How to optimize your savings and prepare for retirement

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At the risk of stating the obvious, it takes money to make money. is less obvious Where and in What command to save and invest. After all, everything from tax-deferred retirement accounts to your cousin’s new startup seem like possible places to put your hard-earned money.

But only because of you can Investing in certain things doesn’t mean you must. If you want to maximize your long-term wealth, you cannot allocate your dollars haphazardly. You need a plan – a systematic way to order your savings and investments. While these don’t have to be hard and fast rules, they can serve as good rules of thumb.

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First, tackle any high-interest debt

Before you invest a penny think it over remove all your high-interest debt first. Prioritize paying off your credit cards, payday loans, and any other type of debt that charges double-digit interest rates. (However, debt with comparatively lower interest rates, such as mortgages and car loans, can be safely held.)

This strategy has two advantages. For starters, reducing that onerous debt can help you sleep better at night. But it’s also good for your financial well-being, as you’re effectively getting back the interest you’d otherwise have to pay.

Second, build an emergency fund

Now that your high-interest debt is gone, it’s time to set up an emergency fund. Also known as the emergency fund, this cash stash serves as a financial cushion if you ever lose your job, need medical attention, or encounter another emergency.

In general, try to put expenses aside for at least 6 months, although you can always play it safe and save a little more. For best results, put your emergency fund in a high-yield savings account or money market fund like Vanguard’s Federal Money Market Fund (NASDAQMUTFUND: VMFXX).

Don’t worry too much about maximizing yield here, though. Even if your money just sits around and gathers dust, it’s no big deal. In fact, arguably that’s the point – having a stable, easily accessible pool of cash on hand when you need it most.

Next, contribute to your retirement accounts

Now that you’ve got your short-term financial needs covered, it’s time save and invest in the long term in a tax-efficient way.

On the retirement front, you can pay into a traditional or Roth Individual Retirement Account (IRA). With a traditional IRA, your upfront payment is tax-deductible — and money, once in the account, earns interest on a tax-deferred basis. Upon receipt, the income is taxed as ordinary income.

On the other hand, Roth IRA Contributions are not tax deductible. However, funds in the account become tax-free and you are not taxed on either earnings or withdrawals.

In 2022, you can contribute up to a total of $6,000 (plus an additional $1,000 if you’re 50 or older) to either type of IRA, although Roth contributions are subject to additional income restrictions. To be eligible, single individuals must have a modified adjusted gross income (MAGI) of less than $144,000, and the combined MAGI of married taxpayers cannot exceed $214,000.

If your employer a 401(k), you can use that too. In 2022, you can deposit up to $20,500 total (or up to $27,000 if you are 50 years or older) in traditional or Roth 401(k)s.

401(k) contribution limits are in addition to IRA limits, so you could potentially save $6,000 (up to $7,000) in your IRA and $20,500 (up to $27,000) in your 401(k) in the same year. Of course, this is a significant sum, so don’t fret if you can’t reach those limits – but if you can, that’s great! Instead, try to max out your Employer Match as much as possible.

Then consider other tax-deferred savings accounts

Retirement accounts aren’t the only ones with built-in tax benefits. if you have one Health Savings Account (HSA) or have set up a 529 college savings plan for a child, consider contributing to those investment accounts as well.

HSAs must be coupled with a high-deductible health plan (HDHP) and are subject to annual contribution limits. In 2022, individuals can save up to $3,650 while families are capped at $7,300. Individuals 55 and older can make an additional catch-up contribution of $1,000.

What that means for you

Finally, if you have money left over after exhausting all of your tax-deferred accounts, you may consider saving and investing in a tax-deferred brokerage account. Or treat yourself – you decide!

Either way, the message is simple: save in a strategic and tax-efficient sequence that maximizes your short- and long-term financial well-being.

For now, keep enough to cover your bills, pay off debts, and get through tough times — but also save enough for retirement, medical bills, your child’s education, and other larger expenses that might come up in the future.

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