Dear soon-to-be college graduate (or parents of a soon-to-be college graduate),
You will soon enter a new era of salaried full-time employment with broad benefits from a great employer. We’ve seen numerous offer letters and countless benefit packages. This new era will bring you new financial opportunity, but it also brings a few financial traps to be aware of. That’s why we’ve compiled this list of four common first-time-job financial mistakes, so that you can be confident in the financial decisions and benefit choices you make on day one of your new gig!
MISTAKE 1: LIVING ON 100% OF YOUR NEW PAYCHECK
You’ve got the offer letter. $60,000 salary. Nice! Quickly, you do the math: just over $1,150/week. Bazinga! You can have a lot of fun with $1,150/week! Sadly, that would be a mistake, because you won’t have anywhere near $1,150/week of disposable income. Instead, you’ll likely end up with about 20% of your pay as disposable income, which is more like $230/week. A healthy way to think about your paycheck would be as follows:
You won’t even see the first 25% of you pay as it will be deducted for taxes and premiums, including federal and state taxes, FICA, and employer benefit premiums. This may come as a shock in the first paycheck you receive!
Now that you’re on your own, you’ll need 40% for essential living expenses such as housing, food, utilities, and maybe even some student loans and debt payoff.
And don’t forget to pay yourself by setting aside 15%. Some will be siphoned off before you see it into your 401(k) and HSA, and some you’ll put into an IRA afterwards. Your future self will thank you for getting into good savings habits early.
Let’s do the math, and that leaves you with 20% as disposable income. Ouch!
MISTAKE 2: RIDING ON YOUR PARENTS’ HEALTH INSURANCE UNTIL YOU’RE 26
You’ve been covered by your parents health insurance for years, and it seems easy to maintain the status quo. But Just because your parent’s health insurance allows them to cover you until you’re 26 doesn’t mean it’s a good idea. It’s usually a pretty bad idea. Often, it means higher premiums paid by your parents and lost opportunity to get free HSA money from your employer. You have to review in detail both the insurance your new employee offers as well as the insurance your parents’ employer offers. Usually, premiums are higher for covered dependents (you would be a dependent on your parents’ insurance) than for the employee themselves. Your parents may be paying premiums that are 50-100% more than what you could pay for similar health coverage. Plus, as a young and healthy individual, it would probably be a wise decision to enroll in a low premium high-deductible health plan offered by your employer, which often comes with a nice contribution to your Health Savings Account. Bazinga!
MISTAKE 3: SAVING TOO MUCH IN THE 401(K) PLAN
Save…yes. But only in the 401(k)…no. If you read the summary of mistake #1, you’ll recall that we suggest saving a total of 15%. But generally, the most you want to save in the 401(k) right of the college is enough to receive the maximum company match. After that, you should be pumping the rest of that 15% in your Health Savings Account (annually up to $3,500 individually or $7,000 if married) and your Roth IRA (annually up to $6,000). Doing so will increase your Financial Agility, or your ability to react to changes in your financial situation in the future. What you need to know is that any money saved in the 401(k) is basically locked away until the age of 59 ½ unless you’re willing to pay early withdrawal penalties to the IRS. However, money saved into your HSA and Roth IRA may be accessed in the short term and even right away without penalty. The gist is that you’re going to use your Health Savings Account to actually accumulate or save money, pay for medical expenses out of pocket, and those unreimbursed medical expenses become future tax-free and penalty-free withdrawals. Relative to Roth IRAs, your contribution basis (the money you contribute, not the investment earnings portion of your Roth IRA account) is always available to you for withdrawal tax-free and penalty-free in the future. The availability of these funds from your HSA and Roth IRA on a tax-free and penalty-free basis provide you with Financial Agility.…all while you’re still getting tax free investment earnings for the future! Bazinga!
MISTAKE 4: ENROLLING IN UNNECESSARY VOLUNTARY BENEFITS
If your employer offers a nice suite of voluntary benefits, it can be tempting to go on a little shopping spree. After all, they’d only offer those benefits if they were a good deal – right? Not necessarily. Look, you don’t need pet insurance, or critical illness or accident insurance, and you probably don’t need to buy an extra two days of vacation. If you need life insurance due to debt or dependents, you’re likely better off applying for a term policy and being medically underwritten on your own versus buying one year of life insurance coverage through the company. Instead of siphoning off your income into these voluntary benefits, you should be setting up a little emergency fund (including your Roth contributions and unreimbursed medical expenses from your HSA) so that you’re able to self-insure those small-ish unexpected expenses as they arise. Save more into your HSA or increase your Roth IRA contributions to increase your Financial Agility. Bazinga!
So there you have it: four common first-time-job financial mistakes that you can easily avoid to give your working career a lift. Just keep in mind that this article is written in generalities, and every situation, every employer, every job offer, and every benefits package is different.
While we’ve captured common mistakes in common situations, you really should find a financially savvy advisor that will work with you in your situation. Find an advisor that will review your benefits package with you and provide enrollment guidance. Find an advisor that will give you a plan on how to allocate your income across living expenses, debt, and savings. Find an advisor that will help you understand all the savings vehicles (401(k), IRA, HSA, etc) available and how and why to allocate dollars to them. Find an advisor that’s willing to work with you for a small fee, even though you likely don’t have investable assets yet. There may not be many advisors that fit that pattern, but we may have a reference or two if you need one. 😊