Where To Put Your Money: Savings or Retirement?

So, you’ve finally committed to getting serious about saving and investing. Congratulations! Over time, even small steps, thanks to the power of compound interest, can reap big rewards in the long run. But if you’re just starting out, it can be hard to decide which you should prioritize, long-term retirement money or short-term savings.

The truth is that both a savings account and a retirement account are critical portions of an overall savings and investment strategy. But if you’ve only got a limited amount to start with and you want to know which choice is more important than the others, there are ways to help narrow down which might be the best choice for you. Here are six questions you should ask yourself to determine whether retirement or short-term savings should be your first step.

If you’re just starting out and have absolutely no savings or investments of any kind, most financial experts would suggest that an emergency fund should be your first move. Even if you can only set aside $500 or $1,000, you’ll be well on your way to having a cushion of safety. 

According to a recent survey from GOBankingRates, a whopping 30% of Americans’ don’t even have a savings account. This means that even a minor unexpected expense, such as a car repair, could force the average American family into debt. That is a perilous financial situation to be in, so direct your first savings toward your emergency fund. Once you’re in a position where minor unexpected expenses won’t derail your finances, you can set your sights on longer-term investment goals.

Winner: Short-Term Savings

If you have access to a 401(k) or other retirement plans at your job, you should take full advantage of it. Not only will you likely get a tax deduction for your contributions, but a workplace retirement plan typically includes matching and employer contributions. 

Many employers will match up to 50% of your contributions, up to 6% of your salary. For example, if you earn $50,000 per year and add $3,000 to your 401(k) plan, your employer might kick in as much as $1,500. On top of those matching contributions, many employers also make non-elective contributions, depositing money into employee accounts whether or not they make their own. 

All of these employer contributions are essentially free money that can get deposited into your account every year. Coupled with the tax benefits of an employer-sponsored retirement plan and the power of compound interest over time, you should always take advantage of these plans if they are offered. In this case, retirement contributions might take the nod over a short-term savings account.

Winner: Retirement Savings

Your age can help tip the scales as to whether you should prioritize short-term savings or long-term retirement investments. If you’re young, you have lots of years ahead of you to earn and save, so you can afford to ride out the ups and downs of stocks or other investments in a retirement account. However, if you’re already approaching retirement, you can’t afford to suffer a huge hit to your nest egg, as you won’t have the time it takes to fully recover. In this case, as an older investor, you should likely prioritize conservative, short-term savings.

One thing to note: If you’re already over age 50, the IRS allows “catch-up” contributions of an additional $1,000 into IRA accounts and $7,500 into 401(k) and other employer-sponsored plans for tax year 2023. This makes the limits for tax year 2023 $7,500 for IRAs and $30,000 for 401(k) plans for the over-50 crowd. If you’ve already got an emergency fund and earn enough to tuck away large sums of money, you might consider taking advantage of these additional contribution limits and put them in a combination of conservative and higher-growth investments in your retirement accounts. As always, however, you should speak with a financial advisor about the right combination of investments that meet your financial objectives and risk tolerance.

Winner: Varies depending on age and overall financial situation

If you have dependents, you’ll want to plan on having enough short-term savings to cover any number of family needs, from schooling and uncovered medical bills to class trips and other expenses. However, most financial experts say that this shouldn’t be at the expense of your own retirement.

For starters, any money you divert away from your retirement is money you won’t likely get back. Your children, on the other hand, will have access to numerous other sources of funding for their schooling, from student loans and financial aid to scholarship opportunities. In other words, prioritize your dependents and their short-term needs but don’t divert all of your savings toward college planning and away from your own retirement, which doesn’t come with financial aid.

Winner: Retirement Savings

Retirement savings carry lots of benefits, but they also have many restrictions. With some rare exceptions, you can’t take withdrawals from tax-advantaged retirement accounts until age 59 1/2; doing so generally triggers taxes plus a 10% penalty. Thus, if you have a short-term savings goal, such as buying a car or a house, retirement accounts are not the place to put those funds.

As a side note, many financial analysts suggest that you shouldn’t put money that you’ll need in the next five years into the stock market, as the risk of an irrecoverable loss is too high. Thus, if you’re looking to buy a house in five years or less – or have other short-term goals, such as a family vacation –  not only should you keep that money in short-term savings, you should also avoid high-risk investments with those funds.

Winner: Short-Term Savings

Depending on what phase of life that you’re in, various forms of insurance are vital to own. From auto and home insurance to life, health and disability insurance, policies sufficient to cover unexpected surprises can help you from draining your emergency fund or going into debt. If you don’t have adequate coverage, you’ll need a significant emergency fund. However, if you’ve got all your bases covered, you can likely divert your savings into your retirement accounts.

Winner: Retirement Savings (if you have insurance in place)