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After President Joe Biden’s historic student loan cancellation announcement, millions of Americans are once again looking at their finances.
Federal student loan borrowers are eligible for up to $10,000 or $20,000 in debt forgiveness, as long as they earn less than $125,000 per year (or less than $250,000 if filing taxes jointly) . Up to 43 million borrowers will see some forgiveness, according to the White House, and about 20 million borrowers will see all of their debt forgiven.
If your student loans will soon be wiped out and you have a few hundred extra dollars in your monthly budget, revisit your goals and decide where that money could be better spent.
4 clever ways to use extra cash
Depending on what you hope to accomplish, your extra money could help you do one of the following:
1. Increase your emergency fund
With a well-funded savings account, car repairs, surprise medical bills, or sudden unemployment don’t have to totally derail your budget. An emergency fund provides you with cushioning in the event of the unexpected and can protect your finances as well as your peace of mind.
A general rule is to save three to six months on your normal living expenses. To determine what is right for you, consider how reliable your income is, how easily you would find a new job, how many people you support financially, and whether you have a partner or family who can support you for a while. time.
Also think about other factors that might affect how much you save. For example, if you have an older pet that may need vet care or your fridge is running out of steam, you might want to consider saving more.
Once you’ve figured out how much to save, you can set up automatic contributions to your emergency fund until you’ve reached your desired amount.
2. Pay off other debts
Once your student loans are settled, turn your attention to other loans or credit card debt that may be weighing you down. There are two common strategies for determining which debts to tackle first: the debt avalanche method or the debt snowball method.
With the debt avalanche method, you first pay off your debt at the highest interest rate. Start by listing all of your loans in order of interest rate. You will continue to make the minimum monthly payments on all your debts while allocating the extra money you have to the loan with the highest interest rate. Once that’s paid off, focus on the next loan with the highest rate, and so on. By using this method, you can minimize the amount of interest you pay overall.
Under the debt snowball method, you will focus on the lowest debt first. List your loans from smallest to largest and continue to make minimum payments on each one. You will spend any extra money on your smaller debt until it is paid off. continue this pattern until you are debt free. The advantage of this strategy is that you can earn gains quickly. Each time you pay off a loan and cross an account off your list, you can find additional motivation to keep going.
3. Save for retirement
If you skimped on your retirement savings, it’s time to catch up. You may have access to a 401(k) through your employer, which allows you to contribute pre-tax money from your paycheck to an investment account. Your investments will grow in value over time, and once you reach retirement age, you will pay your regular income tax on any withdrawals.
Many employers offer a 401(k) match, where they match your contributions up to a specified amount. At the very least, consider contributing enough to earn all of your employer, or you’re leaving free money on the table. You can contribute a maximum of $20,500 to your 401(k) in 2022.
If you don’t have access to a 401(k), you can contribute to an Individual Retirement Account (IRA) instead. A traditional IRA lets you invest money before taxes, while a Roth IRA accepts after-tax contributions. Ask yourself if your tax bracket in retirement will be lower or higher than what you have now. Your answer will help you determine which type of account best suits your needs.
Keep in mind that Roth IRAs have income limits, so high earners may not qualify. Traditional IRAs, on the other hand, offer a tax deduction for your contributions, based on your income. IRAs have a maximum contribution of $6,000 in 2022 (or $7,000 for investors age 50 or older).
Note that IRA and 401(k) accounts have a 10% early withdrawal penalty if you withdraw funds before age 59½. There are a few exceptions to this penalty, but as a general rule, expect to leave the retirement funds alone until you reach the designated age.
4. Focus on other important savings goals
Student loan debt has caused younger generations to postpone important milestones in their lives, according to a recent Bankrate survey. Nearly a third of Millennials have postponed buying a home and 19% have postponed having children. For Gen Z borrowers, those numbers are 25% and 23%, respectively.
Without student loans holding you back, you can start focusing on bigger savings goals. Whether you want to save for a down payment on a house, do home renovations, expand your family, or start saving for your own children’s education, this is a great opportunity to do so.
Decide on the target amount you want to save and a timeline for reaching your goal. This will determine what you need to save each month to get there. You might consider opening a new high-yield savings account to easily track your progress. Wherever you decide to put your savings, set up automatic contributions to stay on track.
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