What’s the Best Thing to Do With Your Excess Cash?

It is a longed-for condition, having excess cash, but individuals often find themselves in this situation unexpectedly and without having planned for it. Sometimes, people simply reach their peak earnings. Other times, remote work allows them to move to less expensive parts of the country and save large portions of their paychecks. Or, they might delay having children or don’t have them at all.

However they got there, many folks find themselves wondering how to make the best use of this extra money. Why are they confused? Are there too many choices or not enough?

Why Is Having Excess Cashflow so Confusing?

“What should I do with my extra money?” is one of the most common questions I hear as a wealth manager. Most people who ask this have discovered that there are many choices for investing excess cash. Their indecision comes from a fear of choosing the wrong option for them or not being informed enough to make a wise choice.

They could put more toward retirement in the form of 401(k)s or Roth IRAs. They could put more toward their kids’ education, but even this option carries many possibilities. Do they open a 529 plan, a Uniform Transfers to Minors Act (or UTMA) account, or a regular account earmarked for education? On the other hand, they could erase their debt. But in what order? Credit cards first? Student loans? Could they pay off their mortgage?

People have vastly different life goals and family structures that demand different kinds of spending and saving, and the variety of options for investing excess cashcan quickly become overwhelming.

However, goals are important starting points for figuring out the very best thing to do with extra money.

How Can Setting Goals Help You Manage Extra Cash?

It’s essential to consider how optimizing extra money now will help you build more wealth for your future and your family. Understanding each option in front of you will help you discern which one (or ones) suits your unique needs and future plans.

The first step is to map out your goals: setting up an emergency fund, buying a house, saving for your children’s education, or funding your retirement. These are just some of the goals that could be on your list, but you might have more specific ones, too, such as building a painting studio, traveling twice a year to a new country, or starting a new business. Until you can identify your goals and the timeframe of each one, it will be difficult — even almost impossible — to make decisions on how best to utilize your excess cash.

Once you identify your goals and put the excess cash to work, it can help you feel on track toward meeting your objectives. That’s not to mention the fact that it is a lot easier to save when you know exactly what you’re saving for. Instant gratification pales in comparison to meeting those lofty but achievable wonders that you saved for in the future.

What Actions Can You Take to Get the Most From Your Excess Cash?

Financial priorities will always be somewhat subjective and dependent on your financial status quo. Are you in debt? Do you have children? Are you in good health? Variables ad infinitum. However, there are some general rules of thumb you can follow (in this order) to help yourself spend your excess money wisely:

1. Make contributions to employer-sponsored retirement plans up to a match.

This is one of the only financial structures where “free money” actually exists. Pay in up to the level of your company match, and you can benefit from employer-sponsored funds that only boost and bolster your retirement investments. It’s so critical for people to understand this and take advantage of it. If you have more cash than you need to cover your basic expenses, this is the place to start.

2. Pay down debt with the highest interest.

The priority for paying off your debts should begin with the highest interest rates. Locate any debt with a 7% or 8% interest rate (or higher) that is not tax deductible. Not all debt is bad, of course, but high-interest debt (like credit card debt) should be avoided if possible. If you have a lot of debt, it is sometimes advisable to split excess cash between debt payments and savings so that you aren’t delaying starting your emergency fund. You can work with a trusted advisor to help you determine what that split should be.

3. Make maximum contributions to investment accounts.

Investment accounts such as 401(k)s, IRAs, and Roth IRAs can help you reach your retirement goals. For example, you can contribute up to $22,500 to a 401(k) or 403(b) in 2023 or $30,000 if you’re 50 years or over. You can contribute an additional $6,500 to an IRA or Roth in the same year, depending on your income level. Keep in mind that traditional accounts (401(k)s or IRAs) have up-front tax deductions but are taxed as ordinary income in retirement. On the other hand, contributions to Roth accounts do not receive tax benefits, but the distributions are tax-free. If you estimate being in a lower tax bracket when you reach retirement age, the latter option might be wisest for you.

4. Avoid private mortgage insurance.

Private mortgage insurance (known as PMI) is a must-pay sum that comes into effect if you are unable to put down at least 20% as a deposit on your home. It is an extra cost that you should try to avoid if you can, and it could be an expense for which extra cash can unburden you, thus leaving more for you to invest in the goals you’ve mapped out.

5. Pay down debt with tax-deductible interest.

Next on the debt priority list is debt with high interest (8% and higher) that is tax deductible. An example of this is student loan debt. Up to $2,500 of student loan interest is deductible on your taxes in 2023. So, if you have both credit card debt (which isn’t tax deductible) and student loan debt, you should definitely pay off the credit card debt first. Then, consider spending any other excess cash to become even more debt-free by moving to the tax-deductible student loan debt.

6. Contribute to investment accounts with returns.

You could open a general brokerage account in addition to your retirement accounts for additional savings. These accounts might be most useful for goals you’d like to hit before retirement because pulling funds from retirement accounts before retirement age can incur penalties. For example, if you plan to buy a second home in 15 years (and you’ll be younger than 59 1/2), you might want to open a brokerage account and invest with a combination of stocks and bonds.

7. Start a 529 plan for your children’s education.

It’s important to plan for your retirement and savings goals before saving for your kids’ education. Your children can likely get loans to cover tuition and might even get full-ride scholarships, so education costs should be lower on your priority list. But if you’re fortunate enough to have excess cash flow, a 529 plan could be a great option; contributions grow tax-free if used for qualified education expenses and beneficiaries can be changed at any point. So, if your oldest doesn’t use all the funds, you can transfer them to your next child (or any person you wish).

Once these priorities are accounted for, any remaining debts can be settled and further contributions can be made to accounts to save for future homes, children’s education, life improvements, and so on. If you are in the privileged position to be investing excess cash, don’t feel overwhelmed. Imagine your goals first, and your priorities should fall in line.

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(Featured image by Viacheslav Bublyk via Unsplash)

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