For many people, student loans remain a major source of stress. You may end up paying on these loans for decades depending on your individual circumstances. Eliminating this debt, whether by paying it off or getting it forgiven through the various programs available, can prove one of the most rewarding personal finance moments. After you are done celebrating, you may wonder what you should do with this new hole in your budget. While rewarding yourself for eliminating the debt is certainly an understandable initial impulse, you ultimately need a long-term strategy for allocating this new money in your budget. You should certainly do something nice for yourself to honor the achievement but after that, consider doing one of the following:
Pay down other debts
If you have debts beyond your student loans that are high in interest, paying them off should become a priority. This includes credit card debt and basically any loans other than a mortgage. Now that you have some extra money, you can funnel the funds toward paying off those debts to minimize the amount of interest that you end up paying on them. Eliminating these other debts increases your financial flexibility by minimizing your obligations. In the event of a financial emergency, you will have much more bandwidth since you will have a higher amount of cash on hand that is not already spoken for in terms of debt payments.
When it comes to tackling debt, you should list all of them and the interest rate they carry. Focus on paying off the one with the highest interest first and then move down the list. Another strategy is to tackle the smallest debt first and then snowball payments for that account into paying off the next highest.
Bolster an emergency fund
Another way to use the extra money you have from paying off student loans is to increase your emergency fund. An emergency fund helps you avoid going into debt when something unexpected happens by keeping cash on hand. You should not have this money invested in illiquid investments since you need to have quick access to it. This fund can cover you if you lose your job, experience a sickness, or have a large healthcare bill. In an ideal world, you should have enough money saved to cover all your expenses for three to six months. However, people with higher monthly expenses may want to have even more money in the account since it will drain rather quickly.
Saving that much money can be intimidating, so it is helpful to have larger amounts of money you can contribute to the account such as the payments that formerly went to student loans. This fund also helps you feel more secure in your finances since you know that you have a safety net. Do not forget that you need to repay any money you use from the account, which is also where extra money from paid-off loan accounts can be very helpful.
Set more aside for retirement
Once your debts are handled and you have money in an emergency fund, you can think about saving more money for the long run through retirement accounts. If your employer offers you a match for contributions, you should already be taking full advantage of that. However, contribute beyond this up to the maximum allowed if you are able with the additional money after no longer having student loans. After maxing out your current account in terms of contributions, think about opening a Roth IRA. Roth accounts get funded with after-tax money with the benefit that you can make withdrawals during retirement without paying any taxes.
Increasing your retirement savings has many benefits. The most obvious benefit is that you will have more money and flexibility once you stop working. The important thing to keep in mind is that interest compounds over time so saving more early means more than saving more later in life. The other benefit of maxing out contributions and opening different types of accounts is added flexibility that can save you money in retirement. For example, if you want to avoid taking out more money from traditional accounts because it would push you into a higher tax bracket, then you can turn to Roth accounts.
Fight the effects of inflation
Another thing you can do with additional income is make investments particularly to curb the impact of inflation, which reduces the purchasing power of your savings. One option for doing this is the Treasury Inflation-Protected Security (TIPS), a bond that adjusts up and down in relation to inflation. Every six months, the bond pays a fixed interest rate on the principal, which is adjusted according to inflation. When the bond reaches maturity, you receive the higher of the original principal or the inflation-adjusted principal.
Another option is the I-bond, which is a government-backed security specifically meant for hedging against inflation. When inflation is high, these particular bonds will pay higher interest rates to help offset the effects of inflation. In 2022, when inflation is at record highs, these bonds are paying nearly 10 percent in interest.