How Much Money Should You Keep In Your Checking Account At One Time?

In this installment of our new weekly finance column, we tackle questions about checking and savings accounts and the prioritization of debt payments.

by Daniel Kurt
Geo Barnett for Fatherly

Hey Bank of Dad, this may sound like a silly question but the answer always escapes me. I rely on my checking account for monthly expenses and therefore have my paychecks deposited into that account. I don’t, however, want to lose out on the interest that I’d get by putting some of my monthly income into savings. So, how much of my money should I keep in checking vs. savings at any given time? — Shane, Des Moines

There are no silly questions when it comes to money management, only lost savings. As far as the amount of money you should have in each account, there really is a balancing act here. It’s so important to have funds readily available when you need them, which is the great thing about deposit accounts. But parking too much of your cash there won’t let that money grow over the long haul. So you want to get it right.

Let’s start with the checking side of the equation. Start by tallying up all of the fixed expenses you’ll incur from one paycheck to the next. There are the obvious ones, of course, like your mortgage (or rent), phone service, and utilities. But don’t blank about all those easy-to-forget debits to your account, such as that sweet, sweet Netflix subscription or those recurring transfers to your savings account (You’re making those, right?)

Once you’ve done this, add up any expenses that vary from one month to the next, like food and entertainment. Average out how much those things have cost you over the past few months to come up with a ballpark figure.

Once you’ve calculated all your outlays, you’ll want to add a few hundred bucks as a buffer. That’ll act as a safeguard in case you and the wife have an expensive date night or you find a particularly steep utility bill in the mail. By having a little extra in your account, you’ll avoid the exorbitant overdraft or insufficient funds fees banks love to stick on you.

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As for your savings account, a common rule of thumb is to have an emergency fund that can cover three to six months’ worth of expenses, plus enough for big one-time outlays like an upcoming vacation. That might seem like a lot of dough to keep in the bank, but you’ll sleep easier knowing that an unexpected job loss or medical bill won’t put you in panic mode.

In those situations, dipping into your savings account is a much better option than applying for a personal loan or making a hardship withdrawal from your 401(k). The latter could mean paying income tax and, for anyone under 59½, forking over a 10 percent early withdrawal fee. You can skirt both of those outcomes with a 401k loan, which lets you borrow from your own account. But not all employers offer them – and you have to pay yourself back with interest. Pulling the money out of a savings account is a lot quicker, and cheaper.

Dear Bank of Dad, I have student loan debt, two credit card bills, and a decent home equity loan. All need to be paid off…obviously. But which should I prioritize first? What’s the best order of operations? — Travis, Louisville

When you’re paying off debt, you want to prioritize the loans with the highest interest rate. That makes your first target pretty easy: credit cards. Even if you’re enjoying a promotional rate on your card, you’ll probably face the reality of sky-high finance charges before long (the average APR is roughly 17 percent at the moment, according to Wiping out those balances now is a great idea.

Where to go from there may be a trickier question. Interest on student loans and home equity loans are both tax-deductible – at least in some cases – so you have to factor that into your decision. In the case of student loans, you can reduce your taxable income by up to $2,500 for the interest you pay, though the benefit is phased out for higher income-earners.

I don’t know your specific situation, but I’ll illustrate the impact of the tax deduction using some fairly typical numbers. Let’s say you’re in the 22 percent tax bracket and all the interest you’ve paid for the year qualifies for the deduction. If your loan carries an interest rate of 6 percent, you’re in effect only paying 4.7 percent [(0.06 – (0.06 x 0.22)]. Keep in mind this is an “above the line” deduction, so you benefit from it even if you take the standard deduction.

Because of the Tax Cuts and Jobs Act, interest on home equity loans is only tax-deductible if the debt is used to “buy, build or substantially improve” your residence — for instance, renovating your bathroom or building a new patio. If you did something along those lines, and you itemize your returns, you’d make a similar adjustment to the interest rate on this loan, too. Now you can figure out whether this debt or your student loan has the smaller real-life interest rate.

Of course, your question implies that you’re dead-set on paying off all your loans as fast as possible. And where your credit card debt is concerned, I think that’s a no-brainer. But if you’re making more than enough to cover your expenses each month – including minimum payments on your loans – you might consider whether that money’s put to better use in a tax-advantaged investment account.

Paying off a four or five percent loan doesn’t make much sense if, based on historical returns, you expect to earn, say, 7 percent from a portfolio of stock and bond funds over the long haul (that’s actually a fairly common estimate among public pensions these days). Investing your extra money makes even more sense if you haven’t yet maximized your employer’s 401(k) match. I’d be sure to do that before accelerating my student loan or home equity repayments.