Many of us are enjoying our summer and grateful for the opportunity to be outside after the pandemic. While this can be an exciting time, summertime is halfway through the calendar year and can also be the perfect time to re-examine our career and our finances. As young professionals, we sometimes get so busy in our day-to-day activities that we miss the opportunity to set goals and achieve milestones that may be important to us long term. In order to transition from merely living life to actually thriving in life, we must set some goals and make plans to achieve the things we want. Ask yourself these 6 questions:
1. Do you want to stay in your current career or job long term? Many people are employed and get paid to do a certain job but not everyone has a fulfilling career that they love. Where do you stand? Do you plan to stay at your current job or business long term? If so, what would you like the next few years to look like? Is there a milestone you want to reach? Being able to set some career goals is key. Once you have these goals, you can write down steps to achieve them and may find yourself more content with your life overall.
2. What aspects about your current work would you like to change? While some people may love their job or business, very few people enjoy every single aspect of what they do. What are some things you’d like to change about your work? What would make it even more enjoyable? One key ingredient to career longevity is enjoyment. The more you like and enjoy the work you do, the longer you will do it. Figure out if there are some things you can change about your career right now that would increase your work satisfaction.
3. What are your income sources and how can you grow them? While some people are paid a large salary for the work they do, many others have multiple jobs or revenue streams to boost their income and provide some diversification. Where do you stand? Are you adequately compensated for the work you do, or are you waiting for a raise? Have you thought of ways to increase your income or establish additional revenue streams? If so, what is your plan to grow them? More money tends to give you more freedom and options in your life, so increasing the amount you make is a good place to start.
4. Do you want to start a business or grow an existing one? Most people accumulate wealth by starting, growing, or investing in a business. Having a business you love can not only brings you fulfillment but it can also increase your income and allow you to positively impact others in your own unique way. Do you have plans to start a business or grow a business? If you haven’t yet started a business, think about the type of business you’d be good at or a hobby you’d like to monetize. If you already have a business, think about the next steps you need to take to grow it to the next level.
5. How have you invested the money you already received? It’s not enough to just make more money. You must also be a good steward of money. Do you spend all the money you get or are you saving some of it? Are you planning ahead for large expenses? Are you investing money for the long-term? If you simply spend all the extra money you have then how will you ever accumulate wealth or get out of debt. Think about your money habits and pinpoint which ones need to change.
6. What do you need to do to take yourself, your career, and your finances to the next level? Your life may be fantastic right now, but take a few minutes to think about ways it could be even better. What could you do to enjoy your career more? What habits could you implement to take your finances to the next level? What things do you need to work on personally to make yourself a better person physically, mentally, and emotionally? We should be constantly striving to grow as people. Re-examining ways to make our lives better is a good start.
What to do with work retirement accounts when you change jobs?
Many money savvy young professionals utilize retirement accounts to invest money and minimize their yearly tax bill. While doing so is great for wealth creation, many people are unsure of what to do when they change jobs. Maybe you’ve wondered the same thing? Perhaps you’ve contributed 5-10% of your salary to your work retirement plan and now find yourself in the transition period about to work for a new employer. While you are excited about the new job, maybe you wonder what to do with the retirement account you had at your old job. Here are 5 options to consider:
Option 1: Leave it where it is. If you like the retirement plan options at your old job and the fees are low just let the money stay there and continue to grow. Unless your old employer demands that you move it, you can likely just the money you contributed in that same account. Although you can’t continue to contribute to that particular work-sponsored account if you no longer work there, you can let the money you already invested keep building over time. You can start withdrawing the money from that account at age 59.5 without incurring any early withdraw penalties but you must start withdrawing it by age 72. If you like the investment options offered by your employer, such as standard low-cost index mutual funds, then keeping the money where it is may be a good option.
Option 2: Roll it into your new job’s retirement plan. This may be a good option if you’re not particularly thrilled with the 401K options at your old employer and like the retirement plan investment options at your new job better. It may also be a good idea if you don’t want to keep track of multiple different 401Ks (or 403b’s) and would prefer to have them all at the same place. If you want to rollover the money into your new job’s retirement plan you simply contact the custodian or manager of the 401K (or 403b) plans at your old job and let them know you want to rollover the funds into the 401K (or 403b) at your new job. This a direct transfer. All you have to do is fill out some paperwork. (Some jobs may make you wait until you’ve been at the new job for a certain length of time before they let you do the rollover so contact your new job and ask). Since the money is going from one pre-tax retirement plan (at your old job) to another pre-tax retirement plan (at your new job) you won’t owe any taxes. You are simply combining 2 accounts into one. If you don’t want to do a direct transfer, you can also have the person in charge of your job’s 401K write you a check for the money and you can then deposit that check into your new job’s 401K yourself. (By law, you must make the deposit within 60 days.)
Option 3: Put the money in a traditional IRA. With this option, you call a brokerage firm like Fidelity, Vanguard, etc and let them know you want to open an individual retirement account (I.R.A) or tell them that you want to roll money from your old job’s retirement plan into your existing IRA. Putting the money into a traditional IRA may be an option for people who may not have good retirement plan options at their new job or want a bit more control over their investment plan options. The biggest advantage of opening an IRA this is that you now will have control of your retirement account and it won’t be controlled by your employer. With this control you can invest in whatever you want, whether that’s individual stocks or various mutual funds you find appealing. You also do not have pay any extra money in taxes when you transfer the funds. Through a self-directed IRA, which is a traditional IRA that you have control over, you can even invest in things like real estate, art, business partnerships, and precious metals. The downside of putting the money in a traditional IRA is that you will now be excluded from using the backdoor Roth IRA method which allows high income earners to put money into Roth IRA accounts each year.
Option 4: Convert it to a Roth IRA. Choosing to convert your work 401K (or 403b) into a Roth IRA is different from putting the money into a traditional IRA. Unlike a traditional IRA, which you contribute to with pre-tax dollars, you contribute to a Roth IRA with post-tax dollars. In other words, you contribute to a Roth IRA after taxes have already been taken out of your check and you never have to pay taxes on that money again. Why does this matter? Because with a Roth IRA you can invest in a way that allows your money to make even more money over time and you never have to pay taxes on the profits. Plus, you can take your contributions out of the Roth IRA at any time without any penalties which means it can serve as an extra emergency fund. In order to convert the money in your 401K (where you made contributions with pre-tax dollars) into a Roth IRA (which you contribute to with post tax dollars), you have to pay taxes on that money. For example, if you have $10,000 in your work 401K, and your marginal tax rate is 25%, then converting your 401K to a Roth IRA will increase the amount of taxes you owe by $10,000 x .25 = $2,500. This may seem like a lot of money now, but when you take the money out in retirement you may be paying an even higher amount in taxes since the overall amount in the amount will have grown over time. Before you decide what to do, see how much money you have in your 401K and calculate the taxes you’d have to pay if you converted it to a Roth IRA. If you can handle the increase in taxes, then converting it to a Roth IRA may be worth it.
Option 5: Cash it out. Technically speaking, you can cash out your 401K at your old job and have them write you a check for you to spend on whatever you want. This may be something to consider if you need the money to buy a home, pay off debt, or use for some other reason. While it may be nice to get an influx of cash, understand that the amount you get may be much less than you think. Since you did not have to pay taxes on money that went into the 401K, if you decide to cash it out, you will have to pay taxes on that money. Plus, if you are under age 55, you will also incur a 10% early withdrawal penalty. For example, if you have $15,000 in your work 401K and you want to cash it out, realize you will not get a $15,000 check. If your marginal tax rate is say 22% and you are under age 55, then you will only get a check for around $10,000 (only 2/3 of the money you had in the account) once you account for taxes and the early withdrawal penalty.
My point? You have 5 options of what to do with your 401K (or 403b) when you change jobs. In order to avoid paying a lot in taxes, some people tend to leave the money where it is or roll it into their new job’s 401K. If they can afford the taxes, then they may try to convert it to a Roth IRA to save themselves money in taxes later in life. Other options are to put it into a traditional IRA or cash it out. The choice is yours.
5 Money Mistakes To Avoid This Summer
Summer is here. Covid cases have declined. Outside is officially open. As you enjoy being able to leave your home and live life as you did before the pandemic, be mindful of your spending. Despite the delayed gratification we all had in 2020, the urge to make up for lost times might be good for our psyche but bad for our wallet. If you aren’t careful, you could find yourself spending way more than you anticipated. In order to continue to progress in your financial goals, avoid these 5 money mistakes this summer:
1. Going out to eat too often. Whether it’s brunch, happy hour, or a birthday dinner many people tend to eat out a lot more frequently in the summer. I know I do. With the increased prevalence of food delivery apps like Doordash and Uber Eats, I order takeout meals more often as well. If I’m not careful, I can easily spend $100-200 a week eating out. Although the food may taste amazing and the time with friends can bring happiness, these endeavors, when done on a frequent basis, can be quite expensive. In order to be a money savvy young professional, we must be mindful of this added cost. It’s not that we can’t eat out at all, it’s that we must resist the urge to do so too frequently.
2. Not having a budget when you travel. Now that things are opening back up, one of the things many of us cannot wait to do is travel! We long to get out of our homes and away from our cities to visit someplace else. Although traveling can be fun and provide a much-needed break from our current lives, don’t forget to budget! Many of us factor in the cost of a flight and hotel, but we underestimate how much we will spend on food, uber rides, drinks and entertainment after we arrive. If we aren’t careful, those expenses can add up quickly and before you know it, you’ve spent way more than you planned and re-accumulated the credit card debt you worked so hard to pay back. Avoid this by budgeting appropriately. Before you go, estimate how much you will spend on incidentals like snacks, drinks, and transport. Find ways to cover those expenses without putting it all on a credit card. Don’t let improper planning turn your vacation into a financial catastrophe.
3. Overspending at bars/lounges and happy hours. If there’s one thing friends love to do in the summertime, it’s go out. Although many of us may no longer be in clubs until 2am, we likely still enjoy a good happy hour after work or a nice lounge on the weekends. Although there is nothing inherently wrong with these activities, they can serve as unexpected money pits that take away all of our disposable income. If you aren’t careful, you can easily drop $20-30 on drinks, another $20 on an appetizer and tip. Before you know it, you’ve spent almost $50 and still need to get dinner. While this may not break the bank if done every once in a while, hitting a happy hour every week can start to add up. Nightclubs and lounges can be even more expensive, especially if you try to get a section to sit down and split a couple bottles or drinks with friends. You can easily send $200-300 if not more, on a night out. While this can lead to great times with friends, don’t let it shatter your financial goals. Try to set a spending limit when you’re out and don’t go over that amount, That way you can enjoy the evening without overspending and regretting it in the morning.
4. Buying new clothes for every occasion. Whether it’s the desire to post photos in new outfits or the unexplainable feeling of excitement I get whenever I purchase a new dress, one of the financial mistakes I used to make a lot is shopping. Specifically speaking, I loved to buy new clothes for special occasions and in the summertime, there was ALWAYS a special occasion like a friend’s birthday party, entertainment event, or upcoming vacation for me to shop for. Although shopping and wearing new clothes brought me joy, seeing my bank account diminish soon after I got paid was definitely NOT a good feeling. If you’re like me, and can get a little carried away when it comes to shopping, try to put barriers in place and approach things differently this summer. Delete text messages from stores about sales, unsubscribe from store emails, make a concerted effort to re-wear things you haven’t worn in awhile, and resist the urge to buy something new when you have other outfits in your closet that could work just fine.
5. Underestimating the costs of weddings/special events. Another thing we need to be careful not to do this summer is underestimate the costs of special events like weddings. As we enter our late 20s and early 30s many of our friends and co-workers may start getting married and having children. This means there will be lots of engagement parties, weddings, gender reveals, and baby showers to attend. Although these events may create memories that last a lifetime, make sure you plan ahead. This means setting aside money each month for these costs and understanding that you may not be able to make ALL of the events. Set a budget and plan ahead.
5 Truths Every Resident Needs To Know
July 1st is just around the corner and for those who are new to medicine or unfamiliar with residency life, July is the start of the new resident physician year. A resident physician is a doctor who graduated from medical school and is getting specialized training in his or her field of choice while still seeing patients. Residents are doctors who are still actively learning (like a student in school) while they are also working and earning money.
Besides experience, the main difference between a resident physician and a regular physician (like an attending physician who is done with his/her specialized training) is that resident physicians work a lot more and get paid a lot less. I’m still a resident myself, so as you can imagine, it’s a busy time in our lives. There are a lot of things we have to worry about, but finances shouldn’t be one of them. Here are 5 money-related truths every resident physician, and young professional with high earning potential, needs to know:
You are not guaranteed to be rich. Just because you are a doctor and will have a high salary, does NOT mean you don’t need a plan for your finances. Most people who make more money, get into more debt. Your time as a resident is not an excuse for poor money management and credit card accumulation. Many doctors’ net worth is not nearly as high as it should be considering how much they get paid. Make some financial goals for yourself now and try to avoid some common pitfalls. Learning a few finance basics as a resident can go a long way.
Spend less. Save more. Minimize debt. Things can be challenging during residency so try to live below your means or at least avoid living above your means. You don’t have to have a detailed budget but creating a basic spending plan to prevent yourself from accumulating [more] debt during training might be helpful. Save money in an emergency fund so that small, unexpected expenses like a car repair, urgent trip back home, or new cell phone doesn’t derail your budget or financial goals. Vacations can serve as a much-needed break from the stress of residency, but try to pay for them in cash by saving a couple hundred dollars from each paycheck. If you can, invest some money in index mutual funds via your work retirement plan or your own Roth IRA. The goal in residency is to keep your head above water financially and avoid getting into more debt.
Have a plan for your student loans. Choosing to “deal with it later” is NOT a plan. Read about the different student loan repayment options and choose one, likely an income-driven repayment plan, so that your payments are affordable in residency. Most residency programs qualify for public service loan forgiveness so take a couple minutes out of your day and sign up for this free program so that you have an option for your student loans to be forgiven after 10 years. When choosing a student loan plan recognize that the optimal student loan plan for you as resident may change when you become an attending. That’s okay. Just figure out the best federal repayment plan for you now, likely PAYE or Re-PAYE and consider hiring a company like Student Loan Advice or Student Loan Tax Experts once you finish training so they can run the numbers for you and help you determine the best repayment plan for you as an attending.
You need Insurance. As a resident physician, there’s a good chance you have health insurance from your employer that is either free or low cost, but health insurance isn’t all the insurance you need. Every resident physician needs long-term disability insurance. You may get a small amount through your residency program but that is unlikely to provide enough coverage. Most residents and attendings will need to purchase an additional individual long-term disability insurance policy. If you have a spouse, kids, or family members that you support financially, you may also need to purchase term life insurance. If you have a side business, you may also need extra liability insurance coverage. Figure out all of the insurances you need and make sure you get them.
Think twice before you buy a house. Owning a home can be a major milestone and lifelong dream, but it may not be wise to do so in residency. You cannot just compare the monthly mortgage price to the monthly rent price and make your decision. There are additional fees and costs associated with home ownership that can be challenging to deal with as a resident. Do what is best for your family, but make sure you consider all of the pros/cons of buying a home before you make the decision to rent vs buy.
Dispelling Myths about Building Wealth Through Retirement Accounts
Many people should prioritize using retirement accounts to build wealth even if they don’t plan to stop working any time soon. The benefits of these accounts are too good to pass up. If you’re still skeptical of using retirement accounts, let me clarify some common critiques:
Critique #1: With retirement accounts you are limited to what you can invest in
Truth #1: Anyone can open an individual retirement account (IRA) and invest in almost anything they’d like. With a self-directed IRA, you can even invest in cryptocurrency and real estate. The few limitations that do exist are in work-sponsored retirement accounts because in those types of retirement accounts people can only invest in the funds that are offered through their employer. This means it is highly unlikely you’ll be able to buy shares of bitcoin through your work 401K or 403b. However, most jobs offer a variety of index funds and mutual funds that you can invest in.
Many jobs also offer target-date retirement funds (or lifecycle funds) which put your investing on autopilot. Index funds in these target date retirement funds offer a return of about 8-10% each year on your money which is more than you’d get from most actively managed mutual funds on wall street. My point? Most people have very good investment options inside of retirement accounts.
Critique #2: There’s a limit to how much you can invest
Truth #2: This is actually true. Contributing to retirement accounts offers various tax and asset protection benefits. It makes sense that the government would try to limit how much of those benefits each person can take advantage of each year. That being said, you can still invest thousands of dollars per year in these accounts before you hit the annual limit.
With your work-sponsored retirement accounts, you can contribute up to $19,000 per year. With a traditional IRA or Roth IRA, you can contribute another $6,000 per year. If you are self-employed or work as an independent contractor, you can open your own retirement account and put up to 20% of your income (up to a max of $58,000) per year. Some people even have access to another pre-tax retirement account called a 457b that allows them to contribute even more money. My point? Although there is a limit to how much you can invest in retirement accounts, that yearly limit is quite high and most people have access to more than one type of retirement account.
Critique #3: You can’t take the money out when you want to
Truth #3: The purpose of retirement accounts is to invest money for retirement. The government gives you tax and asset protection benefits to do so. If you take the money out of the account before you retire there is a penalty. So no, you can’t investment money in retirement accounts, make a profit, then withdraw the money to take a fancy international vacation or buy a new car. The money must be used for retirement. That being said, the government understands that there are many reasons you may need the money you invested before retirement. In fact, there are a list of qualified expenses for which you can withdraw money from retirement accounts.
For example, if you are over the age of 59.5, have unreimbursed health care expenses over a certain amount, want to buy your first home, need the money for education expenses, or get disabled, you can withdraw a certain amount from your retirement account. If you want to use the money for another reason you can also “borrow” from your 401K. When you borrow from your 401K you can withdraw money from the account (up to $100,000 or 50% of the amount you have invested, whichever is less) but you have to pay it back within 5 years with interest. My point? Retirement accounts must be used for retirement but there are a list of reasons for which you can withdraw money from these accounts sooner without any penalty. If you want to use the money for something else, you can borrow money from this account as long as you pay the money back within the repayment period.
Critique #4: You can’t use the money if you retire early
Truth #4: This is not true. Many people have the desire to invest as much as they can as early as they can. They want to build wealth faster and retire at an early age. However, if they retire before age 59.5, they wonder how they will get access to their retirement money without having to pay a penalty. As mentioned above, there are lots of exceptions to the retirement account withdrawal rule like buying your first home or paying back high health care expenses.
If you can’t find an early withdrawal exception that applies to you, you can use the substantially equal periodic payment (S.E.P.P.) exemption. With this exemption, you can use IRS formulas to take out an equal amount of money from your retirement account each year based on the number of years they estimate you have left to live. You must take out the same amount for at least 5 years or until you turn age 59.5, whichever is longer. My point? The government realizes you may want to retire early (before age 59.5) so it created an exemption to allow you take out money from your retirement account for this purpose.
What do you think? Will you use retirement accounts to build wealth?
5 Ways to Pass Wealth to Your Kids
As you continue to get your finances in order, you may also want to help your kids. Perhaps you plan to pay for their college education or assist them financially in some other manner. Here are 5 ways you can pass money (and wealth) to your kids.
1. Teach them good money habits. The first way to pass wealth to your kids is to teach them good money management skills. You can do that by modeling good financial habits yourself and by helping them learn how to handle money from an early age. Life can be unpredictable. Unexpected events or expenses can occur that may deplete your cash flow or alter your finances. Teaching your kids how to manage money, build wealth, and invest in efficient ways will help them create an endless number of resources and cashflow that could last years if not generations to come. However, you also have to commit to be a good example yourself.
Modeling good financial habits in front of your kids is vital because it will provide them with an example of how to handle money. This will help solidify the financial lessons you want them to learn. Kids may not always listen to what you say, but many of them copy what you do. Teaching important skills and modeling good financial habits is key.
2. Put money into a Custodial (UGMA/UTMA) account. Another way to pass wealth to your kids is to invest money on their behalf by opening a custodial account. Technically, there are two main types of custodial accounts: a Uniform Gift to Minors Act (UGMA) account and a Uniform Transfer to Minors Act (UTMA) account. Both of these accounts allow you to invest money on behalf of your child as the “custodian” or person in charge of the account. You contribute as much money as often as you like in the account and invest it however you choose. Once your child reaches the legal age of maturity (which can range from 18-25 depending on the state), he or she will get all of the money and assets in the account.
The perk of using a UGMA or UTMA custodial account is that your child can spend the money in this account on whatever they want. If they decide to go to college, they can use it for college. If they want to start a business, they can use it to start a business. If they want to use part of it to pay for a wedding, a down payment on a home, or travel abroad they can use it for those things as well.
3. Invest money in a 529 account. Another way to pass wealth to your child is to help them avoid debt. Although children aren’t born owing money, many teenagers acquire a substantial amount of debt from one key event in their lives: college. If you can prevent your kids from having to take out student loans for their education, then you will have saved them thousands if not hundreds of thousands of dollars in debt. Without debt, your kids will have more money to invest, start a business and pursue their dreams.
One of the ways to prevent them from taking out debt is to pay for their college education. Since the price of a college education is so high, you should plan for this event in advance and invest money for it early. One of the best ways to do that is to open a 529 college savings account. Through this account, you can invest money for your kids’ education in a tax-efficient manner. The money grows each year and accumulates over time. When your kids go to college you then have a substantial sum of money with which to pay for it.
4. Open a Roth IRA. Another way to pass wealth to your kids is to invest money in a Roth IRA. Through a Roth IRA your kid can start building wealth and investing for their own retirement at an early age. Starting as a child allows them to use the power of compound interest to their advantage which can have drastic effects on their net worth as they age. Investing $10,000 from age 15 to age 16 in index mutual funds through a Roth IRA (assuming an average interest rate of 10% per year) will grow to over $1.1 million by the time your kid turns 65. This means their retirement would be fully funded from an investment they made as a teenager!
Helping them make this investment in a Roth IRA as a teenager not only helps them build wealth but it also gives them the freedom to take more risks in their lives. They can start a business, try other investments, and have the ability to live the life as they want. However, in order to make this investment in a Roth IRA, your child has to have "earned income" in which they are paid as an employee or contractor for work. In order for your child to get this "earned income," you can either have them work a summer job or you simply hire them for your own business. For example, you can start a business and hire your kid or launch a website with some family photos and pay your kid as a model. There are several ways you can help your child earn income to invest in a Roth IRA.
5. Start a Trust. Another way to pass wealth to your kids is to talk to an estate planner/lawyer to open a trust. Technically, there are two types of trusts: revocable trusts (in which you can set up the trust for someone but take money in and out of it at any time if you need to) and an irrevocable trust (in which money placed in the trust is permanently there and cannot be withdrawn by you at a later time).
There are various reasons people may choose one type of trust over the other. However, both types allow you to give money and assets to your kids as you see fit. For example, you can place $10,000 in the trust for them to get at age 25. Put $100,000 for them to get after you die. Or, you can place $20,000 in the trust for them to get in increments of $5,000 every 5 years once they turn 18. With a trust, you can make up the rules and have them implemented however you want.
What do you think? Do you plan to pass wealth to your kids using one of the methods above?
Want to invest and build wealth sooner? Use Retirement Accounts
In the last few years there has been increased interest in investing. People from all over the world have downloaded apps like Robinhood to purchase stock in various companies. Some have even used the app to put money in alternative investments like cryptocurrency. Although this desire to build wealth is well-intentioned, there may be a better way to reach this goal: Retirement accounts.
Before you roll your eyes and write me off, hear me out (or I guess read me out). Retirement accounts aren’t just for middle aged and older adults who want to stop working in the next few years. Retirement accounts are useful for everyone. Although the original purpose was to help people invest money to use when they reached their 60s and 70s, retirement accounts can be extremely useful to you now, even in your 20s and 30s. The benefits you get by using retirement accounts can help you build wealth much more efficiently. You should consider using retirement accounts to invest money and become financially independent for the following reasons:
Using retirement accounts allows you to keep more of your profits– since you pay much less in taxes. Apps like Robinhood are considered taxable accounts. The money you use to invest is taxed, the profits you make are taxed, and the revenue you get after you cash out the investment is taxed. That’s 3 types of taxes! When you invest through retirement accounts you don’t pay nearly as much in taxes. Some retirement accounts like a 401K or 403b are tax-deferred. This means you delay paying any taxes until decades later when you take the money out. With other retirement accounts like a Roth IRA, you invest with money you earned and never have to pay taxes on the profit you make. Plus, you can take out the money you contributed at any time tax-free. My point? Using retirement accounts helps you save money because you pay less in taxes.
Using retirement accounts may help you get extra “free” money to invest – since you may get a contribution “match” from your job. Another perk of using retirement accounts to build wealth is that you usually get to invest more money. Retirement accounts are usually offered through your employer in the form of a 401K, 403b, or 457. As part of a benefits package at your job, your employer may offer a retirement account “match.” This is when the job gives you extra money, in addition to your salary, to invest in a retirement account. The amount they give you usually matches the percentage of your salary you choose to invest in retirement accounts. If you invest 5% of your salary, they will “match” your contribution with an additional 5% to put in your retirement account. With this match your job is giving you extra free money to invest with. Why not take advantage of this offer?
Using retirement accounts can lower your taxable income – which can decrease your student loan payments. Most of the retirement accounts offered through your job (like a 401K, 403b, or 457) are tax deferred. Since the money is tax-deferred, you don’t have to pay taxes on it until you take the money out years later. This means the more money you contribute to retirement accounts, the less money you owe when you file your taxes each year. It could even increase the amount of your tax refund. Since contributing to retirement accounts lowers your taxable income, it also lowers any income-based repayments that are tied to your income – like your federal student loans. The more money you contribute to tax-deferred retirement accounts, the lower your taxable income and the lower your federal student loan payments. Although interest will still accrue on your loans, this may be a good benefit for anyone currently enrolled in a student loan forgiveness program.
Using retirement accounts can help you invest on a more consistent basis – since contributions are connected to your paycheck. If you are a person seeking to invest more money to build your net worth and eventually have enough money to quit your job, pay for your kids’ college, pay off your home, or travel the world, you have to invest. You can’t merely save your way to wealth. Your money needs to make more money and grow. The only thing better than investing your money is doing so on a consistent basis. Year after year, month after month, make investing a habit. Make it routine. Make it automatic. One way to do that is to take advantage of an investment account that is already set up to help you make consistent investments – your work 401K. For some people it may be called a 403b or a 457 or perhaps they are self-employed and have an IRA or solo 401K. Either way, you have retirement accounts at your disposable and these accounts are set up to help you invest on consistent basis every time you get paid.
Using retirement accounts gives you more asset protection – since money in these accounts is protected from your creditors. Sometimes unexpected things happen in life. If for some reason you were sued, owed someone a lot of money, or happen to file for bankruptcy, your creditors could garnish your assets and take any money you have in banking accounts or in a taxable account like Robinhood. That is not the case when it comes to most retirement accounts. Retirement accounts offered through your job (like a 401K or 403b) offer much more asset protection because they are protected under the Employee Retirement Income Security Act (ERISA). This means your creditors cannot take the money you have in your work 401K to pay off your debts. If you are named in a lawsuit, the person suing you cannot go after the money you have in your 401K.
My point? As you start investing, prioritize using retirement accounts. When you use retirement accounts you get better asset protection and more money from your employer. You also pay less in taxes, keep more of your profits, and can invest on a more consistent basis.
Want to Invest Money for Your Child? Consider a Custodial Account
Many parents want to set their kids up for financial success. One of the best ways to do that is to invest money on their behalf. Although there are many different investment accounts to choose from, consider opening a custodial account for your child.
What is a custodial account?
A custodial account is a type of account you can open to invest money on your child’s behalf. Technically speaking, there are two main types: A UGMA (Uniform Gift to Minors Act) and a UTMA (Uniform Transfer to Minors Act). With a UGMA, you can invest money in securities like stocks and bonds on their behalf. With a UTMA, you can invest in securities like stocks and bonds along with additional things like real estate or even put tangible assets like properties and businesses in your child’s name. A UTMA allows you to do everything that UGMA does, plus more. (UTMA’s are not offered in every state so some people are limited to a UGMA).
How does it work?
You call up a financial institution, like Fidelity, Vanguard, TD Ameritrade, etc, and let them know you want to open a custodial account for your child. The account will be in your child’s name and you will be the “custodian” or the person controlling the account. You then put as much money as you want into the account as often as you’d like to invest. Once your child hits the legal age of maturity (which ranges from age 18-21, depending on the state) they get all the money in the account. Some states like Florida, give you the option to delay the age in which your child gets the money until age 25, if you want.
What are the advantages?
It allows you to invest money for your child. By investing money, instead of merely saving it, you will be able to stack up more money for your child over time. If you saved $25 a month for your child starting from the time they were 5 years old, by the time he or she turned 21 you would have stacked $4,800. However, if you had instead invested that money (in index mutual funds which make an average of 10% per year) by the time your child turned 21, he or she would have $10,780. That is more than double what you would have if you only put the money in a savings account!
It provides more flexibility than other investment accounts. Unlike other investment accounts that you can open for your child (like a 529 account or a Roth IRA), with custodial accounts there is no rule on what your child can or cannot spend the money on. If they decide to go to college, they can use it for college. If they want to open a business, they can use it for that. If they want to spend ½ of it to buy a home and the other ½ to pay for their wedding or fund a travel experience overseas they can do that too. It’s your child’s money to do as he or she wishes.
There is no contribution limit. With a custodial account there is no income limit on who can and cannot contribute to the account (like there is with an Educational Savings Account) and there also is no limit to how much or how little you can put into the account each year (like there is with a Roth IRA). It doesn’t matter if you are rich, poor, or somewhere in between, anyone can contribute any amount of money to a custodial account as frequently or infrequently as they want on behalf of their child. Contributions over $15,000 per year will trigger the federal gift tax, but technically speaking you can put as much money in the account as you want. That is not the case with some of the other investment accounts.
What are the drawbacks?
Like almost any type of account, there are things to be cautious of if you decide to open a custodial account on behalf of your child:
The money is your child’s to keep and you can’t take it back. If you are in a financial bind and need money for an unexpected car repair or to repay debt, you cannot withdraw money from the custodial account to do so. When you contribute money to the account you are legally giving the money to your child. This means you cannot take the money back later if you want to. It belongs to your child.
Your child can spend the money on whatever he/she wants. Once your child hits the legal age of maturity, it is their money to spend how they want. While this gives them lots of flexibility, it can be problematic without the right discipline. You may want your child to spend the money on college expenses or a home down payment but he or she may instead choose to spend the money on a fancy car, blow the money on drugs and clubs, or lose it all gambling.
You have to report it on your tax forms and any financial aid forms for school. Since it’s an investment account that makes money, technically speaking, your child must pay taxes on the profit made from investing in the account. Any profits made in excess of $2100 per year is taxed at your (the parent’s) income tax rate. You can choose to pay taxes on your child’s behalf. You can also minimize any taxes owed by investing in low-cost index funds and simply waiting until your child reaches the legal age of maturity to sell any investments. However, if your child goes to college, he or she will have to report any assets they have (including money in this custodial account) to the school which may decrease how much financial aid he or she is eligible for.
Given the drawbacks is it still useful?
Many people think so, but that’s a personal decision that you have to make for yourself. If you know your child will blow the money on drugs and parties then perhaps a custodial account isn’t the best place to invest the money. If you aren’t sure if your child will go to college or anticipate they may need money to pay for a wedding, buy a car, or start a business in the future, then perhaps a custodial account is a good place to invest money.
If you invest money in a custodial account then realize that your child wants to go to college (or think they may be irresponsible with the money in the custodial account) you can use the money to pay for college directly or transfer money from the custodial account into a 529 college account in their name. My point? Custodial accounts can be useful and you can invest in them in addition to other investment accounts like a 529 college savings account or a Roth IRA.
Tell me, would you consider opening a custodial account for your child?