Saving money for the future is an important and healthy financial habit. The more that you can save early, the more that your savings can grow over time, providing you with short-term flexibility and long term security. With possible tax refunds arriving soon, now is a good time to examine types of savings goals and the best ways to jumpstart them.
Everyone should try to build these three basic types of savings:
- Rainy-day Fund
- Retirement Account
- Discretionary Spending Account
Rainy-day Fund- You should build a rainy-day fund to provide peace of mind and protect against unexpected financial storms. Without a rainy day fund, a sudden loss of income, a medical emergency, or even a broken down auto can cause a financial panic. A rainy day fund will help you weather those setbacks and avoid having your financial world crumble.
Standard advice is to build up enough money in your rainy-day fund to cover six months’ worth of living expenses. Don't let the size of the goal discourage you from taking the first steps. Start small and build from there. Having $1,000 in your rainy-day fund is better than having nothing.
Retirement Account- The landscape for retirement is changing, with future generations having to rely on their own savings habits more than guaranteed pensions or government programs. The earlier you begin building a retirement account the more money you'll have to live on when you retire. By saving from a young age, you will allow compound interest to work on your behalf for longer – leading to much higher returns from your original investment.
For example, if you put aside $2,000 a year beginning at age 25, and the average rate of return is 5%, then over 40 years your $80,000 will have grown to over $267,000! Putting aside $166 each and every month will lead to over a quarter of a million dollars in savings when you retire.
If you wait until you're 45, that same $2,000 a year contribution ($40,000, in total) at the same rate of return would only grow to a total of $74,745. An added benefit of many retirement plans is that you can contribute money before taxes are taken out so that more of your money stays with you.
Discretionary Spending Account- It is tempting to use credit to pay for vacations, holiday presents, anniversaries, or other splurges. Resist this temptation and build up a dedicated savings account for these discretionary purchases to avoid creating a debt problem. A discretionary spending account also helps you avoid paying tons of interest on your purchase, which can inflate the actual cost of your purchase to the point that it is not worth it. (That $1,000 TV looks like less of a deal if it costs you $1,600 when the finance charges are added in.)
In order to build these savings accounts, you need to make a plan of action. You have to set goals and then take practical, realistic steps to achieve them.
If you are struggling with debt you've already accumulated, getting your debt under control should be your highest financial priority, but even that does not stop you from setting a long-term goal of building up savings. In fact, you can use the same discipline that you develop paying down your debt to build your savings. Once you have eliminated your debt, just take the same amount that you were paying each month towards servicing your debt and put it into either your rainy-day fund or your retirement savings.
Here are a few ideas for jumpstarting a savings plan:
- Tax Return - We are now in the 2013 tax season. If you are expecting a tax refund, use that to fund your savings account. You can also use work bonuses or any irregular sources of income to do the same.
- Be Disciplined - If you commit to setting aside $150 per month, stick to it. We all know that it’s easy to spend the money, but if you put it aside and pretend that it is not there then you'll come out ahead. Over time, this can become an ingrained habit.
- Direct from Paycheck - It can be easier to save money if you make a deposit into a dedicated savings account directly from your paycheck. In this way, you reduce your temptation to spend the money because it is not in your checking account.
- Cut Frivolous Spending - Eliminating unnecessary expenses is a great way to fund your savings account. Most of us fritter away money in a variety of ways. It is true that eating out less often, skipping Starbucks, or drinking tap water instead of bottled water is not likely to make you rich. But, it can save you a significant amount of money. Use this tool to see how much your small savings can add up to over time.
- Use Military Savings Benefits - Take advantage of the Thrift Savings Plan (TSP) available to you as a military servicemember. The TSP is a government-sponsored retirement savings and investment plan that can be a very important part of your retirement income.
Each year, the IRS sets a maximum amount that you can contribute to a TSP. In 2013 the maximum is $17,500. You can also make 'catch-up' contributions. According to TSP.gov:
"The limit on catch-up contributions for 2013 and 2012 is $5,500. If you are at least age 50 (or will become age 50 during the calendar year) and if you have made or will make the maximum amount of employee contributions for the calendar year, you may also make catch-up contributions to your TSP account."
Some of the key benefits of a TSP include:
- Less Taxes Now - Your TSP contributions are made with pre-tax dollars, so you pay less in taxes.
- Less Taxes Later - You won't pay taxes until you withdraw the money. If you wait until you are in a probable lower tax bracket upon retirement, you'll pay less on your withdrawals.
- Transferability - You may be eligible to transfer money from another retirement account, such as a 401(k) account, into your TSP. You can also transfer money from a TSP into a different qualified retirement plan if you stop serving.
- Matching Funds - In some instances, military servicemembers may be eligible to receive a matching contribution from the military. Check with your Finance and Accounting Center at your military base, to get details.
No matter what your savings goal or where you find the funds, the most important thing is to start now. Take that first step and make it a healthy financial habit for life.