You need 3 investment ‘buckets’ to maximize flexibility, advisor says

the The earlier you investThe more time your money has to grow. But knowing the exact calculations to use can be overwhelming.

after Put money aside To cover daily expenses in a checking account and three to 12 months of expenses in a savings account, you should start looking at putting any extra income into three different investment “buckets,” says Jaime Buss, a certified financial planner and senior advisor at CGN Advisors in Manhattan, Kansas.

“If you have too much cash, you actually lose money to inflation,” Boss says. “Any extra dollars you have should be invested in growth for the future.”

With three investment accounts, you’ll have more flexibility to tap your money when you need it and more control over your tax bill now and later because each “bucket” offers different benefits, Buss says.

How you best allocate your money across different types of accounts will vary based on your income and situation, but the bottom line is that you should use it to your advantage, she says. Be sure to speak with a trusted financial professional for individual advice.

Here are the three buckets she suggests and how they work.

1. Deferred tax bucket

Examples: Traditional IRA, 401(k), 403(b)

Tax-deferred accounts, like traditional accounts 401(k) or Individual retirement accountallows you to contribute pre-tax money from your paycheck to an investment account. This reduces your taxable income for the year you contribute, and your investments grow tax-deferred until retirement.

Withdrawals are taxed as income and are typically penalty-free starting at age 59½. Taking the money early may result in taxes and 10% Penalty for early withdrawal.

2. Tax-deductible bucket

Examples: Roth IRA, Roth 401(k), Roth 403(b)

You contribute money on which you have already paid taxes Roth accounts. Your investments then grow tax-free, and once you reach 59½, qualified withdrawals are not taxed or penalized. Roth IRAs, in particular, also add flexibility by allowing you to withdraw money you’ve contributed at any time without penalty.

Boss says these accounts are ideal if you expect to be in a higher tax bracket in the future or want tax-free income later.

3. Taxable Bucket

example: Brokerage accounts

Taxable brokerage accounts allow you to invest after-tax money and withdraw at any time without penalty. While you’ll generally owe taxes on any realized gains, these accounts offer the most flexibility for expenses outside of retirement, such as a down payment on a house or a vacation, because you can access your money when you need it, Buss says.

Start by checking to see if your employer has Company match A program where they will contribute an additional amount to your retirement accounts that matches your own contributions.

Early in your career, Huey suggests contributing to a Roth 401(k) or Roth 403(b) instead of a tax-deferred 401(k).) Because you’ll likely earn a higher salary as you get older — which makes it smarter to pay taxes now when you’re in a lower tax bracket.

However, even if it’s through a tax-deferred account, “if there’s a match available, you should do what it takes to get it,” because it’s the free money from your employer that boosts your retirement savings, Huey says.

In general, experts recommend Save about 15% of your annual pre-tax retirement income, including any company matching.

Bosse says the purpose of dividing your money into three accounts is to give yourself options, whether that’s making large purchases, lowering your current tax bill, or reducing what you’ll owe in the future.

“I think of it in terms of not investing for your retirement, but investing for your future flexibility,” Boss says. When you have money in your three buckets, “You can work because you want to, not because you need to. You can travel the world. You can do other things.”

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