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Median Income Is Up: Here’s What to Do With That Extra Money

Sept. 15, 2016
401(k), Investing, IRA, Retirement Planning
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You may have gotten richer last year, at least according to the Census Bureau.

The bureau dropped the good news this week, announcing that median household income ticked up 5.2%, or $2,800, between 2014 and 2015, the first annual increase since 2007 — also known as before the recession.

The increase did little to close the gender and racial income gaps, but jumps were seen across nearly all races and income levels. The lowest-income households saw the biggest percentage gain — 7.9%.

If you’re finally feeling the economic recovery trickling into your wallet, here’s what you should do with the extra cash.

Get all your employer matching dollars

Close to 60% of workers have access to a company retirement plan, according to the Pew Charitable Trusts. The vast majority of employers that offer a plan also match at least a portion of contributions, yet at least one report suggests as few as one-quarter of employees contribute enough to earn the full match.

If you’re in the camp that is forgoing free money, this jump in income is a chance to right that wrong. Increase your 401(k) contribution to at least the level your company matches — commonly half or all of your contributions, up to a limit of between 3% and 6% of your salary.

» MORE: Know your 401(k) contribution limits

Start an emergency fund

No, money doesn’t buy happiness. But you likely don’t need research — though it does exist — to tell you that having cash in the bank makes you feel just a wee bit better about life, especially when your car inspection turns into new tires or your teenager’s bad aim sends a baseball through the kitchen window.

Enter an emergency cushion, which doesn’t have to be overstuffed. Most experts recommend three to six months’ worth of living expenses. That’s an admirable goal but an unlikely reality for most people, even in light of this rosy census report. Still, if you can get $500 in the bank now, you can slowly add to that over time.

Open an IRA

If you don’t have a 401(k) or you’ve already earned the match in your plan, an IRA is the next best home for your retirement dollars. You can contribute up to $5,500 to an IRA in 2016. So if your income last year increased in line with the census median, that extra $2,800 puts you more than halfway there. If you’re 50 or older, you get to contribute an extra $1,000 as a catch-up measure.

You’ll need to decide between a traditional and a Roth IRA. The main difference is in the tax treatment. A traditional IRA earns you an immediate deduction on contributions, but you’ll be taxed on distributions in retirement. Conversely, there’s no deduction on contributions to a Roth, but you can pull out the money — including investment earnings — tax-free in retirement. That makes the Roth a crowd favorite, though it’s for a certain crowd: It has eligibility requirements based on income.

You can open a traditional IRA or a Roth IRA at any brokerage, but choose one with an initial deposit minimum you can meet; several brokers require no minimum. Then look for investments that allow you to start small, like commission-free exchange-traded funds, which track a chunk of the stock market. You can buy a small piece of many investments in a single transaction, then put together a few ETFs for a diversified portfolio.

» MORE: How and where to open an IRA

Pay off high-interest debt

There are two ways to earn a guaranteed return on your investment: That 401(k) match is one, and wiping out debt is the other. When you pay off debt, you’re earning a “return” that is equal to the interest rate you no longer have to pay — plus there’s peace of mind that is pretty priceless.

If that return is higher than you could reasonably earn by investing, it makes sense to prioritize paying off debt after you’ve earned your 401(k) match. Payday loans, title loans, personal loans and credit cards often fall into this high-interest category, but a good benchmark is 6% to 7%. If the debt’s interest rate is higher than that, you want to consider wiping it out.

Then watch your back, because debt is a lot like that friend who shows up when things are flush: It tends to rise as income does.

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Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: [email protected]. Twitter: @arioshea.