YOU MIGHT TAKE the savings opportunities available to you and array them from most to least attractive based on their tax advantages, investment costs and potential return.
For many of us, the most attractive place for our savings will be our employer’s 401(k) or similar retirement plan, which can offer the investor’s triple play: an initial tax deduction, tax-deferred growth and possibly a matching employer contribution. Depending on the size of that employer match and the vesting schedule for those contributions, you might effectively receive an immediate 50% or 100% return on your money. If you have a high-deductible health plan, you should also see if you’re eligible to fund a health savings account, which—from a tax perspective—can be even more attractive than a 401(k).
Your next most attractive opportunity will likely be paying off high-cost debt, notably credit card debt. Carrying card debt ranks as one of the most foolish financial mistakes. Don’t have any? In that case, you might stash additional savings in a tax-deductible or Roth IRA, assuming you’re eligible. You won’t get an employer match, like you can with a 401(k), but the tax advantages are comparable and you should earn healthy long-run returns if you invest in low-cost stock funds.
After that, the decision is less clear-cut. If you aren’t eligible for a tax-deductible or Roth IRA, you might fund a nondeductible IRA and possibly look to convert it to a Roth. Alternatively, if you’re an aggressive investor, you could purchase stocks or stock funds in your regular taxable account and aim to invest in the most tax-smart way possible. What if you’re more conservative? Look into paying down your mortgage and other debt, which will usually deliver a better return than buying bonds.
Have yet more money to save? If you want additional tax-deferral, consider a tax-deferred fixed or variable annuity. But you should also carefully consider the drawbacks, notably the high expenses that are often charged. You can learn more about these various savings vehicles by perusing the chapter on taxes.
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