A well-diversified portfolio should ideally have both short-term investments, like a savings account, and long-term savings, like a 401k. Choosing how to allocate your money between these different options depends on your financial goals, time horizon, and the specific details of each option. Here’s a comparison to help you decide whether to put your money in a savings account or 401k.

Is it Better to Put Money in a Savings Account or 401k?

1. Purpose and Goals

• Savings Account: Ideal for short-term goals, emergency funds, or money you need easy access to.
• 401(k): Designed for long-term retirement savings.

2. Interest and Returns

• Savings Account: Typically offers low interest rates, often below the rate of inflation. Your money is safe and insured by the FDIC, but it may not grow significantly over time.
• 401(k): Potentially higher returns, depending on your investment choices (stocks, bonds, mutual funds.)

3. Tax Benefits

• Savings Account: Interest earned is taxable each year. There are no tax advantages with savings accounts.
• 401(k): Contributions reduce your taxable income for the year, and earnings grow tax-deferred.

4. Accessibility

• Savings Account: Savings accounts are liquid, meaning you can withdraw your money at any time without penalties. This makes them ideal for emergencies or short-term needs.
• 401(k): Funds are less accessible due to penalties for early withdrawal (before age 59 1/2). Loans are available from some 401(k) plans, though this could reduce your retirement savings.

5. Employer Match

• Savings Account: No employer match.
• 401(k): Many employers match a portion of your contributions, providing an immediate return on your investment. That’s essentially free money towards your retirement.

401k vs Savings Account: Which is Better?

• If you need short-term liquidity (e.g., building an emergency fund), a savings account is the better option. It provides safety and easy access.
• If you’re focused on retirement and can leave the money invested for the long term, a 401(k) is generally better due to its tax benefits, potential for higher returns, and employer match.

How Much Money Should Go to a Savings Account Vs. a 401k?

Here’s a step-by-step balanced approach to allocating money between short-term and long-term accounts:

1. Establish an Emergency Fund First.

Before prioritizing retirement contributions, it’s essential to have an emergency fund. A good rule of thumb is to save 3 to 6 months’ worth of living expenses in an easily accessible savings account. This provides a safety net for unexpected expenses, such as medical emergencies, car repairs, or job loss.

2. Contribute to Your 401(k) to Get the Employer Match.

If your employer offers a matching contribution, contribute at least enough to your 401(k) to get the full match. For example, if your employer matches 50% of contributions up to 6% of your salary, aim to contribute at least 6% of your salary. This is basically free money, so every attempt should be made to take advantage of it.

3. Balance Between Savings and Retirement

• Once your emergency fund is established, you can focus more on long-term retirement savings. A common approach is to aim to contribute 10-15% of your gross income to retirement accounts, including your 401(k).
• Continue to contribute to your savings account for short-term goals, like a down payment on a house, a vacation, or other major expenses. The amount to keep here depends on your personal goals and how much cash you want readily accessible.

4. Adjust Based on Your Financial Situation

• Income Level: Higher earners may be able to contribute more to their 401(k) while still maintaining a solid emergency fund.
• Debt Levels: If you have high-interest debt (like credit cards), prioritize paying that down before allocating too much toward savings or retirement.
• Upcoming Expenses: If you anticipate large upcoming expenses (e.g., buying a home, having a child), you might allocate more to savings in the short term.

Example Breakdown

• Initial Phase:
  • 60-70% to an emergency savings account until the fund is fully established.
  • 30-40% to 401(k), at least up to the employer match.
• After Emergency Fund is Established:
  • 10-20% of income to savings (for short-term goals.)
  • 10-15% of income to 401(k) or other retirement accounts.

This is a general guideline, and the exact percentages will vary based on individual circumstances. The key is to maintain a balance between having liquid cash for emergencies and maximizing long-term retirement savings.

Have questions about allocating your short and long-term investments? Contact Zynergy Retirement Planning today.