Understanding your savings options

Your alternatives fall into several buckets with different considerations. Be sure to consult with your tax or financial advisor before finalizing your game plan.

Your savings options include:

• Taxable accounts. These include checking, savings, and brokerage accounts. Interest, dividends, realized capital gains, and annual fund distributions are taxable annually.
• Retirement accounts. Employer-sponsored plans, like 401(k)s and IRAs—both traditional and Roth—are some possibilities for retirement savings. All of them offer tax advantages.
• Tax-advantaged accounts. Health savings accounts, 529 savings plans, Coverdell education savings accounts, and Achieving a Better Life Experience (ABLE) accounts can help you save. And they offer tax-free qualified distributions or let you pay taxes later. 

Checking accounts. These accounts are for cash deposits that you tap for everyday transactions like bill-paying and debit card purchases. They’re also highly liquid, so you have immediate access to your money when you need it.

Banks don’t usually pay much, if any, interest on the money in a checking account. That means your funds are unlikely to grow. That said, high-yield checking accounts usually pay more interest, so they might be worth considering. If you do earn any interest, you’ll need to pay taxes on it annually, even if it’s just a few dollars in a year.

Savings accounts. As the name suggests, these accounts are all about short-term saving, not spending. These accounts often offer higher interest rates than checking accounts, so the cash you deposit can earn interest over time. Plus, the money is FDIC insured. You’ll pay taxes annually on any interest you earn.

Brokerage accounts. A brokerage account lets you buy and sell a wide range of investment options, like stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Those investments fluctuate in value and may potentially generate returns that can help to increase your savings.

Money market funds can be a viable option as a lower-risk investment within a brokerage account. A type of mutual fund, money markets seek to maintain a value of $1 per share and invest in cash and high-quality, short-term debt, so they’re designed to have a low level of risk. They also tend to pay a higher rate of interest than checking and savings accounts. However, money markets aren’t FDIC insured. They also aren’t likely to increase in value or be sold at a gain.

Other investments you hold in a brokerage account may increase in value, and you’d have to pay capital gains taxes on any realized growth.  And dividends—money from profits some companies pay shareholders—may be taxed as either ordinary income or at long-term capital gains rates.

Employer-sponsored plans. These are retirement savings accounts through your employer. Among the most popular are 401(k)s and 403(b)s. They have the same annual contribution limit, and you make pre-tax contributions from your wages. Roth 401(k) accounts, which you contribute to with after-tax money, may also be available. If your employer-sponsored plan is at Vanguard, you may have access to advice and money management services. See if your plan offers advice here.

Traditional IRAs. When you make a tax-deductible contribution to a traditional IRA, you don’t owe taxes on earnings or distributions until you withdraw money.** Unlike an employer retirement plan, an IRA isn’t sponsored by your employer—you set it up yourself. Also, IRA providers generally offer a wider array of investment options than employer plans. So, you can select from a larger swath of stocks, bonds, ETFs, or other alternatives. If you open a Vanguard IRA®, you'll have access to Vanguard's advice services, even if advice isn't available through your employer-sponsored plan.

Roth IRAs. While the Roth IRA’s contribution limit is the same as with the traditional IRA, there are important differences. Only people earning below a certain amount of money can contribute to a Roth IRA. In addition, you contribute to a Roth IRA with after-tax money, so there's no immediate tax break. But you can withdraw money starting at age 59½ without paying taxes, as long as you follow specific rules.***

Health savings accounts (HSAs) provide a tax-advantaged way to pay medical expenses—as long as you’re enrolled in a qualified high-deductible health plan. And they’re triple tax advantaged:

• Your contributions are made with pre-tax dollars, meaning they reduce the amount of income you’ll have to pay taxes on.
• Any earnings grow tax deferred.
• You won’t pay taxes on distributions used for qualified medical expenses.

And with an HSA, you don’t have to use it or lose it: You can keep money in the account and roll it over from year to year.  Many account providers will allow you to invest your contributions in mutual funds and other investments that offer the possibility of more growth.

529 savings plans and Coverdell education savings accounts (ESAs) are an option if you’re looking for ways to save for your children’s or grandchildren’s education. These accounts are used to cover tuition, fees, and room and board at colleges, trade schools, and private elementary and high schools, depending on the state.

Many states offer 529 plans, in which your contributions are deposited, and any growth from investments is tax deferred. You can’t deduct contributions on your federal income tax return. But you might get a state income tax break, depending on your state.

When you make a withdrawal from a 529 plan account, in most circumstances you don’t pay federal or state tax as long as you use the money for a qualified education expense.

With a Coverdell ESA, the maximum contribution is much lower. You can’t take a tax deduction for those contributions, but the accounts have low fees and tax-free withdrawals. Plus, Coverdell ESAs can cover more types of expenses than the 529, such as academic tutoring.

ABLE accounts are designed for people who meet specific disability criteria. Annual contributions can’t exceed the IRS annual gift tax exclusion of $18,000 for individuals and $36,000 for married couples. You contribute with after-tax dollars. But then you can invest the money, and any growth is tax deferred. Also, withdrawals are tax-free as long as they’re used for a qualified disability expense.

Importantly, money in an ABLE account doesn’t affect your eligibility for programs like Medicaid and Supplemental Security Income. 

As you determine where to put your additional savings, these steps can help you decide which option is right for you:

• Define your goals.
• Learn more about Vanguard’s recommended hierarchy for retirement savings.
• Make a financial plan, including creating a budget and setting a savings rate you’re comfortable with.
• Put your plan on autopilot by setting up automatic contributions to the savings option(s) you choose. 

*Some employers offer additional after-tax contributions. They can potentially push total contributions past the IRS’ 415(c) limit of $69,000, which can trigger penalties.

**If withdrawals are taken before age 59½, you would owe an additional 10% penalty tax. You may be eligible to deduct some or all of your traditional IRA contributions. If you or your spouse are covered by a retirement plan at work, the amount you can deduct may be reduced or eliminated.

***Withdrawals from a Roth IRA are tax-free if you are over age 59½ and made your first Roth contribution at least five years before; withdrawals of earnings taken before age 59½ or five years may be subject to ordinary income tax, a 10% federal penalty tax, or both.

****Additional options may be available. Work with your advisor to find the best one.

Whenever you invest, there’s a chance you could lose the money.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.