You’ve graduated from college and landed your first job in the “real world.” And now that you have your first paycheck, it’s easy to feel as though you’re finally making “real” money — but that first paycheck is just the first step in learning how to manage your money and prepare for your future.
Before splurging on an expensive purchase, consider how your spending and saving habits now can impact your future livelihood and eventual retirement. Developing good habits and being responsible with your money now can mean financial freedom down the road. Here are some things to think about:
Pay Down Debt and Create a Budget
“If you’re a recent grad with college debt, dedicate a large portion of your earnings toward eliminating that debt,” suggests financial planner Edward Kohlhepp, Jr. He points out that debt can drag on your finances for a long time if you don’t get rid of it.
Tom Drake, a financial analyst, says that creating a budget to manage bills is a good way to ensure that your paycheck goes to the right place. “List your bills and needs, and make sure those are covered,” he suggests. “There is no substitute for planning. Your money will go further if you know how much is coming in, and you watch where it goes.”
Employers are required to withhold money from your paycheck for taxes, but you have some flexibility here. Consult with your human resources department to discuss how different exemptions can impact your paycheck. For example, you’ll be able to claim yourself as an exemption (a dependent), and if you have a spouse and children in the future, you may also be able to claim them as dependents, reducing the overall amount of tax you owe.
Keep in mind that having money withheld from your paycheck is important — you don’t want to end up with an expensive tax bill later. But you also want to strike a balance so that you have enough monthly cash flow for your bills and monthly expenses.
While some people choose to have extra money taken out each month for a bigger tax refund later, there are potential consequences to consider. You may end up not paying down debts as aggressively as you could, leading to higher amounts of interest owed on loans and credit cards. You should also consider the possible downsides of not having enough cash on hand to pay for unforeseen medical expenses and other emergencies.
As your circumstances change (if you have children, get married or divorced or start your own business), you may also need to change your withholding status. It makes sense to talk to an accountant or tax professional before making these important decisions.
Most companies offer insurance benefits that can be automatically deducted from your paycheck. Evaluate your coverage needs for health insurance and choose a plan that works for you.
If you are young and have few healthcare needs, a high-deductible plan can be a good choice, since it requires a lower monthly premium. Check to see if your employer provides matching contributions to a health savings account (HSA) in conjunction with a high-deductible plan. A HSA is another tax-advantaged account that allows those who qualify to receive deductions for contributions. Money saved for qualified health costs grows tax-free.
A flexible spending account (FSA) is another option for saving up some tax-free cash for medical expenses. However, generally speaking there are greater restrictions on FSAs, including a lower savings limit ($2,000 a year), the inability to roll over amounts from year to year, and a lack of portability when moving from one job to another.
Someone with multiple healthcare visits a year might consider a more traditional health plan. The monthly premium is higher, but you’ll have fewer out-of-pocket expenses. Getting your plan taken out of your paycheck helps you cover necessities without thinking about it.
Your Retirement Fund
Even if you think you’re too young or that you don’t have enough cash to build a nest egg, now is the time to start saving for retirement. Lidia Shong, who works with financial-planning service aboutLife, points out that you have a better chance of long-term success if you start early. She recommends setting aside at least 10 percent of your income each month for retirement.
Many companies offer to match employee contributions on a group retirement plan. That means your employer will kick in the same percentage you’re paying into the plan via payroll deductions, up to a certain amount. Because many employer matches are in the range of four to six percent of your paycheck, setting aside 10 percent of your income should be enough to obtain the full employer match, Shong says.
That’s free money for your post-retirement future — don’t leave that sitting on the table.
Even if your employer doesn’t offer a retirement plan, you can still save for retirement. If you qualify, consider opening an individual retirement account (IRA) and having a portion of your paycheck directly deposited into the account. Setting up automatic contributions to a retirement account is the best way to develop a saving habit — you won’t risk forgetting about it or being tempted to contribute less money.
As you continue to earn money at your new job, figure out what matters to you. Speak with a trusted professional who can help you create a spending plan that allows you to meet your needs and prepare for a secure financial future.