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Take that Paycheck and Stash It: How to Save a Raise

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April 11, 2016
Goldfish in a bowl: Savings in an IRA or 401(k); what to do with extra money from a wage increase

Your salary might not be jumping right now at the rate you’d like, but if long-held economic theory wins out, as the job market tightens, wages will rise. What will you do with that extra moolah?

The unemployment rate, as of March, stood at 4.9%—a healthy rate, by most economic standards. That’s considering the impact of workers switching jobs and new workers joining the labor force while others are leaving it. But we’ve seen stagnant wage growth as a result of both cyclical and recessionary labor force issues. The Federal Reserve expects that to change in the not-so-distant future as it weighs interest rate hike decisions and the overall health of the economy.

Let’s say you’re one of those lucky folks to see a nice increase in wages, whether through an annual pay hike or a job change. What should you do with the extra dough? Invest it! Everyone—no matter what stage of their professional lives—knows that investing for retirement is the key to, well, a happy retirement. But study after study finds that we’re just not investing as much as we should, or as much as we need for those golden years. Behavioral scientists have been clamoring for some time now about changing how we think about money. If investing $300 a month seems insurmountable, think about saving $10 a day. Want $500 a month? Invest $16.66 a day.

But where to put those funds? Here are some ideas.

Up the ante on your employer-sponsored 401(k)

This is probably your main retirement investing vehicle, so raising the stakes on it is a no-brainer, according to personal finance experts. If you’re not already at the maximum pre-tax contribution level, make the change that will not only help reduce your tax bill, but increase matching funds from your employer. We call that free money. If you were at the max before the raise, hike the contribution to reflect the entire salary increase. That way you’re working on growing your kitty and heading off lifestyle creep.  

For 2016, the annual limit on your contribution is a pre-tax $18,000, if you’re under age 50; $24,000 if you’re older. If your employer matches 50%, that’s a 50% boost to your efforts that year. Where else can you get that?

Let the retirement funds stay invested, adjusted for risk attitude changes as retirement approaches. If you take out funds before you turn 59½—with some exceptions—you’ll be slapped with a 10% early withdrawal penalty on top of the regular income tax that is due. Ouch.

Just a reminder: These limits are the total per person, not per job. So if you have three jobs and three 401(k) accounts, you can cumulatively fund all three to the $18,000 personal contribution limit.

Open another retirement account

Think of a traditional or a Roth IRA as a tax-advantaged way to invest in and for your retirement. But remember there are annual contribution limits.

When you pay into a traditional IRA, you do so on a tax-deferred basis. You will pay taxes when you start taking withdrawals, which you’re free to do once you turn 59½. If you take money out before then, you will face that stinging 10% penalty on the withdrawal in addition to taxes.

The annual contribution limit for 2016 is $5,500 if you’re under 50; $6,500 if you’re over 50.

A Roth IRA works much the same, except the contributions are made after you’ve paid taxes on them. When you start taking the money out—which you can do at 59½ if the account has been open for longer than five years. Unlike a traditional IRA, you can withdraw from your account without a tax liability. 

The annual contribution levels are the same as a traditional IRA, but there are income levels with Roth IRAs. For 2016, single filers who earn more than $132,000 a year are ineligible; married couples, filing jointly, are disqualified if they earn more than $194,000.   

Open a taxable brokerage account

This is another instrument in your investment tool box, and one without the shackles of IRAs and 401(k)s, although it’s not for everyone. Here are the pros: You can stash away as much as you’d like as short-, intermediate-, and long-term investments. The con is that these accounts don't enjoy the tax benefits of retirement accounts.

Remember this: Diversification across the major asset classes is key to weathering the ebb and flow—and sometimes deep dives—of the markets and the economy over the very long-term. 

Get Professional, One-on-One Help

Offering education, guidance, and support, licensed TD Ameritrade reps are committed to helping you confidently take control of your financial future.

The information presented is for informational and educational purposes only. Content presented is not an investment recommendation or advice and should not be relied upon in making the decision to buy or sell a security or pursue a particular investment strategy.

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