain specified purposes.
- With traditional (but not Roth) accounts you have to start taking some money out when you turn 72 even if you don’t need it. That's okay, you'll just put in regular savings. But you will owe tax on those “required minimum distributions” or RMDs.
There are lots of other intricacies and options with retirement accounts to dig into if you find that you have extra money to save. I hope you have that problem.
The best way to save for college is with a so-called 529 plan (another snazzy name brought to you courtesy of the IRS). Also known as qualified tuition plans, 529 plans are sponsored by states, so they come in a wide variety of flavors, some better than others. They all have federal tax benefits very similar to a Roth retirement account: you put in after-tax dollars, your savings grow tax free, and you owe no tax when you withdraw the money…as long as you use it to pay for education expenses.
A 529 plan account has an owner who controls the account and a beneficiary who will receive the money to attend a school or university. The two can be the same person. The owner can change the beneficiary to another family member at any time without losing any tax benefits. This means you can start saving for a child’s education even before it is born by making yourself the beneficiary.
Another type of account is the Coverdell Education Savings Account (ESA). Up to $2,000 a year can be put into an ESA. The tax benefit is similar to a 529 plan. But you shouldn’t add money after the beneficiary is eighteen years old. The main benefit of ESAs is that they can be used for a somewhat wider range of education expenses.
Don’t think of these accounts as just for a child’s college. Both can also be used for primary and secondary schools, as well as graduate school.
The third way to save for education is through U.S. Savings Bonds. These are bought directly from the Treasury Department. They pay a small interest rate but are guaranteed by the U.S. government and won’t lose money. You don’t owe tax on any interest when you cash them in as long as the money is used for educational expenses or is put into a 529 plan for later use. But you must be at least twenty-four years old when you buy the bonds and your income cannot exceed certain limits in the year you redeem them.
The ability to save for education without paying taxes is very valuable. When it comes to taking out the money things get tricky as to how much and which education expenses qualify, so be sure to get additional guidance.
It is particularly hard to save for healthcare because medical expenses are unpredictable. If at all possible, you should get insurance to cover the potentially devastating costs of a major illness or accident. But insurance is expensive and it may or may not cover more routine expenses such as needed prescriptions, dentist visits, vision expenses, health screenings and checkups, counseling, or physical therapy, to name just a few.
You can sign up or change your health insurance once a year, usually in November or December. If you are healthy and aren’t planning on any major expenses—such as an elective surgery or childbirth—you might consider one of the best saving deals available: a healthcare savings account (HSA). With an HSA you don’t pay taxes when you contribute or when you withdraw money. It’s completely tax-free as long as the money is used to pay for healthcare expenses.
Unfortunately, not everyone can contribute to an HSA. To do so you must enroll in a high deductible health plan (HDHP). Again, if you have high medical expenses this may not be the best option. And if your employer or insurance company doesn’t offer one, you’re out of luck. But if they do, I recommend taking full advantage of it, even before saving in a 401(k) beyond the employer match, especially if your employer also makes a contribution to the HSA. You can let the money in an HSA grow tax-free for years and use it to pay healthcare expenses, including Medicare premiums, when you’re old. 
Many HSA accounts have limited (and lousy) investment options and charge too many fees. However, Fidelity began offering them with no minimums or fees and investment options comparable to a brokerage account. This makes them the go-to for HSAs.  If your employer enrolls you in a lousy HSA by default you can transfer or “roll over” your balance to Fidelity once a year.
There is another savings deal offered by many employers: a so-called flexible spending account (FSA). These also allow you to put in pre-tax money and use it to pay for medical expenses. They are tricky, though, because you have to spend all the money in the year in which you contribute it. That means you need to guess beforehand how much in medical expenses you’ll have in the coming year. Anything you don’t spend, you lose. Still, if managed well FSAs are a good deal. 
We’ve covered the main tax-advantaged ways to save. They all come with restrictions on when you can get at the money or what it can be used for. What about other savings goals?
A common one is to save up for a down payment on a home. While the government doesn’t have a tax break for this, you are allowed to withdraw funds from an IRA to buy a first home, and you’re also allowed to take a long-term loan from your 401(k). (The IRS considers any home your “first” if you haven't owned one in the prior two years.) It’s a bit risky though, because you potentially put a big dent in your retirement kitty. Proceed with care!
What about saving for fun stuff? Sorry, but Uncle Sam won’t pitch in for your jet ski or Disney cruise with a tax break. That doesn’t mean you shouldn’t save – in fact, you should save rather than borrow for this kind of thing. Let’s call this “regular” savings.
In terms of the best places to put regular savings, we’ve already covered high-yield savings accounts and certificates of deposit. These are low risk options that don’t earn much interest. Stick with them for money that you want to access in the next five years.
For goals more than five years out you may want to shoot for a higher return and open a brokerage account. Brokerage accounts let you buy a wide variety of investments like stocks and bonds. If you’re at this point, we’re ready to take a walk down Wall Street. Hold on to your hat!