Do you know what you should be saving for? You know to save for retirement and emergencies. But are you saving for your financial freedom?
Save 20% or more of your income. Put your money into four different buckets: Roth IRA, 401(k), Emergency Fund and the Financial Freedom Fund.
Roth IRA
When it comes to retirement, everyone is in agreement that you should save for it. However, I don’t think Roth IRA gets as much attention as it deserves. By the time I recognized the benefits of the Roth IRA, I was at the top of the income limit for contribution. Yes, you can make more than $124K as a nurse.
Roth IRA is a retirement savings account that allows your money to grow tax-free. You contribute after tax dollars. It grows with compound interest and when withdrawn, you pay zero tax. You do not pay capital gains tax on the compound interest either. This means huge savings during your retirement years.
You can contribute up to $6,000 as of 2020. People 50 or older can add an additional $1000.The income limit is $124,000 for singles and $196,000 for married couples filing jointly.
Roth IRA is one of the few vehicles that exempts you from capital gains tax. This reason coupled with the income limit is the reason Roth IRA is listed first on What You Should Save For list.
401(k) or 403(b)
401k is an employer-sponsored retirement plan; 403b is an equivalent plan for non-profit organization. If your company participates in a 401k, contribute at least the minimum amount to receive the maximum employer match. The most common match is 50 cents on the dollar up to a certain percent of your salary, such as 3%. For example, if you contribute 6% of your salary, your company matches up to 3%. If you make $50,000 per year and contribute $3,000, your company will contribute $1500.
You fund your 401(k) plan with pretax dollars, meaning your contributions are taken from your paycheck before taxes are deducted. This makes it easier to save money since you don’t even see it. It also lowers your tax bracket because it lowers your taxable income. You pay tax on the contribution and gains when you withdraw. You will not be able to access this money without paying a penalty and tax until you are 59 ½.
Contribute as much as you can as early as you can, preferably before you have a spouse or kids. Once you have a family, it may be difficult to put in the maximum account but you’ll be able to make your retirement account compound nicely if you can have a huge kick-start. Lets say you got a job immediately after your college and put away $19K a year for 5 years then nothing after but invested wisely within the fund. After 35 years with an average of 7% growth, you would have over $1million dollars.
“Compound interest is the 8th wonder of the world.” -Albert Einstein
Emergency Fund
Without an Emergency Fund, you’re more likely to use your credit card for unplanned expenses and get into a huge debt. Start by saving until you have an equivalent of expense for one month. Then gradually increase this until you have 3-6 months in your Emergency Fund Bucket. If you have a family and kids, you may need closer to 6 months. Since you have a secure and marketable job as a nurse, you may be fine with just 3 months of emergency fund.
Automate this savings and put it in an account that is not easily accessible to you.
If you have investment properties, aim to save three months of mortgage for each property. This is in addition to your living expenses. You do not want to lose your real estate investment due to vacancies or because you don’t have the money to replace the water heater.
You can put your Emergency Fund in a money market fund, CD, or in an after tax investment fund.
Financial Freedom Fund
Contribute the rest of your savings after the Emergency Fund into an after tax investment fund. It’s easy to open an account with an online broker (TD Ameritrade, Fidelity, Charles Schwab). Directly transfer money into the account and buy stocks, mutual funds, or ETFs.
This fund is accessible to you at any time. You can use this money to take a year off work, retire early, or start a business and work for yourself. This is the reason why I call this the Financial Freedom Fund. I would advice my younger self to put more money into this fund.
Warren Buffet says to put your money in the low cost index funds and forget it.
“Try to save something while your salary is small; it’s impossible to save after you begin to earn more.”
Jack Benny