You need 3 investment ‘buckets’ to maximize flexibility, advisor says
The sooner you invest, the more time your money has to grow. However, finding the exact accounts to use can be overwhelming.
Once you’ve set aside money to cover daily expenses in a checking account and three to 12 months of expenses in a savings account, you should start putting any additional income into three different investment “buckets,” says Jaime Bosse, a certified financial planner and senior advisor at CGN Advisors in Manhattan, Kansas.
“If you have too much cash, you’re actually losing your money to inflation,” says Bosse. “The extra dollars you have should be invested in growth for the future.”
With three investment accounts, Bosse says, you’ll have more flexibility to use your money when you need it and more control over your tax bill now and later because each “bucket” offers different benefits.
How best to allocate your money across different account types will vary depending on your income and situation, he says, but ultimately you should use them to your advantage. Be sure to talk to a trusted financial professional for personalized advice.
Here are three buckets he recommends and how they work.
1. Tax deferred package
Examples: Traditional IRA, 401(k), 403(b)
Tax-deferred accounts like traditional 401(k) or individual retirement accountIt allows you to transfer pre-tax money from your paycheck into an investment account. This reduces your taxable income for the year you contribute, and your investments grow tax-deferred until retirement.
Withdrawals are taxed as income and are generally penalty-free starting at age 59½. Withdrawing money earlier may trigger taxes and a 10% deduction early withdrawal penalty.
2. Tax free package
Examples: Roth IRA, Roth 401(k), Roth 403(b)
You’re contributing money you’ve already paid taxes on. Roth accounts. Your investments then grow tax-free, and once you reach 59½, qualified withdrawals are not taxed or penalized. Roth IRAs, in particular, add flexibility by allowing you to withdraw the money you contribute at any time without penalty.
These accounts are ideal if you expect to be in a higher tax bracket in the future or want tax-free income later, Bosse says.
3. Taxable package
Example: brokerage accounts
Taxable brokerage accounts allow you to deposit money after taxes and withdraw money whenever you want without penalty. While you’ll typically owe taxes on your earnings, these accounts offer maximum flexibility for non-retirement expenses (like a down payment on a house or vacation) because you can access your money whenever you want, Bosse says.
Start by taking advantage of your company match
You don’t need to open three accounts at once, says Patrick Huey, a certified financial planner and owner of Victory Independent Planning in Portland, Oregon.
Start by checking if your employer has a permit. company matching program where they will contribute an additional amount to your retirement accounts that matches your own contributions.
Early in your career, Huey recommends contributing to a Roth 401(k) or Roth 403(b) rather than a tax-deferred 401(k).) because as you get older you will probably earn a higher salary; This makes paying taxes smarter when you’re in a lower tax bracket.
Even if it’s through a tax-deferred account, however, “if there’s a match, you should do whatever it takes to get it,” because free money from your employer boosts your retirement savings, Huey says.
Using all three investment ‘buckets’ gives you options
Experts generally recommend Save about 15% of your pre-tax annual income for retirement, including any company match.
The point of splitting your money into three accounts is to give yourself options, such as making large purchases, lowering your current tax bill or reducing what you’ll owe in the future, Bosse says.
“I think of it as investing for your future flexibility, not your retirement,” says Bosse. When you have money in your three buckets, “You can work because you want, not because you need to. You can travel the world. You can do other things.”
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