Should You Save Your Extra Money in the Bank — or in a Retirement Plan?

A lot of people these days are struggling with higher living costs, and as such, have little to no money left over each month once their bills are paid. But you might be in a different situation — one that leaves you with a decent amount of extra money at your disposal once your bills are covered.

The question is, what should you do with that money? Should you use it to fund a retirement plan? Or should you keep it in the bank for short-term savings purposes?

It all boils down to the state of your savings account

As a general rule, it’s important to have money in your savings account for emergency expenses or a period of extended unemployment. Before the pandemic, the general advice was to sock away enough cash to cover three to six months’ worth of essential bills. In the wake of that crisis, though, many financial experts have upped their recommendations and now say it’s wise to have enough cash to cover eight to 12 months’ worth of bills.

As such, what you do with your extra cash each month should really hinge on what your savings look like, and how much of an emergency fund you think you should have. Let’s say you’re the sole breadwinner in your household and you have three kids and two pets. If you were to lose your job, you’d be in a pretty tough situation.

In that case, you may decide that it’s a good idea to have a year’s worth of living expenses in the bank. And so if you only have six months’ worth in savings right now, then you may want to put your spare cash into the bank until your emergency fund is complete.

But let’s say you’re in a different boat. Maybe you’re comfortable with a six-month emergency fund and are already there. If that’s the case, then it pays to put your extra money into a retirement account like an IRA or 401(k). That way, you can invest that money and grow it into a larger sum over time. And also, you might reap some tax breaks.

Traditional IRAs and 401(k) plans allow for tax-free contributions. So if, for example, you put $3,000 into one of these accounts, that’s $3,000 of earnings the IRS won’t tax you on. You won’t get a similar tax break if you put money into your savings for emergency fund purposes.

It’s all about priorities

Saving for retirement is unquestionably important. But it’s even more important to make sure your near-term financial needs are addressed. That’s why your emergency fund should take priority, and until it’s complete, you may want to favor it over your IRA or 401(k).

But once you have a fully loaded emergency fund, it definitely pays to pump as much money as you can into a dedicated retirement savings plan. Doing so could lower your tax burden, all the while helping ensure you have enough money to live comfortably once your career wraps up.