Ask the grumpies: save for retirement or save for graduate school?

P asks:

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 IRA
My 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 future
So 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?


9 Responses to “Ask the grumpies: save for retirement or save for graduate school?”

  1. Quail Says:

    Definitely the Roth! Take advantage of it while you can.

    Another thing to think about long term is how your graduate school might look at different assets or might give scholarships with or without regard to need. Law schools, for example, might not authorize you to take out public loans if you have certain types of liquid assets available – not sure if retirement is protected, but I would bet just cash is not protected. With student loan rates so high, it might be better to pay the tuition outright in some circumstances, but it would just benefit you to know what the policies are before assuming you’ll have the choice. Also, many law schools have loan repayment programs that can assist with loan payments if you enter public service, and that program might count assets differently as well (but can be very beneficial, especially if the government continues to forgive principal after 10 years in public service). This is just my rudimentary understanding of my spouse’s experience about 5 years ago, so YMMV.

    Also, if you do plan to go into law, try to have some cash in reserve to cover the summer of the bar exam. If you aren’t going straight to biglaw, you’ll likely have to pay out of pocket for a bar review course, rent/regular expenses, bar application fees (not cheap),travel and hotels for the bar exam, health insurance, possible moving expenses and a new apartment deposit, etc. We’re talking thousands of dollars all due in a short period of time. Better for your mental health to grumble as you withdraw the money from a savings account you’ll soon refill with a paycheck than scramble for a loan or credit at a super stressful time. But this could come from student loans or summer employment rather than some account you set up now, because that money might have to go towards tuition first anyway.

  2. bogart Says:

    I lean toward being nuts (i.e. overly enthusiastic) about tax-sheltered retirement savings, especially when you’re young. Thus, I’d lean toward (a) the Roth IRA, which is a great tool for the reasons noted, and for which you’ll be paying lower taxes now (on the money you put in it) than you likely will in the future (when you earn more and/or tax rates go up).

    Then I’d probably (b) max the 401K, or get as close to that as possible, possibly putting the funds into a Roth 401K if that’s available for the same reasons as preferring the Roth IRA particularly in your situation. I might even spend down my inheritance to make this possible. And then borrow for law school.

    But your situation is complex enough it might actually make sense to pay a fee-based ficuciarily responsible financial planner (CFP) for a consult, particularly as I don’t know the tax implications of spending your inheritance and that could influence the answer.

  3. chacha1 Says:

    I would second the recommendation for a Roth IRA. Then I would go off on a tangent.

    If you (the questioner) end up working in biglaw, profit-sharing will likely be a cash amount that is added to your 401(k), NOT a stock award or, god forbid, stock option. Most of the money in my own 401(k) was delivered this way. Most firms vest their profit-sharing contributions on a time scale, some vest it immediately (look for this in benefits packages; my current employer vests on a 6-year schedule, so I have to put in six years before 100% of the profit-sharing amounts is mine). Given that, weight your contributions to 401(k) (which is taken out pretax and thus directly reduces your current tax obligation, a nice feature as your income rises … if you increase your 401(k) contribution every time you get a raise, you will quickly fatten your retirement account and reduce the risk of lifestyle inflation at the same time) and Roth IRA (which is after-tax money) based on … a couple of things.

    23 is VERY YOUNG to be making $42K. Good for you! I didn’t hit that number till age 30. A skilled, experienced paralegal with good references can expect to make over $75K in most large markets, sometimes over $100K. I make $75K as a legal *secretary* in L.A. You may want to consider, after a few years, whether the investment in law school would actually be beneficial in the long run. My observation of law associates is: high debt; high workload; high stress … for a long time. If the associate does not make “partner track” at her first firm within 3-4 years, she will likely need to relocate. My observation of partners is that most do precious little practice of actual law: their job is to generate new business, which is then executed by the associates. So bear that in mind, and watch out for this during your years a paralegal. If your observations track with mine, you’ll want to consider whether law school might mean that you ultimately spend less time actually practicing law than you do as a paralegal, under attorney supervision. Another note: paralegals are often eligible for overtime pay. Associates are not.

    As to pursuing a master’s degree … well, I’ve got one, and it has contributed nothing to my employability. If your proposed master’s is not in a STEM field and calculated purposefully to put you in position for jobs in a technical field, or something to be pursued for pure love, I wouldn’t spend the money.

    Note: some biglaw firms will pay for you to go to law school if you establish your value and have a proven record of delivering good client service (happy clients bring more business).

    Rather than put any money in a 529 at this time, I would suggest keeping a certain amount of saved money very liquid. Relocation will be in your future, inevitably, and possibly many times if you choose to pursue new opportunities outside your current home town. It takes a lot of money to move.

    Good luck and congratulations on being so financially smart!

    • nicoleandmaggie Says:

      Thanks! I did not know that about profit-sharing– I assumed it was like what all my tech friends and relatives get.

      Also, I agree that 42K is great for someone just out of school (I was making 18K at that age, which inflates to about 25K today), it’s just moderately low in terms of government benefit phase-outs.

    • P Says:

      Thanks for the law firm intel, especially re profit-sharing–the information they gave me on it was very vague, since I’m not eligible yet, but I like to plan ahead. Obviously.

      As for future schooling…we’ll see. My specific position is pretty much designed for a recent college grad thinking about law school, and my predecessor’s predecessor in the position is now a summer associate at the firm. But deciding whether I want to go to law school is why I’m here, I’m learning a ton about the industry just being here.

      • Quail Says:

        If you can, use this time to explore other legal career options as well what you are getting through your exposure to a big firm – legal services attorney, government attorney, in-house positions, and explore both plaintiff and defense work, civil and criminal. What you do day-to-day is more important to your career satisfaction than the label “attorney” (which might be part of chacha’s point above), and there is a huge range of what attorneys do. Try to network to do some informational interviews while you are in a position where you aren’t looking for a job immediately. And use this time as a paralegal to determine what it is about your job that you like and what is it that you don’t like.

        I say this as someone who just completed law school after being a humanities academic and has a spouse who is a non-biglaw attorney. I’m very glad I made this career change – but I’m also glad that I didn’t go to law school in my early 20s, because I wouldn’t have known enough about myself to choose a job in which I’d be happy as an attorney. If you are conscious about your decisions, law school doesn’t have to be a debt-ridden albatross that you expunge through enslavement to biglaw. It sounds like you are well on your way to making some good conscious decisions!

  4. P Says:

    Thank you so much for this response! I come from a family of bankers, so you’d think they would be helpful, but they’re not great at breaking things down.

    So is a Roth IRA something I set up on my own instead of through my employer? Because there is a Roth option on the 401(k) enrollment form I just got from Wells Fargo, who administers my firm’s plan.

    • nicoleandmaggie Says:

      Yes, the Roth IRA is something you set up on your own. If you call up Vanguard, they should be able to help you (they’re the best company by far for personal investing in terms of low fees).

      The IRA is essentially a bucket where you can put any kind of investment and it is tax sheltered. Roth vs. Traditional is about whether you pay taxes now and don’t pay taxes later (the Roth) or if you don’t pay taxes now but do pay taxes on the earnings (traditional). That’s why 401K can have a Roth option as well, but that’s not what you want. You want a Roth IRA. You can contribute up to $5,500 each year. (This phases out for people/families with high income, but high income is 6 figures.)

  5. Leah Says:

    My big advice doesn’t have to do with investment (everyone is sound here — save up $5.5k, open up a Vanguard account, and max out your Roth IRA every single year).

    $42k is, as others have said, a lot of money for a 23 year old. I don’t make that much, and I have two master’s degrees in my field. Oh, teaching. I also save approximately 50%+ of my income without too much pain (not sure on the exact percent). My spouse and I travel regularly and have a one year old.

    Live like a college student as long as possible. Crummy apartments aren’t fun . . . but they are cheap. Find ways to keep your expenses low. Don’t go out every night. If your friend group goes out regularly, have one night a week (at least) where you do cocktails at someone’s apartment instead. Heck, if you want to host the weekly gathering, that will make you keep a clean and presentable place. Ask everyone to bring one bottle of liquor, and buy a bunch of mixers. For the cost of going out for one night, you’ve got multiple weeks of drinks.

    Save first. Pay yourself a minimum amount per month. Do this into the Roth in order to max it out, and also pick a set amount into savings. Then, take care of expenses. Keep a cushion in your bank account, and then put anything over that cushion into savings as well.

    You will handily be able to travel, and travel well, on the money you make unless your city is somehow super high COL. Your liquid savings can be used to relocate, pay for school, down payment, etc. Sky’s the limit, really.

    The key is to save and save well. It sounds like you’re headed in that direction already, but I want to add my voice here. You have many possible paths in front of you. Don’t lock yourself into grad school by doing the 529. Save so that you’re open to the opportunities that come up.

    One last piece of advice I wished I had heeded: don’t go to grad school until you have to. Don’t go to figure stuff out or bide time. Go because you have to in order to do what you want, and be sure about what you want.

    good luck!

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