I’m a fairly recent graduate, 23, and just started my first real job as a paralegal at a big law firm at a salary of $42,000 a year. I will probably start graduate school, most likely in law or another $$ professional master’s program, in the next five years. (Future schooling is an important goal for me.) After grad school, I could be in biglaw, making very good money, or elsewhere, probably not making as much. Should I be directing money to grad school savings or to retirement? What would you do?Other considerations:
- I have ~60,000 from an inheritance in an investment account–This could be used for school, or I could think of it as my retirement nest egg. It’s in a mix of no-load/no-fee mutual funds.
- Looking at my budget now, I’m planning to save definitely $500/mo, and probably up that to $600 once I’m more confident about what my general living costs will be.
- I also have probably over-budgeting for general spending (groceries, entertainment, eating out, clothes, etc.), by maybe $100/mo, and I was planning to save the rest of that for travel.
- There’s no match in my employer’s 401(k) plan, but in a year I’ll be eligible for profit sharing. I…don’t know exactly what that is or how it works yet, but I have a year to figure it out!
- No student loans. (Grandma, thank you!) No other debt.
- $2000 in a traditional IRAMy long-term financial goals:
- Pay for my hypothetical future children’s college at whatever school they want to go to, possibly with help from my parents. (No kids for probably close to ten years)
- Travel as much as possible
- Flexibility to quit a job, take a lower-paid job, etc
- Live reasonably well. (Right now I live in a cheap, gross apartment BUT it’s in a great area and I have an indulgent $70/mo. membership to a nice gym.)
- Retire, at some point in the very far futureSo where should I put my savings? Should I open a 529 with the thought that I’ll probably use it, and if not, my kids will appreciate the early help? Split it half and half? Some in the 401(k) and some just in my regular investment account? In a year, when my profit-sharing kicks in (???), would your response change?
All righty, first a disclaimer– this is a bit more complicated than our usual financial questions and we are not financial planners. Always do your own research and/or consult with a fee-based certified financial planner before making big money decisions. When we say “you” here, we’re actually answering the question of what we would do in your situation.
First off, if you had an employer match, generally the no-brainer thing to do would be to put in money up to the match amount because the return on investment there is larger than anything else. But there isn’t an employer match. :( Once the profit-sharing starts, it’s likely that the best bet will be to begin to contribute up to the match and then convert your company stocks to index funds as soon as your holding period is over (you don’t want to be in an Enron situation where your retirement savings are all in company stock– that increases your risk). You will have to look carefully into the details of your company’s program when that time comes.
Before that time period, the next thing you should consider is the Roth IRA. Roth IRAs are extremely flexible– they’re great for retirement, but the principal can be taken out penalty free while the earnings remain in the account. Although you probably won’t want to take money out once you’ve put it in until you’re actually ready to retire, they provide more flexibility than your company plan, 529, or traditional IRA. Max this out before even considering the 529.
Because you are (moderately) low income, the money that you put away for retirement may have an additional tax advantage, the saver’s credit during your first year of work. For example, if you started your job during the summer so you’ve only got half a year of income the first year on the job, then you would get a credit for something like 20% of your contribution at tax time.
If you can’t afford to max out your IRA with your monthly income, gradually convert your savings into tax-advantaged savings.
So, what would we do in your situation?
1. Max out the Roth IRA each year using a Vanguard Target-Date fund from Vanguard. (Alternatively, just put it in the S&P 500 index– you’re still young and have time to diversify your portfolio manually. There’s a small additional fee for setting and forgetting for the Target-Date fund and you don’t need any bonds at your age/distance from projected retirement.) Use your inheritance savings to do this if you need to, though at your current savings rate, you may not (a lot will depend on calendar year considerations). Be sure to get the saver’s credit at tax time!
2. Make sure you have a reasonable emergency fund that will cover, for example, moving costs, or late reimbursements.
3. In a year, look into the profit-sharing option and see what you need to do to get that. If it is manageable on your budget, go for it, but make sure to convert company money to index funds as soon as they allow it. (This is assuming it’s a standard profit-sharing match where the company is already established, if it’s stock options instead… that’s a much more difficult question.) If you can’t afford to get both the match and do the IRA (but you should be able to given your savings), look deeper into your budget/emergency fund. It is most likely that you will want to contribute to the profit-share up to the match and then max out your Roth IRA as much as you can, but there are some situations in which the profit-share wouldn’t be as good of a value as the Roth IRA. Note that if the match is good, even if you don’t plan on keeping the money in your 401k, you may still be better off getting the match and then taking the withdrawal penalty than not taking the match.
4. When time comes to go to graduate school, look at your projected student loan rates (and whether they’re subsidized or unsubsidized– the government may change its mind yet again about whether or not graduate students can get subsidized loans) and compare them to stock market rates (use ~7% for comparison if you don’t want to put in your own number) before deciding if you’d rather take the loan or withdraw savings/IRA principal.
tl/dr: Put it in retirement, but in a way that it can be used for school in a pinch (Roth IRA).
What have we missed, grumpy nation?