What To Do With Your First Paycheck
POV you just received your first paycheck.
Now before you go buy 487 bobas or swipe the card on a new pair of expensive shoes you've been eyeing, consider these 8 Things To Do With Your Paycheck.
Financial knowledge and intuition is the source of true financial freedom. While most of us may be in our 20s, it's never to early to live frugally to leave room to enjoy today while being mindful of future bigger endeavors.
1. Max out your 401k:
A 401k is an employer-sponsored defined-contribution pension account. In plain English that means companies offer employees (you) assistance with saving up for retirement. Most employers will provide a matching program. That means for every dollar you put into your 401k account, your employer will match dollar-for-dollar up to a certain percentage.
Numerically...let's say you invest $100 and your 401k plan offers a 5% match. Your total invested capital is $105 ( your $100 + employers $5 (from 100 x 5%) ).
So you can see the benefit of maxing out your 401k contributions!
Another important thing to know is that there are two types of 401(k)s.
- Traditional 401k: employee contributions are deducted from their taxable income in the year you put it into the account BUT when you withdraw at retirement, they are taxed, Essentially you are deferring tax to a later date.
- Roth 401k: you make POST-tax contributions and the withdrawals are tax-free
2. Calculate your taxes
There are two certain things in life: death and taxes. Most people tend to curse the later every May. From a positive perspective, your ability to pay taxes is an indication of your income level and capacity to manage your finances!
This generally involves federal tax, state tax, Social Security or health benefits tax. Since my perspective is investment heavy, I will not go down the black hole of tax details.
Note the US is a progressive tax system
3. Transfer to your Checking/Savings Account
- Checking Account: designed for everyday spending money, transferring funds, and making convenient bill payments. Generally there is no cap on the number of transactions you can have per month.
- The best types are those that have little to zero monthly fees. You want to maximize the power of every dollar you work for, not put it to fees!
- General Savings Account: growing your money with interest and providing a stable reserve for the long-term. It is very important to consider the fees and withdrawal rules associated with your account. Some providers will limit the number of transactions you can have per month and will assess a penalty for exceeding that. In either case, you should mainly stick to your checking account when swiping your credit card.
4. Build an Emergency Savings Fund
Ahhh as the COVID-19 pandemic has shown us, it's never a bad thing to have an emergency savings fund. For people and businesses who were impacted deeply by the sudden stop in flow of business, an emergency savings account can be a lifeline in keeping a business afloat or even food on the table.
Since we are speaking from the perspective of recent graduates or first time receivers of their paychecks, most individuals will not have that significant amount of disposable income to put into an emergency savings account. (Remember, a big portion has already been deducted for 401k and taxes)
Instead, think of it as a staircase you want to climb. First work at saving up for 1 weeks of living expenses. Then 1 month, 3 months, 6 months, 9 months, up to 1 year.
If you never have to dip into an emergency savings fund...fantastic! If you do, you can feel reassured that you can afford your expenses.
5. Bare Necessities
Disclosure...sushi and getting your nails done is NOT a necessity!
Here, I'm referring to food that can get you buy, paying for rent to have a roof over your head, clean water, safety, and health. Think of yourself as a contestant on Survivor. What would you need?
6. Pay off Debt AFAP (as fast as possible)
Debt may be worse than the pain of watching taxes take a bite into your paycheck. My one and only tip for you...pay it off as fast as possible. As recent graduates, one high-interest debt is our student loans. If you have the means and flexibility, try to pay this off as soon as you graduate. The longer you delay this, the more it will eat into your ability to generate income from investments and your overall livelihood.
While we want to enjoy our freedom as a 20-something year-old, we also need to be mindful that we want to head into the adult world with a clean slate.
7. Invest in Retirement (yes now...even in your 20s)
- Roth IRA: retirement account where contributions are deposited post-tax and withdrawals are tax free. These accounts are limited to $6,000 contribution of earned income per year up to age 50, after-which you can deposit $7,000. Contribution limit for singles is $140,000 and for married couples it is $208,000
- early withdrawals prior to 59 1/2 can trigger penalties if not drawn for qualified expenses
- fantastic for if you believe your retirement tax bracket will be higher than your current
- Traditional IRA: pre-tax dollars grow tax-deferred. There are no capital gains or dividend income taxes assessed until withdrawal. You may contribute 100% of any earned compensation up to a specific maximum dollar amount.
- Standard Brokerage Account (Cash Account): enables your the flexibility to understand the stocks and bond market. Most brokerage firms assess very minimal or no fees since many individuals are taking up their own financial management.
- It is better to start off conservative and build a relatively stable portfolio to test out the waters.
- You may hear about trading options, derivatives, or other forms of riskier investments. More information to come about these but please note that most of these activities require certain prerequisites and a margin account.
8. TREAT yourself: I think I need not say anymore about this last point!
- Financial Freedom is an indication of personal wealth and knowledge
- Live loud, live proud, but be mindful of staying within your means
LINKS for further clarification:
Please take all of these tips with a grain of salt. I am not speaking as a certified professional adviser. I am merely dissecting my personal experience and research. Every person is different depending on their life situation. The allocation between each basket will vary.