Life Events: Your First Job
Congratulations on your first "real" job! It is one of the most exciting time in anyone life and you want to make sure that you put your financial knowledge to some good use. Generally speaking, most of what you learned in school will not prepare you for this. Perhaps you did an internship or participated in some other type of cooperative education experience. In that case, good for you. You will be a step ahead of your peers. However, there is a big difference between being a student at work, and being an employee. Certainly, more will be expected of you. Following are some rules that will help you get acclimated to the world of work and towards a solid financial.
Review your Student loans: Take closer look at your current financial situation. You may have student loans that will be a concern since you must start making payments now. You should check to see if you could get a better interest rate on your student loans as compared to your current rate. Sometime a little shopping around could save you lot of money and this is one of the item that sure can.
Review Employer Retirement Plan: You have a job now so you'll need to retire one day as well. Retirement planning is usually not the first thing on agenda when you're just starting out. However, an early start could make a big difference in the end. You should review your employer's retirement plan and options available to you. Most employers offer a 401(K) plan with some matching contribution. If a 401(K) plan is not offered, there is usually a 403(b) plan that most non profit employers offer. Whatever is the option available to you, you need to make best use of it. Remember, you're allowed to contribute up to a certain percentage of your annual salary towards your 401(k) plan each year. Most employers permit employees to contribute up to 15 percent of their salary to a 401(k). However, your annual contribution is also subject to certain maximum total contributions per year. The annual maximum for 2007 is $15,500. If you are over 50, a "catch-up" provision allows you to contribute an additional $5,000 into your 401(k) account. It is also important to note that employer contributions do not affect an employee's maximum annual contribution limit.
Your employer may also offer a matching contribution. Let's take a simple example to explain this. An employer may offer to match 50% of your contribution with a maximum of 4%. What does that mean is that your employer will match 50% of your match as long as your match is 8% o less. You can still contribute beyond 8% but employer contribution is capped at 4%. So in this case, if you decide to contribute 8% of your salary towards 401(K), you're are essentially putting 12% of your salary(8% yours + 4% employer contribution) ) towards your 401(K).
Here is another example of how 401(K) contribution can help you save big in long run. Let's assume you contribute 6% towards your 401(K). If you live in a state with no income taxes, and earn $50,000/year, here is how your paycheck will look like.
Tax filing status = Single, Annual Salary = $50,000, 6% 401(K) contribution
| Bi-weekly Gross Pay |
$1,923.08 |
| Federal Withholding |
$260.66 |
| Social Security |
$112.08 |
| Medicare |
$26.21 |
| Texas |
$0.00 |
| 401(K) |
$115.38 |
| Net Pay |
$1,408.75 |
As you can see that you're putting $115.38 in your 401(k) account and this money is pre-tax(excluded from Federal income tax, Social Security, Medicare and state taxes). If you increase your contribution by 1%, here is the new table.
Tax filing status = Single, Annual Salary = $50,000, 7% 401(k) contribution
| Bi-weekly Gross Pay |
$1,923.08 |
| Federal Withholding |
$255.85 |
| Social Security |
$110.88 |
| Medicare |
$25.93 |
| Texas |
$0.00 |
| 401(K) |
$134.62 |
| Net Pay |
$1,395.80 |
It is very clear from the table that by increasing your contribution by 1%, your take home pay will reduce by $12.95($1,408.75 - $1,395.80) but your 401(k) contribution will go up by $19.24($134.62 - $115.38). These numbers may not look very large or meaningful but let's do some long term calculations to see how big of a nest egg you'll have with this contribution.
Assumptions:-
Current age = 25 years, Current 401(k) contribution = 6%, Employer match = 50% - up to 6% of salary
Current Salary = $50,000, Expected annual salary raise = 3% for next 40 years
Age at Retirement = 65
Annual Rate of Return = 8%
401(k) Balance at age 65 = $1,732,781
Now if we keep everything same but change your contribution to 7%
401(k) Balance at age 65 = $1,925,315
So just by reducing your take home pay by $13/paycheck or 1% addition to 401(k) contribution, end result would be $192,534 in 40 years. This difference will grow to more than $385,061 if you increase your contribution to 8%.
Your potential saving could be even more if you lived in a state with income taxes. In our calculations, we have assumed that there is no state income tax but in most cases it is around 7%.
Review Your Health Benefits: If you're young and starting your first job, chances are you're in pretty good physical shape. You should use it to your advantage instead of electing a "fit for all" health coverage that your employer may offer. Remember, health care costs are rising at double digits and most employers are looking for ways to allow more freedom and responsible healthy behavior for their employees. High Deductible Health Plan(HDHP) with HSA account is a great option for young and healthy people. HSA is pretty close to 401(k) account when it comes to taxes. All contribution to a HSA is non taxable and that could save you lot of money. Also, if you don't use all the money is your HSA account, it will rollover next year and you won't lose a dime. You want to make sure you get a big advantage by building your HSA balance during early years when you're young and less likely to get sick. A well planned HSA account will help in controlling your out of pocket healthcare expense when you start a family or have higher healthcare expenses. You can read more about HDHP plans and HSA account here.
The sooner you put a concrete financial strategy in place—and commit to that strategy for the long run—the more likely you may be to achieve your goals.
|
