Making Your First Paycheck Work for You
Getting your first post-graduation paycheck can be exciting and unnerving. In theory, you know that your take-home pay and discretionary income will be far less than the salary (or wages) quoted by human resources. But seeing the paycheck with deductions subtracted can still be a surprise. Find ways to fully support yourself — either immediately or sometime in the future — and build wealth.
I spoke with Carrie Schwab-Pomerantz, Certified Financial Planner, financial literacy expert, and president of Charles Schwab Foundation, about ways to handle a first paycheck. We talked about creative approaches for young adults to live independently from parents and save for the future on small incomes. In fact, even my financially-savvy self was surprised at how far Carrie made her first paycheck go in Washington, DC, a city with an extremely high cost of living.
Consider the Job Offer
One of the first things I asked Carrie was whether a young adult should take a job with an extremely low salary.
I’ll start with mentioning that average new-grad salaries reported by the media may not be representative of actual salaries; check Payscale.com or Salary.com to get a feel for salary ranges in your field and geographical area. In the pre-Internet days when I graduated, I compared salaries of friends (the few who actually landed jobs) with news reports and found real-life salaries were often 50-75% lower than the "average," which must have been weighted heavily with those in high-demand fields.
During the 80s recession, my (not yet) husband turned down his first out-of-town offer because he didn’t think he could live on his own with such a paltry paycheck. At the time, very few recent grads relocated to this small town where this employer was headquartered; most lived at home with parents or split expenses with a working spouse. Later, he accepted a higher salary in a different department with the same company.
The question, then, is: how low can you go? Carrie said that a decision can depend on a number of factors, including the location of the hiring employer. Generally, though, it's wise to accept a position that will allow you to begin acquiring skills and experiences needed to further your career and reach your goals. Obviously, destitution isn’t on your life list but you might be surprised at how little you’ll need to make it on your own.
Get Ready for Surprises
Nearly a quarter of your salary will disappear before you can get your hands on your paycheck. Sure, you’re probably aware that social security (FICA), federal taxes, and state taxes can remove a huge chunk of your paycheck. But when you have to rely on the income for your entire existence and pay back student loans, this revelation can be unsettling.
Plus you may not have anticipated paying for utility bills (which may have been included in monthly rates at the campus residence hall), health, auto, and renters insurance, and the amenities of home, such as food in the refrigerator.
Still, whether you are getting ready to move out on your own or just anticipating that day, there are several financial steps you can take now that will ease the transition to the real world and help you make your paycheck work for you.
Carrie lived at home with her parents for about four months as she plotted her exit from the family nest. She saved for her real-world launch by calculating the dollar amount needed as equal to the first and last month’s rent for an apartment, security deposit on an apartment, and price of a bed. During this time, she scouted apartments and found a place to live with multiple roommates, bringing what might have been an $800/month apartment down to a couple of hundred dollars.
She also opted not to get a car, which would involve monthly loan payments, upkeep, gas, insurance, and parking lot fees. Instead, she used readily-available public transportation near her apartment to save loads of money.
So, with these two decisions, she avoided nearly $10,000 in yearly expenses.
My first real job required a move to a small town, not within commuting distance from my parent’s home. Public transportation didn’t exist there so I needed to buy a car to get to work, adding to my monthly expenses. I spent my savings on a down payment for the car and had no money for a security deposit. So, I accepted the company’s relocation package and lived in a hotel for the first 30 days. During that time, I received my first paycheck to cover start-up expenses and found a roommate to share an apartment.
Getting a roommate is top on Carrie's list to afford the move away from home. She also recommended these cost-savings habits:
- host potluck dinners with friends instead of dining in expensive restaurants
- bring your lunch rather than spending the time and money eating out
- enjoy free or low-cost sources of entertainment (Carrie visited museums in Washington while I took hikes along the Blue Ridge Parkway)
- create a work wardrobe using basic colors (black, brown, white) from discount stores.
When you are filling out paperwork for your first job, you’ll probably be asked whether you want to enroll in employee-benefit programs. Carrie recommends that you sign up for your 401(k) and contribute the percentage (or amount) that will reap the full company match; otherwise, you’ll be walking away from free money.
You might be reeling from the realization that your paycheck will be much leaner than you’d hoped. Lopping off an additional 3-6% may seem painful. But, in addition to getting the company match (which adds to your overall earnings), you’ll be able to reduce your tax liability by funding your 401(k). So, your paycheck shouldn't be reduced by the full amount of your contribution but a tax-adjusted number.
If your company doesn’t offer a 401(k), then start putting money aside for retirement in tax-advantaged accounts such as a traditional IRA or Roth IRA. You’ll get a tax break on contributions to the traditional IRA (depending on income requirements) and money in these accounts will grow tax deferred.
One of the decisions you’ll have to make is whether to sign up for health insurance offered through your employer. Get some form of health insurance, whether you decide to opt-in to your employer’s plan or not. If you think your employer's plan is too expensive or doesn't provide adequate coverage, consider buying an individual plan on the open market or get your parents to cover you on their health insurance policies. When making a decision about healthcare insurance, consider monthly premiums, choice of providers, deductibles, and out-of-pocket maximums.
Even if you think your status will change in the next six months (that is, you might be joining the military service or getting married and will become eligible for other insurance), you still should get covered now rather than waiting. A sudden illness or an accident could be very costly and create a burden for years to come.
Carrie mentions that you'll need to buy auto insurance (if you have a car) and should buy renters insurance but probably won't need other forms of insurance when you are starting out as as a young adult with no dependents.
Make Plans for Your Money
You may be so focused on succeeding at your first job that you haven't yet mapped out your life or you may have an intricate plan for your career and personal lives. Either way, Carrie recommends making plans for your money in a few categories:
- Short-term needs, which should start as an emergency fund of 3 months' expenses plus money for this year's vacation, for example
- Mid-range goals, such as purchasing a house, car, or furniture
- Long-term plans, generally focused on saving for retirement (Carrie recommends saving 10% of all earnings to serve as a foundation for retirement).
Set aside money each month in appropriate savings and investment accounts. For example, put your emergency fund in a savings or money market account so that a quick withdrawal for an emergency won't incur penalties. Retirement funds don't need to be accessible in your 20s or 30s but stashed away in your 401(k), Roth IRA, traditional IRA, etc. If you have enough money in each fund, you won't have to rely heavily on credit cards for emergency needs or tap retirement accounts to buy a house.
Build Your Credit History
Sign up for a credit card, or get a gas card or store card to begin building your credit history on your own. Of course, Carrie urges you to pay off the balance each month rather than paying the minimum due. You’ll also need to keep paying on your student loans. Together, timely payments can help you build a solid credit score. Potential landlords, lenders, and even employers might check your history so having a good score can allow you to make financial transactions and save you money in the long run.
Know What You’re Spending
I asked Carrie if young adults should balance their checkbooks in this era of online banking. She doesn't think you have to keep an old-fashioned paper register to keep tabs on spending. But you should monitor your money, categorize spending (housing, clothing, transportation, food, entertainment) and know where your money goes. If you watch inflows and outflows, spend less than you earn, then your bank balance should stay under control.
You might not want to spent lots of time thinking about finances but still want to be responsible with your money. For tips on taking quick actions that collectively can improve your finances, check out Money Mondays or Schwab's MoneyWise Twitter stream @schwabmoneywise.