Laura answers a listener’s question about ten smart moves to make now if you have a little or a lot of extra money.
Laura answers a listener’s question about ten smart moves to make now if you have a little or a lot of extra money.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
Have a money question? Send an email to money@quickanddirtytips.com or leave a voicemail at 302-365-0308.
Find Money Girl on Facebook and Twitter, or subscribe to the newsletter for more personal finance tips.
Money Girl is a part of Quick and Dirty Tips.
Links:
https://www.quickanddirtytips.com/
https://www.quickanddirtytips.com/money-girl-newsletter
https://www.facebook.com/MoneyGirlQDT
https://twitter.com/LauraAdams
Welcome back to Finance Friday, another special edition of Money Girl, where I answer your burning money questions! Today's topic comes from Lauren J., who says:
"I'm a 22-year-old recent college graduate who started my first full-time job a few months ago. I currently have little bills and no debt. I maxed out my Roth IRA for the year but will only qualify for my company 401(k) retirement plan once I've been employed for a year. I have about $20,000 in savings and want to buy a car in a year or so. What advice can you give about what to do with that extra money?"
Thanks so much for your question, Lauren. With a job, no debt, and money in the bank, you're in an enviable position as a young person–congratulations! This post will answer your question with the smartest moves you can make right now if you have a little or a lot of extra money.
Welcome back, everyone, and thanks for joining me on episode 879! I'm Laura Adams, an award-winning author, female finance spokesperson, money speaker, founder of The Money Stack, a Substack newsletter, and host of the Money Girl podcast with over 43 million downloads.
If you're getting value from the free content we love creating, subscribe and consider submitting a 5-star rating or review on your podcast app of choice! If you have a question about money for the show, leave it on our voicemail at 302-364-0308. You can also send an email and sign up for the free Money Stack newsletter at LauraDAdams.com.
10 things you should do with extra money
Whether you receive a cash gift, bonus, or raise, having extra money is an excellent opportunity to improve your finances over the long term. First, identify or review your financial goals to know what you want to accomplish with your money.
For instance, are you like Lauren and want to buy a car in the next year? Or, you may want to throw a big party, take a vacation, pay down debt, start a business, or get serious about investing for retirement. Only you know the answers.
Depending on your financial situation and dreams for the future, here are ten things to do with extra money right now.
1. Start or build an emergency fund.
Lauren, the first place extra money should go is to create a safety net using a high-interest savings account. How much cash you should have depends on your income, expenses, and goals. However, at least three to six months of living expenses is a good guideline.
For instance, if you spend $3,000 monthly on essentials like food, housing, utilities, insurance, transportation, and healthcare, you might need $9,000 to $18,000 as a cash cushion. That savings will be your lifeline in a hardship like losing your job, getting a large unexpected bill, or having a significant out-of-pocket medical expense.
Saving, not investing, is the right move for reaching short-term goals, like being prepared for the unexpected. High-yield savings is also where you should keep money earmarked for an upcoming vacation or buying a car in the next year or two.
While you don't earn as much on savings compared to investing, you can rest easy knowing your cash will be there, plus interest, the moment you need it. You have virtually zero risk when choosing a savings account covered by FDIC or NCUA insurance.
That's different from investments, which fluctuate in value and can lead to significant returns or losses. So don’t risk losing money you might need or plan to spend in the near future.
Check out Raisin, a marketplace of federally insured banks and credit unions for some of the highest yields nationwide.
READ ALSO: High-yield savings accounts–pros, cons, and tips for choosing one
2. Make sure you have enough insurance.
Another essential way to prepare for the unexpected and prevent financial hardship is having insurance, such as health, renters, disability, and life policies. If you have any insurance gaps, fill them using your extra cash before investing it.
Even if you get life and disability coverage through work, it may not be enough. Plus, if you leave your job for any reason, those policies typically end by the end of the month. Life insurance is essential if you have anyone who is financially dependent on you, such as a spouse, partner, child, or other family member.
RELATED: 10 ways to save money on car insurance
3. Contribute to a workplace retirement plan
If you work for a company or organization that offers a retirement plan, such as a 401(k), 403(b), or 457, be sure to participate. It's the first place your extra money should be invested, up to the annual limit, once you're eligible to participate. Lauren mentioned having to be employed for a year, so we'll cover other options.
For 2024, you can contribute up to $23,000 to most workplace retirement plans. If you're over 50, you can make additional catch-up contributions of up to $7,500, for a total of $30,500. For 2025, the limit increases to $23,500, with the same catch-up, for $31,000.
I recommend investing at least 10% to 15% of your gross income for retirement–or at least enough to maximize any employer matching to start. Make a goal to increase your contributions annually until you bump up against the allowable limit, which typically goes up based on an annual cost of living adjustment.
Maxing out an employer-sponsored retirement plan is one of the best ways to grow your balance, reduce taxes, and achieve your retirement goals. However, before age 59.5, withdrawals not previously taxed are subject to income taxes plus an additional 10% early withdrawal penalty. So, never put money in a retirement account that you might need to spend early.
READ ALSO: Am I saving enough for retirement?
4. Contribute to a Roth IRA.
After maxing out an employer-sponsored retirement plan, a Roth IRA is the next best place to invest extra money–so I'm glad Lauren funded one. It's available to anyone with earned income, including minors and seniors.
For 2024 and 2025, the IRA contribution limit is up to $7,000 or $8,000 if you're over 50. You make after-tax contributions but enjoy tax-free withdrawals after 59.5. However, there are income limits to make Roth IRA contributions as follows:
If your income is below those annual limits, you can partially or fully fund a Roth IRA and maximize a workplace retirement plan or self-employed account in the same year, giving you terrific tax benefits.
Note that unlike a Roth IRA, a Roth retirement plan at work has no income limits. You can learn more and open an IRA using a robo-investing platform like Betterment.
5. Contribute to a traditional IRA.
If your income is too high to qualify for a Roth IRA, your next best place to invest extra money is a traditional IRA. Unlike a Roth IRA, a traditional IRA has no income limits.
With traditional retirement accounts, you make pre-tax contributions, giving you an upfront tax deduction in the current year—even if you don't itemize deductions on your tax return.
However, your (and any spouse's) income affects whether you can deduct traditional IRA contributions when participating in a workplace retirement plan in the same year. When your 2024 MAGI reaches $87,000 as a single taxpayer or $143,000 as a joint tax filer, you can't deduct traditional IRA contributions when you also have a retirement plan at work.
Additionally, if you're not covered by a workplace retirement plan but your spouse is, the household MAGI cutoff for deducting all traditional IRA contributions is $230,000.
Those deduction cutoff limits increase in 2025 to MAGI of $89,000 as a single or $146,000 as a joint filer when you participate in a workplace retirement plan. And, if you don't have a workplace plan but your spouse does, the household MAGI cutoff increases to $236,000.
If you need help deciding whether to choose a traditional or Roth account, check out Empower's free retirement planner.
6. Contribute to a self-employed retirement account.
You qualify for a self-employed retirement plan with part- or full-time business income. The most popular are the solo 401(k) and SEP-IRA, which allow you to contribute much more than other retirement accounts, making them an excellent choice for investing extra money.
I use a SEP-IRA because it's easy to maintain with no annual paperwork. It's an excellent option for business owners, with or without employees. You can contribute up to $69,000 for 2024 or $70,000 for 2025.
Another great option when you have no full-time employees (except a spouse or business partner) is a solo 401(k). However, you must fund it through payroll deductions, which creates additional ongoing administration. But a solo 401(k) may allow you to make even higher annual contribution limits than a SEP-IRA.
READ ALSO: How many retirement accounts can you have?
7. Contribute to a health savings account (HSA).
After exhausting retirement account options, the next best place to invest extra money is an HSA. However, you must be enrolled in a high-deductible, HSA-eligible health plan purchased through work or on your own.
For 2024, you can contribute up to $4,150 when you have an individual health plan or $8,300 for a family plan. If you're over 55, you can contribute an additional $1,000. Those limits get bumped up to $4,300 and $8,550 for 2025.
HSAs have no restrictions on your income, allow tax-deductible contributions, and avoid tax on investment growth when the funds get spent on qualified medical expenses. They include a broad range of goods and services–such as medical, dental, vision, hearing, chiropractic, acupuncture, prescriptions, and many over-the-counter medicines and products–for yourself or your family. Or, you can keep your HSA balance invested indefinitely without penalty.
Before age 65, withdrawing from an HSA for non-qualified expenses, like groceries or rent, means they’re subject to taxes plus an additional 20% penalty. So, just like with a retirement account, you shouldn't put money in an HSA that you might need for everyday expenses. However, if you have an HSA balance after age 65, you can spend it on non-medical expenses without penalty.
RELATED: HSA hacks–how to optimize your health savings account
8. Contribute to a 529 college savings plan.
If your emergency and retirement savings are on track, consider investing extra money in a 529 plan to pay future education expenses–such as tuition, books, computer equipment, Internet access, and room and board—for yourself or a family member.
There are no income restrictions to make 529 contributions. While they're not tax-deductible, your investment growth is never taxed if you use 529 funds for qualified education expenses.
The only downside of contributing to a 529 plan is that spending it on anything besides qualified expenses comes with a penalty on the earnings portion of distributions. You typically must pay income tax plus a 10% penalty on amounts that weren't previously taxed.
READ ALSO: 10 ways a 529 college savings plan makes college more affordable
9. Use a brokerage account.
Once you've exhausted tax-advantaged accounts to invest extra money, it's time to look at a taxable brokerage account. The investment firm you choose should depend on the investments you want to purchase, such as mutual, index, or exchange-traded funds.
While a brokerage doesn't reduce your taxes, it's a flexible account you can tap for any reason before age 59.5 without penalty. That also makes it an excellent place to invest for medium-term goals like buying a home or starting a business in more than three years in the future.
READ ALSO: 8 things to know about investing in a brokerage account
10. Hire a financial professional.
If you have a significant windfall, consider hiring a pro, such as a financial planner, insurance agent, estate attorney, or accountant, to help you understand your options and achieve your goals.
Before working with a financial advisor, look them up on BrokerCheck, a free tool from The Financial Industry Regulatory Authority (FINRA), to learn about their background and disciplinary history. You can also check with your state securities regulator to ensure you choose a qualified financial professional.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
Money Girl is a Quick and Dirty Tips podcast, and I want to thank our fantastic team!
Steve Riekeberg audio-engineers the show. Brannan Goetschius is our director of podcasts, Holly Hutchings is our digital operations specialist, Morgan Christianson is our advertising operations specialist, Davina Tomlin is our marketing and publicity associate, and Nathaniel Hoopes is our marketing contractor.