Broker Check
How much should I be saving

How much should I be saving

August 31, 2023

While this might seem like a simple enough question, answering this for my clients is what keeps me busy. The answer to it—like the answer to seemingly every question you ask an attorney—is “it depends.” But for most people, there’s a general beginning framework for utilizing the various types of tax-advantaged accounts out there. Below are some of the first places you should save.

Maximizing an Employer’s 401k Match

The very first thing every employee should do is ask if your employer has a 401k and whether they match employee contributions up to a certain amount of their pay. Not every employer offers a 401k, and of those that do, there’s not necessarily a match. When there is, it is usually designed as a percentage match, up to a percentage of salary. An employer might match 100% of employee contributions up to 3% of their pay. Or they might match 50% of contributions up to 5% of pay. Alternatively, they could match a certain percentage up to a certain dollar amount of employee contributions. Whatever the case, this benefit is worth taking full advantage of, and (generally) is worthy of the top retirement savings priority in almost everyone’s financial picture--and you don't need a financial advisor to do that. Your employer’s 401k will have a handful of generally suitable investment options for you to choose from. Usually there are some “target funds” that are tied to an expected retirement date, such as 2050 or 2060. Picking the fund that most closely correlates to your 65th birthday is probably the easiest “set-it-and-forget-it” option. If you’re in your 20s or 30s, a growth fund with a low expense ratio is also a fine choice in the short term.

In 2023, you can actually contribute up to $22,500 per year ($30,000 if you’re over 50 years old) to a 401k plan, but I would suggest getting further down this list before you contribute more to your 401k than what is necessary to take full advantage of any match.

Health Savings Account

The next thing every employee should ask their employer is whether the employer makes contributions—or allows you to make contributions—to a Health Savings Account (HSA). An HSA is an incredibly versatile tax-advantaged savings account. First, you don’t pay income taxes on contributions to an HSA. And, unlike a Flexible Spending Account (FSA), you never lose your contributions to an HSA. You can save them your whole life if you want to. Money in an HSA grows tax-free, similarly to how it does in a 401k or traditional IRA. But, unlike a 401k or an IRA, you can use the money for qualified medical expenses before you turn 59½. And when you use the money for qualified medical expenses, you don’t pay taxes on it then either.

Also, there’s no risk of overfunding an HSA, because when you turn 59 ½, you can basically treat the HSA as a traditional IRA. Specifically, you can withdraw the money simply by paying taxes on it at the current rates according to your then-current income. Or you can keep using it as an HSA, paying for qualified medical expenses tax-free during your retirement.

If your employer doesn’t offer an HSA, you still may qualify to make your own contributions if you have a “high-deductible health plan” (HDHP). What qualifies as a HDHP changes from year to year, but suffice to say that these days, most health plans are HDHPs. If your health plan is a HDHP and your employer hasn’t set up an HSA partner, we can help you open your own.

Roth IRA

Next, if you qualify to contribute to a Roth IRA, that's a pretty good idea. The unique tax advantage of a Roth IRA is that you pay taxes on the money now (when you’re in a relatively low tax bracket), but then the money grows tax-free and you can withdraw it tax-free when you reach the age of 59½. There are maximum income restrictions in order to qualify for a Roth. The income restrictions and contribution limits change from year to year, but they are easy to find and only change by small amounts every year.

Ideally, you will only qualify to contribute to a Roth IRA when you are at the beginning stages of your career. In other words, hopefully as you get older, you make too much money to use this! That’s why it’s important to utilize it while you can.

That’s the end of my list of no-brainers, but you will need to save more. After this point, choices become more nuanced based on a number of personal factors, such as age, income, family status, residence, job security, and others. If you’ve made it this far down the list on your own, it may be time to start thinking about hiring a financial professional, either for help with a one- time financial plan, ongoing investment management, or both. An advisor can help you assess how much you might need in your rainy-day fund, help you get it invested in a tax efficient manner (since this will be kept in a taxable account), and help you achieve the appropriate allocations across your multiple accounts, based on your individual time horizon and risk tolerance.

As a general rule of thumb, I encourage my clients to save 15% of their gross income for retirement (not including HSA contributions). Another 7.5% should go toward a rainy-day fund (this includes contributions to your HSA, if eligible). Finally, another 7.5% should go toward other savings projects, which I briefly discuss at the end of this post.

Rainy Day Fund

A rainy-day fund is an important risk management tool that will give you peace of mind in an emergency, some breathing room if you lose your job, and some flexibility to voluntarily leave your job if it becomes a bad situation. Most importantly, rainy-day savings will protect your retirement savings. Not only are withdrawals from your retirement accounts before the age of 59½ subject to penalties, you can easily burn through years of retirement contributions in a matter of weeks and months.

A good minimum rule-of-thumb is to accumulate six months of your expenses in a rainy-day fund. Depending on the volatility of your job/industry, you may want to increase this to nine or twelve months. It’s also a good idea to increase this as you become more experienced and specialized and as your expected level of pay increases. Six-to-twelve months of expenses doesn’t just appear in your account overnight because you want it to. The best way to accumulate this amount of money is by coming up with a plan and saving a little bit each month—probably over several years—until you’ve met your goal. We can help you come up with an effective and reasonable plan to build this fund.

Beyond Building a Retirement Foundation and Saving for a Rainy Day

The next things to think about would be saving for a down payment on a home, saving for children’s college, contributing to a traditional IRA if you don’t qualify for a Roth, contributing more to your 401k, or saving so that you can start your own business. We can also help with any or all of those things.