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Have money to put away for future use? Read on to see how to choose the right account.
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Many people have been struggling financially over the past couple of years due to rampant inflation. And as of October, living costs were still up 3.2% on an annual basis, as per that month’s Consumer Price Index. So if spare money has been tough to come by in your world, that’s totally understandable.
But what if you’re not spending down your paychecks month after month? What if you somehow have money left over consistently after all of your bills are paid?
If so, you’re in a really good place. But you’ll also want to make sure you’re finding the right home for your money. And you may be torn between a savings account and an IRA. To figure which account your money should go in, ask yourself these questions.
1. Do I want near-term access to my money?
When you put money into an IRA, you’re earmarking those funds for retirement (IRA actually stands for “individual retirement account”). As such, the IRS imposes rules on when you can access your funds.
If you take a withdrawal from an IRA prior to age 59 1/2, you’ll face a 10% penalty unless you qualify for a limited exception (for example, you can remove up to $10,000 from an IRA to purchase a first-time home). With a savings account, you can access your money whenever you want.
So if you’re hoping to give yourself a bigger cushion for when emergency expenses strike, or you’re saving up for a specific goal, like putting a down payment on a car purchase, then a savings account is probably your better bet. If you like the idea of setting money aside for retirement and being able to invest it, then an IRA is the account you should choose.
2. Do I want to save money on taxes, or potentially add to my taxes?
Paying taxes is a fact of life when you earn money. If you’re looking to shield some of your income from taxes, then opening to an IRA is the way to go. Contributions to an IRA are tax-free, so if you put $3,000 into one of these accounts, that’s $3,000 the IRS will not tax you on.
The money you put into a savings account will not help your tax situation, since your contributions won’t shield income from the IRS. In fact, quite the contrary — when you earn interest in a savings account, that’s considered taxable income. Not only that, but interest is taxed as ordinary income, which means it’s subject to the same rate as your regular paycheck.
Think about your recent tax returns. Have you been writing the IRS a check every April for the past few years? If so, then you may want to do your best to max out your IRA, or come as close to it as possible. In 2024, maxing out means contributing $7,000 if you’re under age 50, or $8,000 if you’re 50 or older.
3. Should I split my money between both account types?
There’s absolutely no need to choose between a savings account or an IRA when the option to fund both exists. See how you’re doing with emergency savings. If you have enough cash in the bank to cover a few months’ worth of bills but want a little extra protection, then you may want to stick some extra money into a savings account, but put the rest into an IRA and invest for the future. That way, you get some tax benefit.
It’s important to find the right home for the money you don’t need for bill-paying purposes. Both IRAs and savings accounts offer their share of perks. Run through these questions if you’re not sure where your money should go.
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