Getting out of debt is a beautiful thing. You’ve spent months or years or decades with a single financial goal, throwing whatever you can at its big, ugly face. You create rules, you create processes, you download tools, all with the same goal in mind — not owing anyone a single dime. And then one day it happens. You deliver your Mortal Kombat “FINISH HIM!” move on the Debt Monster and you’re done. You’re debt free. So you shift your focus to building up a few more months of your emergency fund, then saving for a house, and then… and then what?
The transition from getting out of debt to figuring out what to do with your savings is tricky. For so long, there was only one choice, one focus. And then suddenly, you’ve got extra money sitting around in savings with endless options before you. You’re like a sixth grader at his first dance — you’re pretty giddy, but you have no idea where to put your hands. So assuming you’re emergency fund-ed for at least six months, and there aren’t any other pressing financial goals (like buying a home, car, etc.), here are a few places you should put your hands… err, extra savings.
Invest in an IRA
I know, I know, pretty boring. But if you’ve got extra savings, there are few things more important than investing for retirement. You can read about the why and the how here. When it comes to IRAs, you’ve got a choice between a Traditional and a Roth. All those choices boil down to one question — when do you want to reap the tax savings: before or after?
With a Traditional IRA, you’ll be able to deduct whatever you put in now and then pay taxes on withdrawal when you’re 59 1/2. With a Roth IRA, you’ll use already-taxed dough but withdraw tax free after you’re 59 1/2. Should the need ever arise, you can also withdraw whatever you contribute to your Roth without penalty. Of the IRA bros, Roth’s our go-to guy for now.
Maximum yearly amount: $5,500/individual, $11,000/married
Contribute to an HSA
Health insurance seems like the last place you’d want to put some of your extra money, but trust us on this one. Health Savings Accounts (or HSA for cool people) are super cool tax-advantaged savings accounts that can be used with qualifying plans with high deductibles (defined as $1,300+ for individuals, $2,600+ for families). On the outside, it’s just another health insurance plan with copays and premiums and all that boring mumbo jumbo. But the magic comes in the form of tax-free contributions, tax-free growth earnings, AND tax-free withdrawals on any medical expenses — the tax-dodging geek trifecta! And if that wasn’t enough, many employers are also willing to throw some money into your HSA, so check with your HR peeps. An HSA might not be for everyone, but give this a close look the next time you’re in open enrollment.
Maximum yearly amount: $3,350/individual, $6,650/family
Open a 529
After the scare earlier this year with President Obama threatening to dropkick 529 plans, don’t take these tax-deferred education savings plans for granted. If you’ve got kids, you think you want to help them pay for their education, and you’ve got some extra dough laying around now, make the most of it by putting it in a 529.
We’ve explained 529s before, but basically these state-sponsored education plans can potentially hook you up in two ways: 1) your state might allow you to deduct your contributions from state income taxes, and 2) you can use all invested earnings tax free on withdrawal for education expenses. So in New York, for example, we can deduct up to $10,000 in state taxes for any money we invest in a 529 plan. You can find out what your state offers here. And why might you want to get an early start on making hefty contributions? Here you go.
Maximum yearly amount: none (though most states have maximum allowable tax deductibles)
Invest in an I Bond
Long before Steve Jobs introduced us to the iPhone, he invented the iBond — a beautiful, sleek inflation-indexed bond. This is absolutely false. But I bet more people would buy I Bonds if they had a shiny Apple logo on them. Here’s the deal: if you have money sitting in a checking account, money market account, savings account, or CD, I can almost certainly guarantee one thing: you are losing money. Save for a handful of 3-to-5 year CDs, no bank accounts are beating the rate of inflation.
Meet the I Bond, a bond with an interest rate tied directly to the inflation rate (so as of today, 1.48%). If the inflation rate rises, your I Bond’s interest will likewise rise semi-annually. You’ll need to keep your money in the bond at least a year, but after that, it’s easy to redeem your bond and cash out. I Bond earnings ARE subject to federal taxes (unless they’re used for education expenses), but are not subject to state and local taxes. If you’re looking for an easy way to not LOSE money, this is a really safe bet.
Maximum yearly amount: $10,000 electronically, $5000 paper through tax refund only
Pad Your 401k
And last but not least, we meet our old friend the 401k. With this option, we’re not talking about matching your employer contribution. That step should have been done while you were still paying off debt, RIGHT? RIGHT?! If you’re not, stop reading this post, open a new email, and tell your HR to immediately begin contributing up to your employer’s match. Then press send and then throw a stapler at yourself for missing out on free money. And then apologize to yourself.
My intent in including this in the list is AFTER you’ve already met your employer’s match, contributed to an IRA, and maybe tackled a few other things on this list, then you should circle back to your 401k and contribute whatever else you can. You’ve got a lot of room to max out a 401k, so if you’re able to cross this one off your list, you’re graduating to a whole new world of taxable savings and investing. Congrats, and God speed.
Maximum yearly amount: $18,000
So maybe these aren’t the sexiest alternatives to your also-bland savings account, but they’ll all make your money work a lot harder for you. All are tax-advantaged, all will (usually) beat your savings accounts’ paltry interest rate, and all are smarter, more conservative plays than throwing whatever extra money you’ve got straight into the stock market. While most of these involve investing, none of them are short-term plays.
What’s the most attractive option to you? Any other options that you’d add to the list?