Inspired by ELI5, a post on the r/personalfinance community titled ELI22 petitioned for advice for more older young adults slightly more conversant in personal finance. A lot of great advice rolled in from people who had overcome personal finance challenges immediately after college or shortly after entering the workforce. ELI22 was such an incredible conversation that we were inspired to write an article discussing our favourite suggestions in the thread.
ELI22's advice is intended for people who have a job, who are finished school, and who are responsible for supporting themselves.
The reality is that when you start earning an income, you quickly realize that taxes are now a serious expense in your life. Understanding how taxes work and how you pay into politicians' coffers is critical to making informed financial decisions throughout your working life. The post mostly focused on Americans, but the basic ideas apply across most western industrialized nations (i.e. Canada, western Europe, Australia, NZ, etc.).
One of the most misunderstood concepts is the idea of tax brackets. The U.S. and Canada have progressive tax systems where you pay a higher tax rate as you move up the income ladder. Some people think this kind of tax makes it pointless to get a raise or work harder to earn more because the government will just take more of your money away in taxes. However, the important thing to remember is the fact that the higher tax rate only applies to your income within the particular bracket. The table below shows a simple example of how this works.
Based on the table above, if you made $35,000 last year, you might expect your entire earnings to be taxed at 20%, since your earnings are in the "Between $20K and $40K" bracket. You would think you'd get taxed $7,000 and only take home $28,000.
But actually, the first $20,000 you made would be taxed at 10% ($2,000 in tax) and only the additional $15,000 you made on top of that will be taxed at 20% ($3,000 in tax). You would only pay $5,000 in tax and actually take home $30,000. In other words, your total after-tax earnings won't go down if you move into a higher bracket. So, keep impressing your boss and don't be afraid to ask for a raise!
Plus, the extra taxes on your higher income can be avoided by putting the extra money away into tax-deferred retirement savings. The only thing to keep in mind here is that although you won't get taxed on the money now, you will get taxed when you withdraw your savings in retirement.
This strategy can save you money because you are more likely to be in a higher tax bracket when you're young and working full-time to earn a living. Once you're retired and don't have a lot of income, you could fit into a lower tax bracket even once you take that money out and it's taxed. These retirement savings programs generally save money on taxes for most people. The only time it doesn't work is if you end up having a lot of income in retirement. Still, these government-sanctioned programs are a powerful tool to reduce your tax burden during your working years.
Yes, retirement belongs in ELI22! Seriously!
Retirement planning is something you should start doing as soon as you start working. You might be young now, but you will retire someday — and saving and investing your money when you're young will make a big difference later in life. Putting away funds regularly builds good money habits, and you can take advantage of the power of compound interest when you start saving earlier.
If your employer offers a pension or retirement contributions, it's almost always a good idea to opt into those programs. "Take the match" is a common piece of advice; if your employer offers matching contributions, take the money! In this scenario, for every dollar you put into your retirement savings, your employer also puts in the same amount. If you put in $2,000, so do they. Yes, this is exactly what it sounds like: free money! Even if your investment loses some value over time, you are still going to come out ahead.
Depending on your home state, province, and country, you might have other options like Individual Retirement Accounts, Tax-Free Savings Accounts, income supplements, healthcare programs for seniors, and other social programs. It's difficult to forecast what you might have in retirement in 40 or 50 years from now, but the government will probably offer you some extra money or income support depending on your savings and income in retirement. Learn more about your local retirement programs and make sure you understand how they affect you and your family's finances.
If you have student debt, paying it down should be a priority. Pay your obligations on time and stick to the repayment schedule. It's also a good idea to start building your credit to help you qualify for a car loan or a mortgage down the road. Get a no-fee credit card, use it to get cash-back benefits and other perks, and always pay the whole balance off every month. This will quickly build up your credit score and make it easier and more affordable to borrow money later on.
Check out the ELI22 reddit thread for more tips for grads and young professionals, and be sure to share this article with your friends! Leaving school and entering the workforce can be a daunting task.