Yes, it's me....back with a second installment in our series, ELI22. This assumes you read ELI18 (and even read the links relevant to you. You'll learn 10X more from the links!) and have done the things pertinent to your situation.
The "22" here means you finished 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; ELI30 will cover marriage, home ownership, and children.
So, you have money now, congratulations! Read this excellent summary of how to handle it. Here's a ginormous flowchart that is really quite good, if a bit intimidating at first. Good self-study! We'll highlight three Big Ideas to get you started.
Taxes. Your employee income is taxed / withheld like so: 7.5% of the first $118K goes to payroll taxes. (The hope is you will benefit from these in the future.) Then your income is taxed at higher rates as you make more. Assuming no special deductions, 0% for the first 10K due to standardish deductions. Then 10% of the next 9K, 15% of the next 28K, and then 25% tax rate kicks in; this is your rate from 48K to 102K gross income, so a popular rate. (It's only 28% up to 200K, as well.) This is your tax bracket / marginal tax rate. (Most states also have state income taxes of ~6%ish but they vary a lot.) Note that higher brackets only affect your additional income; you never end up worse just because you go into a higher bracket from more income. You can reduce your taxes by certain types of deductions. Big idea 1 will be ways to 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!
The longer you take to pay back the loan, the more interest you'll pay. You have to pay back the money you borrowed, too; that's called principal. The longer your loan term, the smaller each payment, but the more interest you'll then pay. It's a tradeoff. Big idea 2 is to reduce the amount of interest you pay by getting lower interest rates, and avoiding / quickly repaying higher interest debt.
Investing. In ELI18, I noted bank interest won't make you rich. The good news in ELI22 is: investments can make you rich. Really rich; current millionaire rich. The catch is: it takes decades, and you have to put in significant money regularly. This why you start at 22! We won't go into detail at this stage. The ELI22 simplified introduction to investments is something called a Target Date Fund, where you buy shares of a mostly stock-based index fund that is designed to be worth a lot more when you retire, at the target date 40+ years in the future. Historically, these accounts gain something like 6% annually after inflation, though it varies tremendously. That means your money doubles every 12 years, and goes up by 10X in 40 years. (More than that, since these numbers are net of inflation.) 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 all your retirement savings. Do not panic! It will come back eventually.) This is why 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. You should invest for the future 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 good round number to pick for ELI22 purposes is 10%, but it's up to you; more is better, but you can't go above $18,000 annually. The one cardinal rule here is Take The Match if you have one. A typical employer might add 3% of your salary if you contribute 6%, so that's like Free Money. Take The Match. (Your actual match, if any, depends on your employer's rules.) All of this contributed money is invested for you as you designate, and you can take it out without penalties when you retire after age 59.5 (usually.) If you change jobs, the money stays with you. The downside of a 401k is that you can only invest in what your employer offers. Most employers have target date funds, so choose those if you want an easy decision. If you need or want to, you can achieve an even better result with a bit more effort by picking from the 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. But, when you take the money out, then you pay taxes on it. The good news is you delayed the taxes. The bad news is you still pay them. If you think that's a bad deal, you can reverse this in some cases. If your employer offers a "Roth" option, you can invest your 401k contributions paying taxes on them now, but then the money including gains is tax-free on retirement. The choice of what to do is complicated, but if you are below the 25% bracket, Roth is usually your best option.
Yet more retirement options: IRAs. Individual Retirement Accounts are the do-it-yourself version of a 401k. You set up an account with a company like Vanguard, Schwab or Fidelity, and give them money to invest for you, up to $5500 annually. You'll have more choices, target date funds as well as others. Depending on your income level and what your employer offers, you either get a tax deduction ("traditional") or not so much ("Roth"), but then you get the opposite treatment for future withdrawals when you reach 59.5. IRAs are your go-to option if you have no employer 401k. Even if you do have an employer plan, you still may (and even should) want to use an IRA, especially a Roth IRA. You can sometimes tap IRA and even 401k resources before retirement for certain good reasons, though it's not an amazing idea to do so because you lose future gains and might owe current taxes. If you do want raidable retirement savings, a Roth IRA is the best choice because it is untaxed and contributions can be taken out without penalty.
OK. That was a fun topic. Ready for student loans? Sure you are!
Maybe you don't have any of these, but probably you do. If you do have them, the interest rate clock is ticking. Loans are typically 10 year repayment, so you'll owe about 1% of the loan amount (i.e. principal) 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 as fun.
You have to pay these back, unless you get them forgiven. You have several approaches available:
Pay them back on schedule. It sounds crazy, but it just might work! This is also your primary option on private loans. 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. 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. (Note that forgiveness programs other than PSLF will charge you taxes on the amount forgiven when that happens 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 is an idea, but 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 ROI is iffier these days. Going to grad school because you are not sure what else to do is probably a huge mistake, especially if you have to pay for it.
If you are responsible for yourself, you are probably responsible for your health insurance. (You could be on your parents' plan until age 26 in many cases.) If your employer will pay for it, that's your best option. They may offer a High Deductible Health Plan (HDHP), where you pay most of the routine costs, but insurance kicks in for major expenses. This is probably less expensive if you are in good health, since premiums will be lower. You can and should take advantage of a Healthcare Savings Account (HSA) with an HDHP. This gives you a tax deduction for contributions that can be used to pay for out-of-pocket medical expenses. HSAs have other unique features that make them good financial options if you have them. You can contribute $3350 annually to your HSA. Some employers pay some of this on your behalf.
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.
Since you have more money now, you can get a nicer place to live within the same 30% of takehome guideline. You may not even want a roommate! Just remember that any money you spend on housing is money you don't have for other things. Keep in mind that living with your parents is still a viable option if you want to save to pay down student loans, for example. Once you have a nicer place to live, you'll want to get renter's insurance as you start to accumulate stuff. (Note that we assume you are not yet ready to buy a house; that's generally a good assumption for anybody who is not yet sure where they want to live long-term, has limited work history, or insufficient down payment.)
You can also get a nicer car, since you have more money, probably better credit, and will get lower insurance rates. (You don't have to, and you'll save money if you don't, but it's your money.) Paying cash is still an option, but if you qualify for a 2% car loan, take it. A good target price is perhaps $15K with a $10K loan, 4 years at $220/month. That would keep your total cost-of-car to around $5K annually. Selling your old car privately will probably get you 20% more than you would by trading it in to a dealer.
With all these new expenses, budgeting becomes much more important. You'll want to have more ready savings in your 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 moving pieces, 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 obvious 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.
Whew! That was a long one. I think that does it for this week. ELI 30 next week: marriage, children, home ownership, life insurance, job changes. Fun things like that!
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