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After President Joe Biden’s historic student loan forgiveness announcement, millions of Americans are taking a second look at their finances.
Federal student loan borrowers are eligible for up to $10,000 or $20,000 in debt cancellation, as long as they earn less than $125,000 annually (or less than $250,000 if filing taxes jointly). Up to 43 million borrowers will see some amount of forgiveness, according to the White House, and about 20 million borrowers will have their entire debt forgiven.
If your student loans will soon be erased and you have a few hundred extra dollars in your monthly budget, review your goals and decide where that money could be best put to use.
4 Savvy Ways to Use Extra Money
Depending on what you hope to accomplish, your extra money could help you do one of the following:
1. Boost 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 gives you some padding when the unexpected happens, and it can protect your finances as well as your peace of mind.
A common rule of thumb is to save three to six months’ worth of your normal living expenses. To determine what’s right for you, consider how reliable your income is, how easy it would be for you to find a new job, how many people you financially support and if you have a partner or family who can support you for a time.
Think about other factors that could affect the amount you save, too. For example, if you have an older pet that’s likely to need veterinary care or your refrigerator is on its last legs, you might consider saving more.
Once you’ve determined how much to save, you can set up automatic contributions to your emergency fund until you’ve reached the desired amount.
2. Pay Off Other Debts
After your student loans are out of the way, turn your attention to other loans or credit card debt that may be weighing you down. There are two common strategies to determine which debts to tackle first: the debt avalanche or debt snowball methods.
With the debt avalanche method, you’ll pay off your highest-interest debt first. Start by listing all your loans in order of interest rate. You’ll continue to make the minimum monthly payments on all of your debts while putting any extra money you have toward the highest-interest loan. Once that is 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’ll focus on the lowest-balance debt first. List your loans from smallest to largest, and continue to make the minimum payments on all of them. You’ll put any extra money toward your smallest debt until it’s paid off; continue this pattern until you’re debt-free. The benefit of this strategy is that you can earn wins quickly. Each time you pay off a loan and cross an account off your list, you can find some extra motivation to keep going.
3. Save for Retirement
If you’ve been skimping on your retirement savings, now’s the 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 into an investment account. Your investments will grow in value over time, and after you hit retirement age, you’ll 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 your full employer match—otherwise, 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 allows you to invest pre-tax money, while a Roth IRA accepts post-tax contributions. Consider if you’ll have a lower or higher tax bracket in retirement than you do now—your answer will help determine which type of account is best for your needs.
Keep in mind that Roth IRAs have income limits, so high earners may not be eligible. Traditional IRAs, on the other hand, offer a tax deduction for your contributions, depending on your income. IRAs have a contribution maximum of $6,000 in 2022 (or $7,000 for investors aged 50 or older).
Note that both IRA and 401(k) accounts have a 10% early withdrawal penalty if you remove funds before age 59½. There are some exceptions to this penalty, but as a general rule, expect to leave retirement funds alone until you reach the designated age.
4. Focus on Other Large Savings Goals
Student loan debt has caused younger generations to postpone major life milestones, according to a recent Bankrate survey. Nearly a third of Millennials have delayed buying a house, and 19% have put off 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, complete home renovations, grow your family or start saving for your own children’s education, this is a great opportunity to do so.
Decide the target amount you’d like to save and a timeline to meet 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 monitor your progress. Wherever you decide to stash your savings, set up automatic contributions so you can stay on track.
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