So you have some cash now… Congrats! Read this outline of the way to handle it. What to do first: invoices? loans? investments? We are going to highlight three Big Ideas to get you started.
Your worker income is taxed / withheld like thus: 7.5% of the first $118K goes to social security/medicare taxes. (We trust you’ll profit in the future, too!) Afterward your income is taxed at higher rates as you make more. Assuming no special tax write-offs, 0% for the first 10K due to standardish tax write-offs. Then 10% of then, and the next 9K, 15% of the next 28K 25% tax rate kicks in; this is your rate from 48K to 102K gross income, so a rate that is favorite. (It is just 28% up to 200K, too.) This really is your tax bracket / marginal tax rate. (Most states also have state income taxes of ~6%ish but they vary a lot.) Higher classes exclusively change your added income; you consistently come out ahead even if more income means a new top tax bracket. You reduce your taxes with credits and deductions. Big Idea 1 is: by making less of your income taxable, reduce your present taxes.
You borrow cash now so that you can spend it, yay! But then you need to pay it back, and commonly repay more than you borrowed, boo! You have lost money as a result. The interest rate determines the additional amount you repay; the yearly rate is known as APR.
3% APR student loan? You will pay $30 annual interest on $1000. Not bad.
12% APR auto loan? You’ll pay $120. Not good.
23.9% APR credit card? You’ll pay $239. Yikes! (Never do this!) You refund the money you borrowed, too; that’s called principal. The the more time you take to pay off the loan, the smaller each payment, but the more interest you’ll then pay. Itis a tradeoff. Big Idea 2 is: reduce the quantity of interest you pay by avoiding / promptly refunding higher interest debt, and getting lower rates of interest.
Bank interest won’t make you wealthy. The great news is: investments can make you present millionaire wealthy. The grab is: you also must often invest considerable amounts, and it takes decades. This you start at 22! This introduction to investments is situated on the Target Date Fund, wherein you buy shares of a largely stock-based index fund designed to be worth a lot more when you retire at a target date 40 years in the future. Historically, these accounts gain about 6% annually after inflation, though it fluctuates year to year. Your money doubles every 12 years, and goes up by 10X in 40 years. (All amounts are after taking inflation into account.) So that $5000 you put at 22 could easily be worth $50,000 of today’s dollars at 65. (But, there may be years where you temporarily lose 10%, 20%, even 30% of your savings. Don’t panic! It’ll come back eventually.) Big Idea 3 is: invest early and often for your future, notably your retirement.
Got the the Big Ideas now? Good! Let us see how we join them for some significant benefits for your young self.
Retirement contributions. You’re going to retire someday. Invest and perhaps reduce current taxes by letting your company contribute a percent of each paycheck to your 401k account (or similar matters with distinct names for government employers). A recommended investment percentage is 10%, but it’s up to you; more the annual maximum is $18,000. The cardinal rule is when you have one Take The Match. A typical employer adds 3% of your wages when you put up 6%, so that’s like Free Cash. Take The Match. (Your real match depends upon your company’s rules.) The cash is invested for you, available fee-free when you retire after age 59.5 (typically.) The money can go with you in the event you switch jobs. A 401k can only invest in what your employer offers. Most companies have target date funds, so choosing one is an easy choice. If you desire or need to, you can occasionally attain an even better result by deciding on other available choices.
“What do you mean ‘maybe reduce current taxes’?” Retirement savings are wery complicated. (Thank your congresspeople.) A “conventional” 401k reduces your present taxes because it exempts your contributions from your taxable income. You pay taxes when you take the money out, deferring the taxes, but something is still paid by you. In the event you’d prefer, you can revoke this if your employer offers a “Roth” choice. In that case, you pax taxes on your 401k contributions, but no taxes when you take the cash out. The best choice is complex; for those below the 25% bracket, Roth is usually better.
Yet more retirement options: IRAs. Individual Retirement Accounts are do-it-yourself 401ks. You give them up to $5500 per annum to invest for you, and set up an account with a company like Vanguard, Schwab or Fidelity. You have more investment choices, target date funds plus other options. Whether you have a company 401k and depending on your income level, you start a traditional or Roth IRA, with tax treatment identical to the previously described 401k sorts. IRAs are your go to choice in case you don’t have any company 401k, but you nonetheless may (and even should) need to use an IRA, particularly a Roth IRA, even in case you have one. You can harness on IRA and 401k resources before retirement for certain allowable reasons, though it’s not generally recommended because you might owe taxes that are present and lose future increases. A Roth IRA is the most suitable choice for raidable retirement savings because contributions can be taken out at any time without taxes or penalties.
OK. That was a lot of information! Ready to repay student loans? Let’s find out:
If you do have student loans, the interest rate clock is ticking. Loans are commonly 10 year repayment, so you’ll owe about 1% of the loan balance every month for ten years.
$200/month. in the event you owe $20,000, that’s Like a car payment. Not horrible.
Should you owe $100,000, that will be $1000/month. Like a mortgage payment, just minus the house. Not enjoyable to pay.
You need to pay these back unless you get them forgiven. You’ve several strategies available for repayment:
Pay them back on schedule. It sounds crazy, but it just might work! If your income supports it, pay the minimum on low-interest (4%) loans. Refund them quicker on higher interest loans, especially with additional payments should you have more income, by paying less interest than you would over time and save. This really is your main option on private loans. If you have high-interest private loans, look into refinancing them; if you’ve got good income and credit, you’ll qualify for lower rates of interest.
In the event you have a lot of federal loans but little income, research reduced payment strategies like Income-Established Repayment (IBR) and Pay As You Earn (PAYE) plans. You will pay less (even nothing) each month, based on your own current income, but you’ll pay longer, and finally pay more through time oftentimes.
In case you’re actually in a deep hole, possibly over $100K national with only $40K yearly income, give a specific look into Public Service Loan Forgiveness (PSLF). This software allows you to work for ten years in public service, make minimal payments, then your unpaid balance is magically forgiven, when you can get it, which is a really sweet deal. (This differs from forgiveness programs for IBR/PAYE which will charge you taxes on any amount forgiven later on.)
Enough about student loans. Let’s wrap up to 22 year olds with a few other topics of general interest:
Grad school may be a great thought, but may also be an extremely expensive idea. In case you are certain this is for you, attempt to get someone else to pay for it, whether the school via scholarships / stipends, or your company, if they do instruction reimbursement. Med school would be worth the money no matter who pays. Law school and MBA return on investment is iffier these days. Going to grad school since you aren’t sure what else to do is likely a big mistake, especially so when you need to cover it.
Perhaps you are responsible for your health insurance. (You could be on your parents’ plan until age 26 in many cases, though that could cost them something.) In case your employer will pay for it, that is your smartest choice. They may offer a lower-premium High Deductible Health Plan (HDHP), where you pay routine costs, but insurance kicks in for major expenses. This really is a great choice in case you have good health and make few claims. You need to take advantage of a Health Care Savings Account (HSA) with an HDHP. This allows you to deduct contributions to pay for out of pocket medical expenses, with other unique characteristics that make them appealing. You can contribute $3350 yearly to your HSA. Some employers pay some of this for you as free money.
In case your company doesn’t offer health insurance and you can’t use your parents’ strategy, you’ll want to get an individual plan such as those located on healthcare.gov. You can just sign up at particular times, including open enrollment in November / December. You could pay a fee of up to ~$2000 at tax time, unless you have an exemption should you not have health insurance of some kind.
Within the same 30% of takehome guideline, you can let a nicer location with more income. You might not even need a roommate! Obviously, any cash spent on home is cash you don’t have for other things. Living with your parents is still a feasible option in the event you want to save, e.g. to pay down student loans. Please ensure you have renter’s insurance, it is well worth the little cost. (Note that we assume you are not yet prepared to purchase a house; you might not yet be sure where you would like to dwell long-term, have limited work history, or have insufficient down payment.)
You may also afford a nicer car, since you have better credit, and lower insurance rates. (You don’t have to upgrade your car, and you will save money if you do not.) Paying cash continues to be an alternative, but if you qualify for car loan that is 2%, consider taking it to free your money for purposes like loan repayments and retirement investments. An excellent objective price is maybe $15K, with a $10K loan, which works out to FOUR years at $220/month. Your total cost-of-car would be about $5K annually. Selling your old car privately should get you 20% more than you would by trading it in to a dealer.
With more expenses, budgeting becomes a lot more important. You will desire to have a bigger emergency fund; we recommend at least three months’ expenses, to cover that awful day when you lose your car breaks as well as your work. With more expenses to track, look into an application like You Need a Budget (ynab) or Mint to help to keep tabs on wherever your cash is, and where it needs to be in the future. Look for methods to economize where you can, whether by more economical cell phone plans, taking advantage of employee discounts, or learning to cook so you intend to eat at home.
While you do not have a lot of tax deductions yet outside of retirement / HSA savings, take a look at potential tax breaks for student loan interest, moving expenses associated with a job change, and certain tuition expenses (American Opportunity Tax Credit). Income limitations apply in some situations, although you do not have to itemize to take advantage of these.
Whew! That was a long one. Hopefully this helps some of our college grads out there!