Spending Smart: A Guide to Banking, Saving and Investing
Seeing as the reason for college is to prepare one for the job market and best equip them for their profession and making a living, it’s imperative to understand where your money can go once you have it and, in some cases, how to make more money out of it. Upon receiving a paycheck, individuals have various options, including saving, spending and investing. While there are many options available, I will outline some of the most common benefits and drawbacks one may encounter when accepting a job offer or deciding how to manage a paycheck.
A bank offers basic checking and savings accounts. These accounts typically just hold your money and allow easy withdrawal. When choosing a bank or opening a new account with your existing bank, it is essential to consider all your account options and determine which accounts best suit your specific needs and goals.
Checking Account: A checking account is one’s primary banking account. This account is what is used for everyday transactions, such as shopping, ATM withdrawals, paying bills, and more. Linked to this account are a debit card, checks, and an ATM. At the moment of the transaction (barring a pending action), the money is directly removed from your account. Once all the money is removed, there is none left. Interest earned on this account is usually very low or none. Checking accounts are best for managing daily cash flow and tracking daily spending.
Savings Accounts: Savings accounts are the second most common type of account. Their purpose is to store money safely while earning interest. There are various types of savings accounts with different access options and interest rates. A basic savings account is best for building emergency funds or a short-term goal. Interest rates on this account are typically low, with many banks offering rates below 1%. Some savings accounts have limited monthly withdrawals, normally around six withdrawals per month.
With both your savings and checking accounts, the Federal Deposit Insurance Corporation (FDIC), a US government agency, insures your deposits up to $250,000 per person (check with your bank to see the policy there) to help protect against monetary loss due to fraud or other issues.
High-yield Savings Accounts: A high-yield savings account is the same as a savings account, just with higher interest rates. Interest rates can range from 4 to 5%. Online banks typically offer high-yield savings accounts.
Money Market Accounts: Money market accounts are a combination of checking and savings accounts. Many money market accounts include debit and credit cards; however, unlike some checking accounts, they require higher minimum balances. Money market accounts offer higher interest rates than traditional savings accounts, but rates fluctuate. These accounts have limited access, and one cannot withdraw funds frequently.
CDS: A Certificate of Deposit, commonly known as a “CD,” is a way of high-interest savings offered by banks. One deposits their money for a set amount of time and cannot remove it before that stipulated time is up; you will incur penalties if you withdraw from it during the allotted time. The interest growing on your money in a CD is predictable and is higher than in other savings accounts. This account is best for people who have a fixed amount of money set aside that they want to grow at a low-risk, predictable rate.
Investment accounts, similar to bank accounts, hold your money and allow it to grow with interest. However, they do so at different rates, and if you invest your money in the market, it is subject to fluctuations based on market patterns. When one invests through brokerage accounts or chooses to transfer their retirement accounts and invest them, it is advisable to do so through brokers or wealth managers.
Brokerage accounts: Brokerage accounts, also known as money market funds (not to be confused with MMA, money market accounts), are an investment product offered by brokers, not banks. This investment account invests your money into short-term securities that are not FDIC-insured. Interest on these accounts fluctuates with the market rate. Brokerage accounts are best for people who are looking to keep their money liquid and are okay with investing in higher-risk accounts than bank accounts. Because this is strictly an investment account, it’s important to note that, as it is invested in the market, one can gain or lose money accordingly.
401(k): A 401(k) is an employer-sponsored retirement account, which can only be acquired through one’s workplace. Contributions to this account are pre-tax contributions. This means that your taxable income will be lower. Money put into your 401(k) is taxed at withdrawal. Many employers will match part of their employees’ contributions. There are contribution limits to one’s 401(k) in 2024. The limit in 2024 was $23,000 a year if you were under age 50 and $30,500 if you were age 50 or older. When one withdraws from their 401(k), they are taxed on it as if it were income. If one begins to withdraw before the age of 59 ½, penalties may apply. It's important to note that one is required to begin taking distributions from their 401(k) at age 73.
Roth IRA: A Roth IRA is a retirement account. When one receives their paycheck, they can opt into making Roth IRA contributions. If one wants to, they pay taxes on their money up front, so that when they withdraw it later, it is tax-free. The money inside one’s Roth IRA is tax-free. Meaning, if one invests that money in stocks, bonds, or other funds, those profits are not taxed. There is no age at which one has to withdraw from their Roth IRA. However, if one wants to withdraw from their IRA tax-free, then they need to wait until they are 59 ½ (into their 60th year). It’s important to note that, in addition, one must have held their Roth account for at least 5 years, regardless of the age of withdrawal. There are contribution limits as to how much you can put in per year. As of now, if you are under age 50, you can contribute up to $7,000 a year, and if you are over 50, you can contribute up to $8,000 a year. One’s contribution amounts are subject to limits based on one’s income at the time.
A traditional IRA is set up differently from a Roth IRA. In a traditional IRA, contributions are tax-deductible; however, withdrawals are taxed. After age 59 ½, one begins getting taxed on the money, and at age 73, one is required to start withdrawing from the account. Traditional IRAs are best for individuals who want a tax break today on the money that they are investing.
This all may seem overwhelming. There is no shortage of places to store one’s money. It is imperative that when unsure, one researches and asks for help. Be honest with yourself about your financial needs — these are important decisions, and understanding them early on can set you up for an easier financial future.
The information provided in this article is for educational and informational purposes only and should not be construed as financial advice. Readers should consult with a qualified financial advisor or other professional before making decisions regarding their personal finances.
Photo Caption: Coins in a glass cup with a growing plant.
Photo Credit: Unsplash
