While turning 18 and heading to college is a major step in its own right, handing in the cap and gown and stepping off campus as an employed adult usher in a host of new considerations. In our prior piece about turning 18, we outlined 10 items that provide the basis for launching a young adult’s financial life. Below are key items to consider when graduating from college or graduate school and starting a career. Of course, everyone’s situation is unique and requires adapting these guidelines as appropriate.
SETTING A FOUNDATION
- Legal Documents. Ensure that you have key legal documents in place, such as a health care proxy, durable power of attorney, will, and revocable trust. See our “Turning 18” article for details.
- Budget. Prepare a budget for your planned income, spending, and savings. Use it to provide a concrete assessment of limitations and set priorities, including the trade-offs across the areas listed below. As a forward-looking document, a budget can prove challenging, but at least track spending by category. Be sure to include savings as a line item. Numerous sample budgets are available on the Internet, if you need a template.
- Credit History. As you might expect, your credit history will impact your ability to borrow money in the future, as well as the interest rate level. What is less obvious is that it can impact your employment. Prospective employers, especially those in the financial services industry, will often check your credit report during the final stage of the hiring process. To develop a good credit history, you need to have a credit account(s) of some kind, such as a credit card, student loan, or auto loan, and subsequently make payments consistent with the terms of the account. For credit cards, you will still build your credit even if you pay off the balances every month (which we strongly recommend doing whenever possible), but be careful not to regularly charge close to your available credit line as this can lower your credit rating. Using a debit card will not help you build your credit rating.
- Health Insurance. Take time to evaluate health insurance options, whether staying on a parent’s plan or signing-up for employer-sponsored health insurance. If you are on a parent’s plan, beware of the timing of being forced off the plan at age 26. Make plans in advance to secure health insurance through your employer or directly with an insurance company. Typically, going through your employer will be the more attractive option.
- Disability Insurance. The ability to generate income is usually one’s most valuable asset. Even so, becoming disabled and unable to work is not a natural concern for a recent graduate, typically at the age of “invulnerability.” However, roughly one-in-four 20-year olds will become disabled before retirement age at 67, according to the Social Security Administration. Disability insurance typically replaces about 60% of income if you are not able to work due to certain illnesses or injuries. This coverage is generally inexpensive and could reduce the risk of having to use emergency funds. If offered by your employer, be alert to eligibility windows, which exist sometimes only at the beginning of employment. If not provided or offered by your employer, consider buying it privately. The Social Security Administration does provide some minimal coverage for those who have paid Social Security taxes.
- Property & Casualty Insurance. Auto, renters/homeowners, and umbrella liability insurance are important policies to secure. Compare coverages, deductibles, and premiums from different firms. You will also want to research customer satisfaction ratings, as some firms have better reputations for processing and paying claims.
- Retirement Savings. Many employers offer 401k or other retirement savings plans. If your company matches your contributions to the plan, save at least the amount needed to maximize the employer match since that is “free” money (although it may be subject to vesting over time and deferred taxes). If your employer offers a Roth 401k, consider using that option (relative to the traditional 401k). Roths are particularly attractive for younger employees who are typically in lower tax brackets. If you have the opportunity to save for retirement beyond the employer match, you should compare saving in your employer’s plan to saving in a Roth IRA. Some factors to consider are investment options, investment advice, fees, loan options (not available on IRAs) and contribution limits. The difference between starting to save right out of school versus waiting just three or four years can be significant by retirement age. According to Bankrate.com, with a 10% employee contribution and a 6% annual return on investments, a typical retirement fund would grow to $1,424,000 over 45 years versus $1,158,000 over 42 years. That equates to 23% more savings for only 7% additional time of savings.
- Emergency Fund. Build up an emergency fund that can cover three to six months of expenses. Assume that essential living expenses like food, rent, transportation, and utilities consume roughly 50% of your take home pay. If these expenses total more than 50%, explore ways to reduce them, such as dining out less and other living arrangements. If one encounters an emergency before the fund has built up sufficiently, retirement savings can be accessed, in some cases via a loan. Be aware that there are potential penalties and taxes on early retirement account withdrawals, and you will lose the future tax benefits of any funds that are withdrawn from retirement accounts.
- Loan Reduction. If you have any student or other loans, set up a plan to tackle your debt. Try to pay off any high interest loans early. A target of 10-15% of salary dedicated to debt reduction is a standard guideline, but this could vary considerably based on your situation.
- Other Savings. Beyond emergency fund and retirement savings, other savings priorities may include funding future education, buying a car, or saving for a down payment on a house. Some people find it useful to set up separate accounts for each savings priority in order to make it easier to track progress toward goals.
After leaving college or graduate school, financial literacy becomes paramount. However, even finance majors often lack a sound grasp of personal financial management. Take the time to learn about and address these issues since they can make the transition to adulthood smoother and set you up for a successful future.
The opinions expressed in this article are as of the date issued and subject to change at any time. Nothing contained herein is intended to constitute legal, tax or accounting advice, and clients should discuss any proposed arrangement or transaction with their legal or tax advisers.