The Worst Savings Account in America
March 07, 2013Imagine I told you about a special savings account that you could contribute to with money automatically deducted from your paycheck every pay period. Sounds like a great way to save, right? Now imagine that this account earns no interest and has no possibility of any growth or future earnings.
You might start getting suspicious but then again, regular savings accounts are paying practically zero too. What if you could only withdraw from this account during certain times of the year and when you request your money, it takes a while to receive it? Now what if there’s talk that your withdrawal could be delayed indefinitely because the institution holding your money is having trouble paying its bills? Would you put money into that account?
That’s exactly what you’re doing when you use your tax withholding as a form of savings. Many Americans purposely reduce their W-4 exemptions to have more money withheld so they can get a nice big fat refund check this time of year. In fact, for many of the employees we talk to, this is their only form of saving.
While it’s certainly not the optimal way to save, I suppose it’s better than not saving anything at all. I’ve seen many people financially rescued by that refund check. So what savings vehicles can duplicate some of the benefits of tax withholding (happens automatically and you can’t spend it on frivolous things) without the drawbacks (no earnings, no access in case of an emergency, long delay to get funds)? Here are a few:
1) Your employer’s retirement plan. Rather than increasing your withholding, why not increase your retirement plan contributions? This has the same convenience of payroll deduction but you also get tax benefits, the money is actually invested to grow, and your employer may even match some or all of your contributions. In addition, it’s hard to withdraw the money before retirement unless you have a severe financial hardship. Of course, that benefit can also be a drawback if you don’t have any other savings and need the money in an emergency.
2) Roth IRA. This is where the Roth IRA comes in. You can set up automatic contributions from your checking account. Like your employer’s retirement plan, you get tax benefits, in this case, tax-free withdrawals as long as the account has been open for at least 5 years and you’re over the age of 59 ½. Unlike your employer’s retirement plan, you can access the money much easier and there’s no tax or penalty for withdrawing the sum of your contributions. However, you do need to fill out a withdrawal form every time you make a withdrawal so it’s not as easy as writing a check or going to the ATM machine. The Roth IRA has a big downside too though. You can only contribute up to $5,550 per year or up to $6,500 if you turn 50 or older this year.
3) HSAs or FSAs. These are other tax-advantaged accounts that you may be able to have deducted from your paycheck. HSAs and health care FSAs can be used tax-free for qualified medical expenses. Dependent care FSAs can be used tax-free for dependent care expenses. However, they all have limits on your contributions and how the money can be withdrawn penalty-free.
4) 529 plans. Some employers also allow you to contribute to a 529 college savings plan from your paycheck. These grow to be tax-free for education but there may be a 10% penalty if you use the money for something else so make sure all of your other needs are taken care of first.
5) Regular account. If you’re maxing out all of these tax-advantaged accounts, you can always have money automatically set aside in a regular savings or investment account. While you’ll have to pay taxes on the earnings each year, at least you’ll have earnings to be taxed. Just be sure to align the type of account with your goals (savings account for short-term needs like an emergency fund or a home purchase in the next few years and investment account for longer term goals like retirement and college expenses).
If you make one or more of these changes, you won’t have as large a refund check to look forward to each year. However, you can get a much bigger check from one or more of these accounts in the future. More importantly, you won’t have to rely on these guys to get your money.