The Macro View

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Key Takeaways in This Blog Post: 

  • Young professionals and other individuals just getting started with financial planning can easily position themselves for long-term success with just a few thoughtful financial choices 
  • Make the most of your 401k plan by contributing enough to maximize your employer’s matching contribution 
  • Take advantage of a Health Savings Account (HSA) if available to you 
  • Start a ROTH IRA to supercharge your retirement and emergency savings 
  • Pay down high interest debt as quickly as possible 

Contribute Enough to Your 401k to Maximize Your Employer Match 

If you are just starting your career, saving for retirement may be the last thing on your mind even from a financial perspective;  hopefully though you have been educated on the benefits of saving early and letting investments compound over-time.  If you forgot this lesson, or were never exposed to it, just know that if you save $10,000 now there is a good chance that 40 years from now that $10,000 will be worth over $200,000 (assumes an 8% average annual rate-of-return).  This should be motivation #1 to contribute to your company’s retirement plan.  

Motivation #2 is that chances are by choosing to save to your company’s 401k plan you will receive additional money from your company in the form of a 401k matching contribution.  For example, your company may match 100% of your contributions up to 6%.   Let’s assume your salary is $50,000.  If you choose to save 6% of your pay to your 401k you will contribute $3,000 (6%*$50,000) over the course of the year and your company will also contribute $3,000 for a total savings of $6,000 or 12% of your pay.  

Max Fund Your HSA if Available to You 

A Health Savings Account (HSA) is an account you can use to pay medical expenses, tax-free.  When it comes to savvy financial planning HSAs check a lot of boxes: contributions are tax-deductible (federally and in most states), investment gains can be tax-free and in many cases your employer may contribute to your account.  However, not everybody is eligible to contribute to an HSA.   In order to make contributions you must be covered by a high-deductible health insurance plan, which in 2021 is defined as a plan with a deductible of at least $1,400 for individuals and $2,800 for a family.   A high-deductible plan may not be the best choice for someone that regularly has a lot of doctor visits and prescription needs but if you are younger and in relatively good health it can be a great way to reduce your health insurance premium costs and receive all of the savings benefits.   

It’s also worth noting that most high-deductible health insurance plans cover the cost of doctor visits for preventive care (ie. check-ups).  In the case of an illness or injury that result in services subject to the deductible you can dip into the HSA to cover the out-of-pocket costs.  The most optimal use of an HSA though is to not use it for as long as possible, that may mean covering expenses out of other savings.   By not withdrawing money from the HSA you enable the tax-free investment gains to accumulate and compound over time and which will lead to more funds being available when you have higher medical expenses later in life.  

For 2021, if you are covered by an individual health plan you can contribute up to $3,600 to an HSA account, the maximum contribution for family coverage is $7,200. 

Contribute to a ROTH IRA; Contributions Can be Withdrawn Tax-Free for Emergencies 

After making contributions to your employer’s retirement plan and funding a health savings account the next thing to consider is making contributions to an emergency account which could be a ROTH IRA.  The general financial planning rule-of-thumb is to have an emergency “fund” equal to about 6 months of non-discretionary (aka required expenses) so that if you were to lose your job you have sufficient resources to avoid going into debt and to give yourself the time to make the next best move for your career.  If your job is very stable then you may not need as much of a reserve.  Also, if you have access to a ready source of credit, with a reasonable interest rate, such as a homeowner with the ability to take a home equity line of credit then you may be able to get away with less.  Typically though if you are just starting out in your career your job is less secure and you don’t have home equity.  

Without a financial cushion you could find yourself in a desperate position where you need to accept the first job opportunity that is available to you rather than making the best decision for your long-term career.   Making a bad career decision can be more devastating to building long-term wealth than anything else because it can result in years of reduced income that ultimately fuel your long-term financial planning. 

So why a ROTH IRA? While you can withdraw money from your 401k and HSA it is not a great decision because you will owe taxes and an early withdrawal penalty for doing so prior to age 59 1/2 in the case of the 401k and if not for medical expenses with the HSA.   ROTH IRAs however allow you to take withdrawals of your principal (contribution amount) tax-free.  The IRS actually considers distributions from a ROTH IRA to be on a first-in, first-out basis so you won’t pay taxes until your withdrawals exceed the amount you contribute.  The best case scenario however is that you never need to take a withdrawal from the ROTH IRA until after age 59 1/2.  Withdrawals after age 59 1/2 are tax-free which means there are no taxes on the investment gains in the account which can be very sizable if you start saving early.   

The IRS limits who can contribute to a ROTH IRA, for 2021 your income can not exceed $140,000 if you are a single filer or $208,000 if you are married and file a joint tax return.       The IRA also limits how much you can contribute, for 2021 you can contribute $6,000 if you are under age 50 and $7,000 if you are age 50 or older. 

Pay down and ultimately pay-off high interest debt 

Debt is one of those four-letter words that your mom and dad might have warned you against.  Not all debt is bad debt, but having too much debt relative to your income might mean that you don’t have enough left over to save to your 401k, HSA or towards other goals.    When it comes to wiping out debt you will want to start with your credit-cards.  Credit cards are short-term debt with high-interest rates typically well in excess of 10%.  When money flies out the door to pay interest it is going to someone else (a bank….and not your bank account).   

First you need to  set up a realistic payment schedule.  You can attack this in two ways: 

  1. The aggressive approach.  You start with a goal, such as a date that you want to pay a card balance off by.  You will then need to run a calculation to see what your required monthly payment will need to be.  You then plug that monthly amount into your budget as a high priority item. 
  1. The budget driven approach.  You start by creating a budget: your income minus NECESSARY expenses to determine your discretionary income.  You then decide to dedicate a portion of your discretionary income towards paying down the debt. 

Regardless of the approach you take once you calculate the amount you want to paydown per month, automating the payments so they happen without you having to lift a finger is key to staying disciplined and consistent, just like in savings.  Removing emotions and, yes, our own occasional laziness from the situation will help us stay on task with our paydown strategy.   The second part of the equation is to avoid the temptation to spend more than your budget allows so that you are not adding to your debt at the same time you are paying it down.  That is called treading water and as you know that is only sustainable for so long. 

One of the great features of financial planning is that there is always an opportunity, even in your earliest professional days, to make a decision that benefits your long-term financial picture.  The strategies discussed here can be utilized to dramatically enhance the odds of creating the long-term, sustainable wealth needed to keep you on track to live the life you want.  

As a busy young professional, the life and career you’ve always envisioned can often seem a little too far off in the distance however a commitment to sound financial decisions can make the journey there a heck of a lot more enjoyable. 

Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities.  Full disclaimer.

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