Surplus Funds
Surplus funds in the investment world typically refer to positive cash flow, or simply, surplus funds represent money that you don’t need to pay for your expenses. When you have surplus funds, it is generally unwise to leave them in an account that does not earn interest. Instead, it is wise to invest this extra money for a period that you may need in the future.
Investing Surplus Funds in an Individual Retirement Account (IRA) for Non-Retired Investors
For non-retired investors, putting surplus funds into an Individual Retirement Account (IRA) can be as simple as setting up a systematic investment plan (SIP). Before retirement, most people need about 70% of their income to cover expenses and 20% of their income to pay off debt. This leaves 10% of income for savings, or what some financial planners call discretionary income or surplus funds.
Assuming the investor has set up an emergency fund and has no high-interest debt, surplus funds should generally be allocated for retirement savings. If the investor has access to a 401(k) plan with an employer match, it is wise to contribute enough to get the maximum match. If there are surplus funds beyond this amount, the money should be invested in an Individual Retirement Account (IRA).
A systematic investment plan can be established at most mutual fund companies and online brokerage firms. Depending on the designated income limits for Individual Retirement Accounts (IRAs), an individual can contribute up to $6,000 to an IRA, in addition to contributions to their 401(k) plan, which is capped at $19,500 for 2021 (increased to $20,500 for 2022). For those over 50, the allowed contribution limits increase by $1,000 and $6,000, respectively.
Investing Surplus Funds in an Individual Retirement Account (IRA) for Retired Investors
Investing surplus funds in an Individual Retirement Account (IRA) can be challenging for retired investors, but there are some fundamental ways to do it:
1. Investing Earned Income: More and more retirees are working part-time during retirement. If you have earned income, you are typically eligible to contribute to an Individual Retirement Account (IRA). If you do not need any part or all of your earned income, invest it in a Roth IRA. This way, once the account has been open for at least five years, you can withdraw funds from it without paying taxes and there is no minimum required distribution (RMD) related to Roth IRAs.
Note: Contributions to a Roth IRA can always be withdrawn without taxes or penalties, but the earnings on those contributions must meet the five-year rule to avoid taxes and penalties.
2. Investing Required Minimum Distributions (RMDs): At age 72, you must take required minimum distributions (RMDs) from savings held in a traditional IRA. This also applies to savings held in a 401(k) plan if you are no longer working for the sponsor of the 401(k) plan. If you do not need the required withdraw funds for income, using surplus funds smartly means investing them in a taxable brokerage account. Most investment firms and brokers allow for the easy transfer of required withdrawal funds (RMDs) (minus applicable taxes) into a taxable brokerage account held with them. Additionally, required minimum distributions (RMDs) are not required on funds in a Roth IRA. It should be noted that funds held in a Roth 401(k) are subject to required minimum distributions (RMDs).
3.
The conversion to a Roth account: If you want to take advantage of the tax-deferred growth benefits of a traditional Individual Retirement Account (Traditional IRA) and you won’t need the money for several years, it may make sense to convert excess funds in a traditional Individual Retirement Account (Traditional IRA) to a Roth Individual Retirement Account (Roth IRA). Since you will have to take required minimum distributions (RMDs) by age 72 anyway, it may make sense to convert your traditional Individual Retirement Account (Traditional IRA) to a Roth account over a period of five to seven years. Converting to a Roth account isn’t suitable for everyone, but generally, the longer you have before you need the funds from your Individual Retirement Account (IRA), the more sense it makes to convert to a Roth. Also, required minimum distributions (RMDs) are not required on Roth account funds.
Conclusion
For retirees, deciding how to best utilize surplus funds can be challenging, especially if the retiree wishes to invest the surplus funds in an Individual Retirement Account (IRA). However, general simple rules suggest that if you have high-interest debt, it should be paid off first before investing. Additionally, an emergency fund that covers at least three months of expenses should be funded before investing.
The Balance does not provide tax, investment, or financial services and does not offer advice in this regard. The information is provided without regard to the investment objectives or risk tolerance or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future performance. Investing involves risks, including the risk of loss of principal.
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Source: https://www.thebalancemoney.com/best-strategies-to-invest-surplus-funds-in-an-ira-4582906
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