Advice for young adults | ages 18-25
- Advice for high school students and teenagers | ages 15-20
- Advice for young adults | ages 18-25
- Advice for older young adults | ages 25-35
- Advice for mid-career adults | ages 35-45
Back with another installment in our series of simple lifestage-appropriate tips based on US situations. This assumes you have read the earlier guides listed above.
The "young adult" here means you're done with full-time education, have a career with meaningful income, and are responsible for your own support. Some people start this at 18, some at 26; age is not important. Specifics pertain to the US in some cases. This assumes you are a single childless renter employee; the next section after this covers marriage, home ownership, and children.
How to handle $
You have money now, congratulations! Read this excellent summary of how to handle it. Here's a ginormous flowchart showing what to do first: bills? loans? investments? Good self-study! We'll highlight three Big Ideas to get you started.
Taxes. Your employee income is taxed like so: 7.65% goes to Social Security and Medicare taxes until you reach ~$127K. Also, at the same time your income is taxed in chunks at various rates. Assuming no special deductions, 0% for the first ~$10K due to standard deduction and exemption. Then 10% of the next ~$9K, 15% of the next ~$28K, 25% of the next ~$54K, and so on. For more detail about how taxes are computed, see the wiki page on Taxes. Most states also have state income taxes of ~6%ish but they vary a lot. Your marginal income tax rate affects only the dollars within the highest bracket; so you always come out ahead with more income, even if it means entering a new top tax bracket. You reduce your taxes with credits and deductions.
Big Idea 1 is: reduce your current taxes by making less of your income taxable.
Debt. You borrow money now so you can spend it, yay! But then you have to pay it back, and typically pay back more than you borrowed, boo! You've lost money as a result. The extra amount you repay is determined by the interest rate; the annual rate is called APR.
3% APR student loan? You'll pay $30 annual interest on $1000. Not bad.
12% APR car loan? You'll pay $120. Not good.
23.9% APR credit card? You'll pay $239. Yikes! (Never do this!) You repay the money you borrowed, too; that's called principal. The longer you take to repay the loan, the smaller each payment, but the more interest you'll then pay. It's a tradeoff.
Big Idea 2 is: reduce the amount of interest you pay by getting lower interest rates, and avoiding / quickly repaying higher interest debt.
Investing. In Advice for high school students and teenagers, we noted bank interest won't make you rich. The good news for you now is: investments can make you current millionaire rich. The catch is: it takes decades, and you must regularly invest significant sums. This why you start at early! Our introduction here to investments is based on the Target Date Fund, wherein you buy shares of a mostly 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 varies significantly year to year. Your money doubles every 12 years, and goes up by 10X in 40 years. (All numbers are after taking inflation into account.) So that $5000 you put aside at 22 could easily be worth $50,000 of today's dollars at 65. (But, there could be years where you temporarily lose 10%, 20%, even 30% of your savings. Do not panic! It will come back eventually.)
Big Idea 3 is: invest early and often for your future, especially your retirement.
Got the the Big Ideas now? Good! Let's see how we combine them for some meaningful benefits for your ~22-year-old self.
Retirement contributions. You are going to retire someday. Invest and perhaps reduce current taxes by letting your employer contribute a percent of each paycheck to your 401k account (or similar things with different names for government employers). A recommended investment percentage is 10%, but it's up to you; more is better, the annual maximum is $18,000. The cardinal rule is Take The Match if you have one. A typical employer adds 3% of your salary when you contribute 6%, so that's like Free Money. Take The Match. (Your actual match depends on your employer's rules.) The money is invested for you, available penalty-free when you retire after age 59.5 (usually.) If you change jobs, the money can go with you. A 401k can only invest in what your employer offers. Most employers have target date funds, so choosing one is an easy decision. If you need or want to, you can sometimes achieve an even better result by picking other available choices.
"What do you mean 'perhaps reduce current taxes'?" Retirement savings are wery wery complicated. (Thank your congresspeople.) A "traditional" 401k reduces your current taxes because it exempts your contributions from your taxable income. You pay taxes when you take the money out, deferring the taxes, but you still pay something. If you would prefer, you can reverse this if your employer offers a "Roth" option. In that case, you pax taxes on your 401k contributions , but no taxes when you take the money 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 set up an account with a company like Vanguard, Schwab or Fidelity, and give them up to $5500 annually to invest for you. You have more investment choices, target date funds plus other options. Depending on your income level and whether you have an employer 401k, you open a traditional or Roth IRA, with tax treatment equivalent to the previously described 401k types. IRAs are your go-to option if you have no employer 401k, but you still may (and even should) want to use an IRA, especially a Roth IRA, even if you have one. You can tap IRA and 401k resources before retirement for certain allowable reasons, though it's not usually recommended because you lose future gains and might owe current taxes. A Roth IRA is the best 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 typically 10 year repayment, so you'll owe about 1% of the loan balance each month for ten years.
If you owe $20,000, that's $200/month. Like a car payment. Not terrible.
If you owe $100,000, that will be $1000/month. Like a mortgage payment, only without the house. Not fun to pay.
You have to pay these back unless you get them forgiven. You have several approaches 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. If you have even more income, repay them faster with extra payments, especially on higher interest loans, and save by paying less interest than you would over time. This is your primary option on private loans. If you have high-interest private loans, look into refinancing them; if you have good income and credit, you'll qualify for lower interest rates.
If you have a lot of federal loans but little income, look into reduced payment plans like Income-Based Repayment (IBR) and Pay-As-You-Earn (PAYE) plans. You'll pay less (even nothing) each month, based on your current income, but you'll pay longer, and ultimately pay more over time in many cases.
If you are really in a deep hole, maybe over $100K federal with only $40K annual income, give a special look into Public Service Loan Forgiveness (PSLF). This program allows you to work for ten years in public service, make minimal payments, then your unpaid balance is magically forgiven, which is a really sweet deal if you can get it. (This differs from forgiveness programs for IBR/PAYE that will charge you taxes on any amount forgiven in the future.)
Enough about student loans. Let's wrap up with a few other topics of general interest to 22 year olds:
- Grad school can be a good idea, but can also be a very expensive idea. If you are sure this is for you, try to get someone else to pay for it, whether the school via scholarships / stipends, or your employer, if they do education reimbursement. Med school is worth the money no matter who pays. Law school and MBA return on investment is iffier these days. Going to grad school because you are not sure what else to do is probably a big mistake, especially so if you have to pay for it.
You may be responsible for your health insurance. (You could be on your parents' plan until age 26 in many cases, though that may cost them something.) If your employer will pay for it, that's your best option. They may offer a lower-premium High Deductible Health Plan (HDHP), where you pay routine costs, but insurance kicks in for major expenses. This is a good choice if you have good health and make few claims. You should take advantage of a Healthcare Savings Account (HSA) with an HDHP. This lets you deduct contributions to pay for out-of-pocket medical expenses, with other unique features that make them attractive. You can contribute $3350 annually to your HSA. Some employers pay some of this for you as more free money.
If your employer doesn't offer health insurance and you can't use your parents' plan, you'll want to get an individual plan such as those found on healthcare.gov. You can only sign up at certain times, including open enrollment in November / December. If you don't have health insurance of some form, you could pay a penalty of up to ~$2000 at tax time, unless you have an exemption.
With more income, you can rent a nicer place within the same 30% of take-home guideline. You may not even want a roommate! Of course, any money you spend on housing is money you don't have for other things. Living with your parents is still a viable option if you want to save, e.g. to pay down student loans. Please make sure you have renter's insurance, it's well worth the small cost. (Note that we assume you are not yet ready to buy a house; you may not yet be sure where you want to live long-term, have limited work history, or have insufficient down payment.)
You can also afford a nicer car, since you have better credit, and lower insurance rates. (You don't have to upgrade your car, and you'll save money if you don't.) Paying cash is still an option, but if you qualify for a 2% car loan, consider taking it to free your money for purposes like retirement investments and loan repayments. A good target price is perhaps $15K, with a $10K loan, which works out to 4 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 much more important. You'll want to have a bigger emergency fund; we recommend at least three months' expenses, to cover that bad day when you lose your job and your car breaks. With more expenses to track, look into a program like You Need a Budget (ynab) or Mint to help keep track of where your money is, and where it needs to be in the future. Look for ways to economize where you can, whether by cheaper cell-phone plans, learning to cook so you want to eat at home, or taking advantage of employee discounts.
While you don't have a lot of tax deductions yet outside of retirement / HSA savings, take a look at possible tax breaks for student loan interest, moving expenses associated with a job change, and certain tuition expenses (American Opportunity Tax Credit). You don't have to itemize to take advantage of these, but income limits apply in some cases.
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