May is the month of college graduations. Graduates, their family and friends
celebrate, reflecting on how far the student has come and the promise of his
future. The graduate is transitioning
from academic life to the “real” world.
Finances are a significant part of that world. Habits established the first few years of
working life set the precedent for financial stability in the future. What should the graduate do?
The first step to financial success is a
budget. Estimate all your expenses
(rent, utilities, student loan payments, other debt payments, food, car or
commuting costs, savings, any other recurring payments. List all sources of income. For salary, use take-home amount. Otherwise, you must include salary deductions
for taxes as expenses. Subtract total
expenses from total income. Hopefully,
you’re not in the red – more expenses than income. If so, look for expenses that can be
cut. Track your expenditures, compare to
your plan, at least monthly. The process
is iterative, adjusting as things change.
Manage
Debt
Managing debt and becoming a good credit risk is
essential to accomplishing long term goals of acquiring those big ticket items
(a car, a house) and eventually supporting your family. College graduates often finish school with student
loan debt and credit card debt.
Credit
card debt is expensive. Finance charges on outstanding
balances can be very high. Any debt
incurred during student days should be paid down as quickly as possible. Pay more than the minimum on the credit cards
with the highest rates. Pay on time to
avoid late fees. Late payments adversely impact credit rating. If a credit card charges an annual fee
consider closing it. But don’t divest
yourself of all cards. Your credit score
will be higher when the total amount owed is low compared to the total credit
available. Keep the credit, just don’t
use it. Only use the credit when you
know you have the funds to pay for the purchase in full when the bill comes in.
Student
loans. Know the
terms of your student loans. If you have
multiple loans, look to consolidate them.
This will help you manage the loan and often makes the monthly payment
lower. Investigate an income based
payment plan. With this plan, loan payments start out lower and increase as
your income increases.
Save
The habit of saving should begin with the first
paycheck. Called “paying yourself first”,
some amount of money should be saved before you access the remainder for
regular expenses. Automatic transfer to
an account can often be set up with your employer. Ideally, you should save 10
to15 percent of your income. But if you
can’t manage that, start with $25 to $50 a pay period. The key is to start.
Emergency
fund. The first
savings goal is to build up a 3 to 6 month emergency fund. This is to cover rent, utilities, and basic
living expenses if you should lose your job.
Keep it in a liquid account (bank savings), don’t touch it. It’s for an emergency, not for the trip your
colleagues are planning to Vegas.
Retirement. It’s hard to think of retiring when just
starting a career but the best way to secure a comfortable retirement is to
start early. It is especially important
to new employees since employers have cut back on employer funded pension
plans. If your employer offers a 401k
retirement savings plan, participate as soon as you qualify. Your contribution lowers your taxable
income. The employer often matches a
percentage of your contribution. Make
sure you contribute enough to take advantage of the full matching. Where else can you earn 100% on your money?
If your employer doesn’t offer a 401k or
participation requires you wait a year to qualify, consider a Roth or
traditional IRA. The traditional IRA may
lower your taxable income now, contributions and gains are not taxed until
withdrawals which can’t start until you reach age 59 ½. If you access the money before then, you will
pay a 10% penalty. A Roth IRA is funded
with after tax dollars. The gains are
not taxable. Withdrawals are to start at 59 ½ years of
age. However, if you hold the Roth for
five years and then need the money, you can take out your contribution with no
penalty.
401k and IRA funds may be invested in various
financial instruments: certificate of deposits, stock funds, bond funds,
etc. Each of these instruments has a
level of risk, from none (CD’s) to high (aggressive growth stock funds) with a
related potential for growth. It is
important to learn about the options available.
Don’t avoid saving because you are a novice. Start accumulating the funds, investing in
what you understand.
Curb
the Splurge
A steady paycheck may seem like a financial windfall
to a recent college student. Exercise
restraint. Is the new car really
necessary at this stage? We all have
heard about how a new car depreciates when driven off the lot. A first apartment may be more affordable with
roommates. Do you really need those
premium channels? The choices made now
establish spending habits for the future.
Taking responsibility for personal finances and
building financial security is an integral part of the graduate’s transition to
the “real” world. Some of these topics
may be new. Read, investigate, question. The learning mustn’t stop.
IRS
Circular 230 Disclosure
Pursuant
to U.S. Treasury Department Regulations, we are now required to advise you that
any federal tax advice contained in this communication, including attachments
and enclosures, is not intended by the Sender or Sandra G Johnson, CPA, P.C. to
constitute a covered opinion pursuant to regulation section 10.35 or to be used
for the purpose of (i) avoiding tax-related penalties under Internal Revenue
Code or (ii) promoting, marketing, or recommending to another party any
tax-related matters addressed herein.
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