You’ve just come into some money. It might be a year-end bonus, a tax refund or even a small inheritance. Oh, what to do with this windfall of cash? Take a vacation? Shop ’til you drop?
It’s fun to dream about the possibilities, until reality (and responsibility) sinks in. But all grand plans aside, what should you really do with the money?
Here are five options to consider when it comes to newfound cash.
1. First and foremost, replenish or establish an emergency fund
The primary purpose is to help keep your finances and savings goals intact if you lose your job or expect a change in income for a short period of time. Sure, it can also be used to handle large, unexpected expenses, but think of it as your own personal safety net.
It’s recommended that an emergency fund cover at least three to six months of your living expenses. Keep this in an account that affords you easy access, like a savings account at your bank. Your money won’t earn a lot of interest, but it will be there if you need it.
2. Pay off any lingering credit card or high interest debt
You’ve racked up the points, now ratchet down the balance. Credit cards are great because they’re so convenient, but pretty darned pesky because they’re so convenient. If you’re using credit cards for holiday purchases, chances are you’re spending more than you budgeted.
3. Have you been saving appropriately for retirement?
Many of us will be relying on our own personal savings coupled with Social Security benefits to fund our retirement. We recommend saving 15 percent of your pre-tax salary (including any employer match, if saving in a workplace plan). The table below gives an idea of how much you, as a household, should be saving for retirement based on your current age.
You could use an unexpected financial windfall to open or contribute to an IRA, a Roth IRA (if you are eligible) or even a spousal IRA. Depending on your income, you may be able to contribute up to $6,00 ($7,000 if you are 50 or older) to a Roth or Traditional IRA for 2020.
4. Give your kids a financial head start by opening or contributing to a 529 college savings plan
With the College Board estimating the average cost of a four-year education at a public, in-state university around $80,000, it is crucial to put money away to combat future student debt. These accounts allow you to save on a tax-deferred basis so when it’s time to pay the bills, you can take out the money tax-free. Depending on where you live, you also might be able to take a tax deduction or credit for your contributions.
If your kids have earned income, help them set up their own Roth IRA. Sure, they certainly aren’t thinking about retirement, but a Roth IRA can provide a foundation for their future savings while offering flexibility too. It may even spur some valuable money and investing conversations.
5. Open or add to a health savings account (HSAs).
If you have a high-deductible health plan, HSAs allow you to contribute to and withdraw money tax-free to pay for certain out-of-pocket medical, dental and vision expenses. One other benefit to HSAs is that the account earnings grow tax-deferred.
HSAs differ from flexible spending accounts (FSA) in that HSAs allow you to roll over any unused funds from year to year. For 2020, contribution limits to these accounts are $3,550 for individuals and $7,100 for families. There is also a $1,000 catch-up contribution for those 55 and older.
Having extra money sure feels great. Treat yourself a little today and make sure to invest in your tomorrow.