How Much Should You Save Every Month?
When unexpected expenses — car repairs, replacing a broken appliance or a medical procedure, for example — pop up, 39% of Americans say they can’t pay a bill of $400 or more, according to the Federal Reserve. In fact, according to a survey from The Ascent, 56% of people in the United States have less than $5,000 in savings, and another one-third have less than $1,000. Yet savings should be one of the top priorities for our financial goals.
When it comes to personal finance, saving is a must. From having emergency savings in the event your financial situation changes to having short-term savings toward that vacation you want to take and from putting aside enough money for a down payment on a home to having an investment account toward retirement, having a savings plan is crucial.
To determine how much exactly to save, the popular 50/30/20 rule is a good rule of thumb. This suggests that 50% of your monthly income goes to necessities such as living expenses, 30% toward discretionary items like travel, and 20% toward savings. When budgeting for your monthly savings, there are three key areas where you need to put your money: an emergency fund, retirement savings, and a general savings account.
Your emergency fund should be the savings you can quickly access for the sole purpose of paying unexpected expenses. Examples include a car repair, replacing a broken appliance, or a medical procedure. Having this “rainy day” fund provides the cash you need without dipping into your regular savings or running up credit card debt.
For an emergency fund, most money experts recommend having enough savings to cover between 3 and 6 months’ worth of living expenses in the event you should lose your job or are unable to work. Although you can save more, this amount should be your target goal if you are just starting an emergency fund.
When saving for retirement, a good target for your savings goals is between 10% and 15% of your annual income. That may sound like a lot when you’re also trying to build up your emergency fund and regular savings, but you may already be on your way. If you have a 401(k) through your employer, those savings count toward your goal. For example, if you currently direct 5% of your income to your 401(k), that counts. And if your employer matches that 5%? Even better. Now you’re at a 10% savings rate.
To further contribute to your retirement savings, consider setting up your own individual retirement account (IRA). According to the Internal Revenue Service, you can contribute up to $6,000 per year into a traditional or ROTH IRA. If you are age 50 or older, this amount increases to $7,000 per year.
When you contribute to a traditional IRA, you may be able to deduct those monies on your taxes. As your earnings grow in the account, you won’t pay taxes on them until you start to withdraw the funds. When you do, it’s possible you will pay less taxes because you are now in a lower tax bracket.
With ROTH IRA contributions, the money is deposited after you’ve paid taxes, so both your earnings and withdrawals will be tax-free provided you meet certain requirements. Although the contribution limits are the same as a traditional IRA, there are certain income limitations for ROTH IRA contributions, so it’s important to review those to decide if a traditional IRA or a ROTH IRA offers the best fit for your financial goals.
If you are a small-business owner or are self-employed, a simplified employee pension, or SEP, IRA could be the right choice for you. Unlike other IRAs, the contribution limits are much higher. Per the IRS, you can contribute the lesser of 25% of your compensation or $58,000 for 2021. If you have employees, you can set up SEP IRAs for them as well, but they cannot contribute to the account. When they do withdraw funds, they will need to pay taxes on them as income.
Similar to a SEP IRA, a “savings incentive match plan for employees,” or SIMPLE, IRA allows employees to contribute to their own accounts. This is in addition to the contributions required by employers. Regardless of who makes the deposits, all contributions are tax-deductible. With these IRA accounts, the IRS limits.) employee contributions to $13,500 from their salary. Employers have two options for contributions: They can match the employee’s contributions or contribute 2% of the employee’s compensation.
Your savings account is where you want to stash money for your long-term goals such as buying another car, paying college tuition, or taking a vacation. To make the most of your regular savings, look for savings accounts with a good interest rate. The national average savings rate on most traditional savings accounts is very low; in fact, according to the Federal Deposit Insurance Corporation (FDIC), the average rate is 0.05%. Therefore, consider some of the other savings accounts that may offer a higher rate of return.
High-yield savings accounts
As the name implies, high-yield savings accounts work like traditional savings accounts, but often have a higher interest rate. For example, the rate of MutualOne Bank’s online savings account is 0.70% for balances up to $1 million. However, you will need a minimum deposit of $500 to open the account.
When shopping for high-yield savings accounts, shop around for the best terms and fees that work with your budget. Many financial institutions offer accounts with no opening deposit or minimum balance requirements, no monthly maintenance fees, and no transfer fees. Some accounts include an ATM or debit card for easy access, while others require you to link a checking account so you can transfer your savings over to access.
The terms of each account are key to deciding which one is for you, so compare them to find one that works best for you. Remember that many online banks now offer high-yield savings accounts, so look beyond the bank down the street.
Certificates of deposit
Certificates of deposit essentially put a hold on your savings; however, in return, you receive a higher interest rate than those associated with traditional savings accounts. Currently, the national average savings rate for certificates of deposit range from 0.21% for a two-year CD to 0.34% for a five-year CD, per the FDIC. CDs can be a great option if you know you won’t need the money throughout the CD’s term. If you cash it outside the specified term periods, though, you will pay hefty fees.
Money market accounts
Money market accounts work similarly to high-yield savings accounts because both earn a higher interest rate than traditional savings accounts. However, with a money market account, you have check-writing privileges and usually an ATM or debit card so you can access your money when needed. Because this is a savings account, though, that access is limited to six withdrawals per statement cycle, typically six per month. Any withdrawals beyond that amount will incur a fee for each transaction.
Ways to Increase Your Savings
To maximize your savings to reach your long-term goals, try one (or more) of the following methods.
Create a budget
Although many people have a general idea of where their money goes each month, it’s hard to pinpoint how each dollar is spent so you can see what you have available to direct toward savings. With a budget, you can see and track each dollar, so you can see how much you have for savings, as well as areas where you can cut back to increase your savings potential. To create a budget:
Make a list of your regular monthly expenses, including your mortgage or rent, utilities, groceries, gas, car payments, and regular loan payments such as those for a car or student loans. Subtract this amount from your monthly income—the amount you bring home, not your gross income. Take the remaining amount–your discretionary income–and itemize how you spend it. This includes eating out, going to the movies, picking up that new video game and other nonessential expenses. Knowing where your money goes can help you reroute some of those funds into your savings. For instance, cancel any subscriptions or memberships you don’t use. When was the last time you went to the gym or logged onto that members-only website? Instead of eating out four times a week, reduce that to once a week. Or skip going to that new release at the movies, and wait for it to come out on cable. All of these are simple ways to save money.
Although the initial amount you have to direct to your savings may seem small, just get started. Once you do, stick with it until you reach your financial goals. It might take some time, but it will pay off in the long term.
Take advantage of savings tools
Finding extra savings may seem difficult, especially if money is tight. To help you boost your savings, use savings tools to send extra cash your way. For example, if you have direct deposit at work, you may be able to direct some of that money into your savings account. Check with your employer to see what options you have for designating funds into your checking account and your savings.
Also, talk to your bank to see what savings tools they have available. One example is to set up an automatic transfer from your checking account to your savings account. This way, you know your money is going into savings, and you don’t have to worry about forgetting it.
Your bank account may have additional savings programs that could boost your savings. For instance, with Chime’s Automatic Savings Account, every time you use your debit card, your purchase is rounded up to the nearest dollar, and the “round up” amount is transferred into your savings account. It might not seem like much at the time, but these little tidbits of savings can add up to extra money quickly.
Also, check around for a credit card with “cash back” rewards. These cards may offer as much as 2% cash back, which you can deposit in your savings account. Use this card to pay for your monthly living expenses such as utility bills, groceries, and gas. Then, make sure you pay off the bill in full each month. Be diligent that you use this card expressly for earning the cash back reward. It should not be an opportunity to increase your credit card debt, which can hurt your credit score and have you paying higher interest on purchases, loans, and mortgages, a waste when that extra money could go toward savings.
Another savings tool are the many savings apps now available. For instance, with the Earnin app, you can tip yourself for “good service.” Made it to the gym today? Tip yourself. Finished all the laundry? Tip yourself. Once your tip jar gets full, just transfer the money to your savings account.
Splurge a little, save a lot
Everyone loves a windfall, but, as the saying goes, don’t spend it all in one place. So the next time you get a bonus at work, your tax refund comes in, or you find yourself with an amount of money you didn't expect, such as the Stimulus checks recently issued, treat yourself to something small, and dump the rest into savings. When you reach your long-term goals, whether it’s that beach vacation or retiring a year early, you’ll be glad you did.
The bottom line
When planning out your financial goals, savings is a key element to reaching them. From a “rainy day” fund for emergencies to purchasing a new car to retirement, your savings are essential to paying for both what you need and what you want in the future. Therefore, it’s important to set up a budget with the goal of saving 20% of your income each month.
To maximize your savings, research the different savings accounts available to find the ones that best fit your needs. This could include an assortment of accounts, from a high-yield savings account for your emergency fund to a money market account for your regular savings to an IRA for retirement.
Coupling the right account with such savings tools as automatic savings deposits and savings apps could boost your savings and help you reach your savings goals in no time. The key is getting started and sticking with your plan. When you do, you’ll have the savings you need when you need them.