Picture a cake with different layers on top of one another. "Layering your savings" means the following:
First Layer: Save Items and Emergency Savings
This focuses on having enough money to meet your monthly expenses by planning for large bills, especially when money needs to be saved from one pay period to another for a large expense. Examples include rent or mortgage payments, a car payment, and semi-regular insurance premiums. Emergency savings provides funding to cover these same expenses in an emergency.
Second Layer: Short-Term Savings
The second layer is money put into short-term savings plans. This represents money set aside for short-term goals—a vacation, special purchase, and protection from unexpected loss of income.
Third Layer: Long-Term Savings
The third layer is money that is placed in long-term savings plans. It is there if you need it, but its main purpose is to grow. This savings is designed for long-term goals such as a college education fund, buying a car, or a down payment for a house.
Fourth Layer: Retirement Savings
The fourth layer—retirement savings—is money that is placed into a long-term, tax-deferred account such as an IRA, 401(k) plan, or other qualified retirement plan. There are substantial penalties if the money is withdrawn early. The only purpose of this money is financial security during retirement.
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