Client Question: Allocating savings

March 10, 2023

I worked with two clients this week that had a set amount of cash to deploy to longer-term savings & investment accounts. Their question – what accounts should I allocate this to – and how much in each?

It can be definitely be challenging to figure out your savings strategy and like most things in finance, the answer varies greatly by individual. I like to use a bucket analogy when working thru these exercises with clients as it is easy to visualize. Each bucket is assigned a different capacity (based on their unique needs, income levels, tax situation, total available cash, age, and other factors) and are placed in an order in the savings que that is optimized to them. With that outline in place, all they have to do is focus on filling one at a time!

What’s the names, capacity, and order of the “buckets?” My answer (yes, you know what’s coming) is – that depends on each client. However, to give you something to go from, I’ve outlined a few of the buckets I commonly use below as a place for you to start. As always, I encourage you to use this as a guide to your own situation and consult your financial advisor to implement a savings deployment strategy that best serves your specific financial needs.

Potential Buckets

1.) General Cash Reserves – I’ve discussed this topic in depth in a prior post. This is cash you want to keep on hand for unexpected costs (health care, home repair emergencies, or day to day living expenses in the event you lose your job). The amount will vary greatly by person but a rough formula I like to use is monthly spending * months you believe it would take to replace your income. Most individuals land on 6 months of spending but again, your bucket capacity may vary. I usually suggest this bucket be filled first as it protects all those that follow (by not requiring you to make withdrawals for unexpected costs)

2.) Specific Cash Needs – if you have a known expense coming up in a year or less, set aside a bucket for it and ensure you have the cash on hand. Planning a big vacation? Renovating your home? Scheduling a surgery that will trigger your deductible? Save money ahead – and save yourself stress later on

3.) Employer plans – are you employed by a company and if so, do they offer a retirement plan (such as a 401k)? It’s worth assigning a bucket to reach at least to the employer match. After reaching the match, you can consider contributing up to the max ($22,500 in 2023, plus an added $7,500 if you are over age 50). However, depending on your total deployable funds, you may wish to do so after other buckets are filled (this order will hinge upon the specifics of your plan (ie: Roth vs. Traditional, investment line-up, management fees within investment selections, and many others), as well as your situation when it comes to earnings, taxes, age, etc).

4.) Self-employment savings plans – if you work for yourself, there are many other buckets you can consider such as SEP IRAs and individual 401k plans. These can be a bit more complex so involving a tax advisor to determine capacity is important for these buckets.

5.) Individual retirement accounts – are you eligible to contribute to an IRA directly (traditional or Roth)? Or can you utilize the backdoor Roth option? The max IRA contribution for 2023 is $6,500, with another $1,000 catch-up if over age 50. Combining these retirement accounts with employer plan savings may be beneficial to you, if your situation warrans

5.) Health savings accounts – these accounts are available for certain individuals, depending on your health insurance plan. They can be powerful ways to pay for current medical costs or used as investment accounts. Consider this bucket (and how you will use it) if your health insurance plan allows and it meets your needs

6.) After-tax savings – saving money in a brokerage account (that is not behind the gates or rules of a retirement account) is an important bucket to consider as it will give you flexibility down the road (no restrictions on withdrawal timing as an example). There is no limit on this bucket – but you need to consider if in the context of your whole savings approach and remain mindful that its activity will be taxable as incurred

7.) Education accounts – if you have children, you can save in a tax advantaged manner in education accounts (also called 529 plans after the tax code that created them). Much like oxygen masks, I always suggest you take care of your own savings before helping a child with theirs, but these can be great accounts to fund if cash flow permits

Those are just a few of the common buckets I use in clients’ savings strategies, listed in no particular order. If you have cash to deploy into savings and investments, consider your own facts and circumstances, consult your advisor, and set up your own row of buckets you can fill one at at time!

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