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?
You are right, these are not the sexiest investment strategies but they work. I was demanded to put money in my jobs retirement fund and I am so glad that I did. With my bad spending habits in the past there would be no telling when I would of started. I would be smacking myself right now. Great tips.
We missed a few smack-worthy opportunities to put money away for retirement. But the most important thing is to learn from the mistake, buck up, and make it a priority.
Why not a taxable account? If your income is below a certain level, then any qualified dividends would be taxed at 0% and then you would also have easier access to the money.
I am all for tax sheltered investments, but having a taxable account isn’t so bad either.
Nothing wrong with tax-free taxable investing. For this particular post, I wanted the focus to be on more conservative, longer-term savings options (read: minimize the risk of losing any of their hard-earned savings). It also opens up a whole can of worms that would merit its own post full of do’s and don’ts so that one’s taxable investing strategies still minimize risk.
All good points. I think HSAs don’t get enough credit for their investment potential. You mentioned the triple tax advantages they offer. I would further point out that currently there is no time limit on when you need to be reimbursed for a medical expense. As an example, if I go to the Dr. this year and it costs $1k I can pay for it with my HSA, or I can pay for it out of pocket and have my HSA reimburse me later. That ‘later’ can be 30 years from now (as long as you keep good documents in case the IRS comes-a-calling), and that $1k will have had an additional 30 years to be invested and hopefully grow tax-free! With this in mind we’re maxing out our HSA each year, but we are paying all medical expenses out of our after-tax pockets and meticulously saving copies of our receipts. If we need some emergency money before retirement we can be reimbursed for the amount of all our medical expenses over that time. If not, we’ll continue to let it grow tax free, and only take distributions in retirement when ALL of those dollars can come out penalty free.
That’s crazy. I wasn’t aware of that. I’m so OCD about paperwork and claims that it will require a lot of self-restraint to not immediately submit HSA reimbursement. But I love the idea of loaning yourself money for medical expenses while letting the HSA funds cook for years. I want to do a little more research on it and see if there’s any chance or likelihood of it being changed by the government, but otherwise, I’m sold.
For what it is worth check out Q&A #39: “Thus, there is no time limit on when the distribution must occur.” (http://www.irs.gov/irb/2004-33_IRB/ar08.html#d0e1935) Of course the government can always change things, but the fact that the IRS has explicitly opined on the matter makes me think it is somewhat safe for now.
I’m conflicted. My employer doesn’t match contributions in the 401K they offer. Thus the reason I have not contributed anything to it. The really bad news is I haven’t contributed to anything since leaving my old job in 2012.
I have a small Simple IRA that I want to rollover, but I don’t know what or where to. 🙁
You should be able to rollover (actually it might just be a transfer since it is an IRA to IRA type transaction) your Simple IRA to any of the brokerage firms out there. You are probably best going with the one with the lowest fees, so you would be looking at Vanguard, Schwab, Fidelity, etc. If you contact them they would be more than happy to walk you through the process.
Hope that helps!
Brian has some good insights. Call Vanguard and ask them about their rollover process. When we rolled over a 401k to a Roth, it was pretty painless — and that was likely a much more complicated process than your IRA transfer.
Once you get that squared away, set up an automatic “drip” so that you don’t have to make the decision of whether or not to put that money away every month — it just happens.
This probably won’t increase the sex appeal, but how about a “future you” savings account? I mean one that includes at least a little return, like an Ally savings account. Personally, my partner and I both have motorcycle savings right now.
Our plan for after we purchase our hogs?
I’ve been a home remodeler for a long time, so this was a no brainer for us. We love to travel and likely will never reside in one place for an extended amount of time.
This leads to my question:
How do 529 plans work out for people who don’t continue to reside in the same state for the duration of their offspring’s youth?
We watched a tiny house documentary and loved the idea. I don’t think Joanna’s completely sold yet, but living in NYC again is helping us remember living in small spaces has its perks.
529 plans are actually super portable. In fact, if you’re not totally sold on your state’s 529 options, you can invest in Nevada or Texas or whatever-state-you-want’s plan. Going that route will likely disqualify you from the initial state tax deduction, but you’ll still get the tax advantages on withdrawal. Should you decide to use your current state’s plan, though, and you move out of state, you can keep the money there (and either keep investing it that account or open a new one in your new state) or roll it over into your new state plan. Each state has different rollover rules, but 529s are great options for us nomads.
What if you live in a state without income tax such as Washington and work in say Idaho which has a 7.9% income tax. Would you set up the 529 in Idaho to get the tax break or Washington because you live there and your child would likely go to school there?
You’ll only get the tax break that your state of residence offers. So if you live in Washington, you’re getting Washington’s 529 tax break (assuming they offer one). If, however, you choose to invest in an out-of-state’s 529 plan, you are likely forfeiting any potential deductions (AZ, KS, ME, MO, PA being the exceptions).
More important to a lot of investors is the different investment options that a state offers. So even though you might forfeit an in-state tax deduction (which might only amount to a couple hundred dollars anyway), you’ll have a much better fund selection that might perform better.
In the end, it’s a bunch of trade offs that all depend on your particular situation.
These are all great ideas. I’m still in the debt repayment phase, but I should be done with that soon (waiting on my tax returns, heehee). Then it is finalizing my emergency fund. I don’t have a specific plan after that, but I know I have different options and I’ll decide when the time comes.
Going off of both what y’all said about HSAs as well as “TT”‘s comment above, HSAs are great investment vehicles. Another somewhat hidden benefit that after age 65 you can actually take taxable disbursements (exactly like a traditional IRA) with no penalty for non-medical expenses! So if you max out your HSA for 30 years, and don’t use it up on medical expenses, it acts as an additional retirement account. A great additional investment if you already max out your IRA and 401k!
Yep, a great point. Every way you look at it, HSAs are an awesome option.
Great advice! If/when I have extra cash, I like to throw it in a savings account to build up my emergency fund, but I also hope to do some basic investing in the near future to help tuck some money away for the future.
Definitely keep on building up that emergency fund. But if you’re close, it might be worth starting a small automated drip of money into retirement so that when you’re done with your EF, you’re all ready to start to turn up the spigot and make it rain.
This year we hit the 2ooK mark in our RRSP’s (the Canadian Version of the 401K) and got our emergency fund fully funded. So we opted to crank up our house payments $200 more a month. Feels like an investment in paying it off early. 😉
Congrats! And that’s another awesome place to throw that extra money. The guaranteed interest rate that you’re “earning” (by avoiding it taking more time and more of your money), is better than a lot of the options on this list.
Christy: I think this article assumes you are already out of debt. It would be absolutely silly to invest at something that pays 1.48% interest while paying out more than that in debt. Always always always payoff debtors first!
I think Christy was only referring to a mortgage, which yes, while debt, doesn’t carry a high interest rate like credit and some student loan debt. In the case of Christy, putting money toward retirement investing is a smart play. And then once that’s maximized, extra mortgage payments is an awesome place to put it.
We are still adding to our emergency fund, and trying to pay off debt (student loans and auto loan), as well as save up for a house. All because my husband took a new job in another state, and we lost money on our house, then I was unexpectedly unemployed for a year. But, now things are more stable, we did decide to put more into our HSA this year, just in case. We took a gamble and didn’t put much in the first two years because a) we were done having kids and b) we were generally healthy. But this year, we put in more. Now we’re at $200 with plans to contribute more next year. But the best part is, my husband’s employer matches that $200!! So now we have $400 per month put in there. It’s just as well because I’ve been pretty sick this year, and in six months, our portion of the medical bills stands at $1300, and it’s only mid-February (there’s that “just in case”) .
I guess the downside of the HSA is that it comes with the HDHP, and that means a lot of expenses are passed onto the patient, because you are expected to put money in the HSA to help pay for it. Our gamble of not fully funding it because we needed that money to pay for other expenses worked out for us, because we stayed healthy until now. But I can’t imagine how tough that must be for people who need every penny to make it through the month.
Employer matches are the best. And the nice thing with HSAs is that you’ve always got that money sitting there should any medical costs arise — now or further down the road. And should you not need it, you’ve got yourself another IRA. Score! So absolutely no harm putting that money away in HSA, unless, like you mentioned, you need that liquid cash for other expenses that an emergency fund couldn’t cover.
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I am disturbed that considering diversifying your long-term investments by owning a real estate rental is not on your list.
Owning a real estate rental is a great long-term investment option, but I think you’re missing the point of this post. This is intended for those who have recently gotten out of debt and are trying to figure out where to put some of their savings (“some” being the operative word). It’s easy enough to put a few hundred dollars into an IRA or HSA every month. Throwing down 20% to 25% for a rental home down payment? That’s going to take a little more time.
I agree with that statement. But I would encourage folks to think about how they can capitalize on existing assets (like equity in their homes) to find ways to put their money to work while diversifying with an eye towards a longer horizon. No small feat with the 25% down req’t, to be sure. Yet once people have a grip on lifestyle choices (ie; no credit card debt, probably home ownership, stable vehicle) and are ready for more…why not consider hunting for Big Game? No risk: no reward? I just get frustrated that so many articles focus on cutting coupons or something; it just won’t get the job done. I am hungry for more ideas, once the basics have been achieved.
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