Where to Save Now?
You've cut your spending, shifted priorities, and are saving more. Last year's market decline spurred many to do this. In a survey of our customers, almost 60% had cut their spending.1
Now you need to make sure you're maximizing these extra savings. That's why we created a “savings hierarchy”; what we believe is an optimal savings order for many investors. It's a general guide. You can factor in your own situation and priorities and create your own hierarchy with our Savings Planner.
Our hierarchy may seem contrary to advice you may have heard such as that you should pay off credit card debt first, or save for college before retirement. But we believe saving for retirement should be most Americans' top priority. Why? You can probably get loans to pay for other things—a house, a car, your children's college tuition—but there are very few ways to fund your retirement. Also, we suggest setting aside three to six months of expenses in an emergency fund before you do anything else.
Our savings hierarchy is as follows:
#1. Contribute up to the match in your workplace plan.
If you have a 401(k), 403(b), or 457 plan and your employer offers a matching retirement contribution, take advantage of it. The matching contribution is like getting "free" money. And you get the added potential benefits of any tax-deferred growth and compounding returns.
The sooner you start, the more potential your money has to grow. Even if you are in your thirties or forties, it's not too late. If you're age 50 or older, you may be able to add extra "catch-up" contributions to your workplace savings plan.
One caveat: if your employer's matching contribution is low (less than 50%) and you have credit card debt with an interest rate of more than 25%, paying down the debt typically makes the most sense.
#2. Pay down high-interest credit card debt.
If your interest rate is high on your credit card debt, more than 9% for example, use any extra savings to pay down the balance. If you have multiple accounts, you can work on the one with the highest interest rate first. Continue to make the minimum required payments on the other cards (so you don't get hit with any penalties). When that first card is paid off, you move on to putting your extra money toward paying off the next. Each card gets easier to pay off, because you have more money to work with. You can do this until you're out from under all your high-interest debt.
#3. Contribute the maximum to your workplace plan.
It makes sense to contribute the maximum to a workplace savings plan or other retirement accounts before tackling low-interest or tax-advantaged debt. That's because the amount you need to save for even basic expenses in retirement can be hundreds of thousands of dollars, or more. Building tax-deferred savings early makes sense. You don't want to be borrowing money for living expenses later. You may be able to contribute up to $16,500 to your 401(k) or other workplace savings account for 2009. If you are age 50 or over, you might be able to contribute up to $22,000.
#4. Fund an IRA.
When you've maxed out your 401(k), consider other investment choices such as an Roth IRA. If you don't qualify for one because of your income, a traditional IRA might be another option.2 The annual IRA contribution limit for 2009 is $5,000 ($6,000 if you are age 50 or older). To make it easy, set up your IRA contributions to be automatic, as they are for 401(k)s.
#5. Start working on other key goals.
Automatic investing plans can also work for other saving goals.3 Have a set amount of money transferred each month into an investment account from your bank or paycheck.
When saving for a child's college expenses, consider tax-advantaged accounts like 529 college savings plans and Coverdell Education Saving Accounts.4 Again, set up automatic investments to make it easy.
Taking steps to get rid of high-interest debt and set aside money for retirement and college is not only financially savvy, it's also good for you emotionally. Living under a burden of debt and financial uncertainty is stressful. Being prepared isn't.
1. Fidelity Consulting Group, March 2009 Customer Panel Survey.
2. Anyone with employment compensation can contribute to a Roth IRA, subject to the following income limits. For single filers: up to $105,000 for 2009 ($105,000 to $120,000 in 2009 for partial contributions); for joint filers: up to $166,000 for 2009 ($166,000 to $176,000 in 2009 for partial contributions). You must be at least 18 years old to open an IRA with Fidelity.
3. Automatic investment plans do not assure a profit or protect against a loss in declining markets.
4. Fidelity does not offer Coverdell accounts.
Retirement Quick Check is an educational tool offered for use by Fidelity Brokerage Services LLC, member NYSE, SIPC.
The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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