What Account Type(s) Should I be Saving into?

What Is the Best Type of Account to Save Into?

Brennan McCarthy, CFP®

When it comes to personal finance, the question of where to save your hard-earned money is crucial. The answer, as with many financial matters, is not one-size-fits-all. It depends on your unique circumstances, financial goals, and risk tolerance. With that said, there are some best practices to follow when trying to decide which types of accounts to save into.

1. Cash Reserves (Checking/Savings)

Pros:

Liquidity: Cash reserves provide immediate access to your funds.
Safety: These accounts are typically insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor.

Cons:

Low Interest Rates: Traditional savings accounts offer minimal interest compared to other options.

Best Use:

Emergency fund: Keep 3 to 6 months’ worth of living expenses in a high-yield savings account. This should be your first priority before starting any type of investment.

2. Taxable (Non-Retirement) Brokerage Account

Pros:

Flexibility: You can invest in stocks, bonds, mutual funds, and other securities.
Potential for Higher Returns: Unlike savings accounts, brokerage accounts allow you to invest in the stock market.

Cons:

Tax Implications: Gains are subject to capital gains tax.
Potential for Higher Losses: As with any investment, the potential for greater upside also means the potential for greater downside.

Best Use:

Intermediate or long-term goals excluding retirement, such as buying a home or funding education.

3. Roth (IRA or 401(k))

Pros:

Tax-Free Growth: Contributions are made after-tax, but withdrawals in retirement are tax-free.
Diverse Investment Options: Roth IRAs and 401(k)s allow you to invest in various assets.

Cons:

Income Limits: Not everyone qualifies for a Roth IRA due to income restrictions.

Best Use:

Retirement savings: Contribute consistently to benefit from tax-free growth.

4. Pre-Tax (401(k), SIMPLE, SEP, Traditional IRA, etc.)

Pros:

Immediate Tax Benefits: Contributions are tax-deductible, reducing your current taxable income.
Compound Growth: Investments grow tax-deferred until withdrawal.

Cons:

Tax on Withdrawals: You’ll pay taxes when you withdraw funds in retirement.

Best Use:

Employer-sponsored 401(k) plans or individual retirement accounts (IRAs) for retirement savings.

5. Health Savings Account (HSA)

Pros:

Triple Tax Advantage: Contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free.
Long-Term Savings: Unused funds roll over year to year.

Cons:

Eligibility: You must have a high-deductible health insurance plan to qualify for an HSA.

Best Use:

Combine with a high-deductible health plan to cover medical expenses and save for retirement.

Having some money in each of these "buckets" is extremely valuable. Having diversification across different account types is equally (or more) important than having a diversified blend of investments in each of these accounts. Consider your short-term and long-term goals, risk tolerance, and tax implications when deciding where to save. Whether it’s building an emergency fund, planning for retirement, or achieving other financial milestones, the right account can make all the difference. Remember, there’s no one-size-fits-all answer—choose wisely based on your unique financial situation