With unemployment at its lowest level in 16 years, wages drifting steadily higher and inflation still less than 2 percent, the U.S. economy may be at its strongest point in decades. But the robust economy is creating a new problem for many Americans who must decide what to do with extra earnings at the end of every month.
Having too much cash is always a great problem to have, but putting that cash to good use now while the economy is healthy could go a long way in preparing Americans for the future.
Most Americans with 401(k) accounts and individual retirement accounts know it’s a good idea to dump any extra cash at the end of the month into those accounts in preparation for retirement. In addition to tax advantages, employers often match a percentage of retirement account contributions, essentially providing a cash bonus for retirement investors. However, the annual contribution limit for a 401(k) account is $18,000. For IRA accounts, it’s only $5,500. Americans who max out their annual retirement account contributions face a tough decision about what to do with that extra cash.
[See: 7 Investment Fees You Might Not Realize You’re Paying.]
First of all, anyone who has been consistently contributing at or near the maximum annual limits to a retirement account is likely very well-positioned for a long, happy retirement. But that doesn’t mean that there’s nothing to gain by putting that extra cash to work.
Opening a taxable investment account can provide Americans with the opportunity to put that extra cash to work in stocks, bonds, real estate and other assets. But, Jeffrey Corliss, executive director of RDM Financial Group at HighTower, says Americans should first take inventory of their financial situation and goals.
“Most people have some debt, so they should definitely try to pay down any debt such as credit card or student loan debt as quickly as possible,” Corliss says. “They should also look at another vehicle such as a Roth or a non-deductible IRA contribution depending on their income limits.”
According to Bankrate, the average interest rate on a variable-rate credit card is now 16.7 percent. Anyone carrying a monthly credit card balance is shooting themselves in the foot by paying these exorbitantly high rates.
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Owen Murray, director of investments for Horizon Advisors, says paying off high-interest credit card debt is one of a handful of high-priority financial goals all Americans should have.
“Excess capacity to save should be directed at paying down high interest credit cards and making sure you have a sufficient cash reserve,” Murray says. “Beyond that, it makes sense to begin building an after-tax portfolio.”
Murray says Americans should create an emergency savings account stocked with enough cash to cover at least three months of living expenses. The key to these types of accounts is ease of access in the event of an emergency, but certain savings accounts also pay annual interest rates of up to 1.5 percent, according to Bankrate.
Mike Loewengart, vice president of investment strategy at E-Trade, says 401(k) accounts are the best place for retirement investors to start, but a comfortable retirement may require outside investing as well.
“Deploying investments across a variety of accounts — both taxable and nontaxable — may actually go a long way to ensuring your portfolios are optimized for long-term tax efficiency,” Loewenrt says. “For instance, opening a Roth IRA adds distribution diversity because what you contribute is considered after-tax income.”
Loewengart says Roth IRAs may be particularly useful to younger investors who are starting out a career in a lower income tax bracket than they plan on being in when they retire.
Joe Heider, president of Cirrus Wealth Management, says investors shouldn’t shy away from setting up an outside investment portfolio, but only once they have maxed out their 401(k) contributions. “Assuming they have a sufficient emergency fund set up, they should create a diversified portfolio for growth and income which will serve them well into their retirement years,” Heider says. “I am a proponent of fully funding their 401(k) first because of the tax leverage.”
[See: 9 Dividend ETFs for Reliable Retirement Income.]
Deciding what to do with extra income once annual 401(k) and IRA contributions are maxed out can be a difficult decision, but simply being in that situation is an accomplishment in itself. A study by Vanguard found that only 12 percent of 401(k) participants maxed out their contributions in 2016.
If you’re one of the many Americans who still has room to contribute more money to a retirement account, that’s probably the best place to put any excess cash at the end of the month. If you’re among the 12 percent of Americans who has already maxed out annual contributions, paying down debt, setting up an emergency savings fund and opening up a taxable retirement account are three potential options that could help fast-track your long-term retirement goals.
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