Deciding How to Fund Your Future

Starting a full-time job can be daunting for more than a few reasons. New coworkers, new environments, and an abundance of information to learn paired with a limited timeframe in which to learn it can make the prospect of starting work intimidating for any young adult. One of the most stressful and confusing subjects across all industries, however, is how to properly save for retirement. To many, the idea of foregoing money now in order to receive money later seems impractical. When young adults first start full-time work their expenses are high and their salaries are low; it may seem more reasonable to spend money on expenses when they are young and begin saving later than to go without today and have more money in the distant future.

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To some extent, that logic can be correct in certain situations. If a worker has to choose between saving for retirement and paying off high-interest debt, such as student loans or credit cards, it is usually better to pay off the debt. As wonderful as compound interest is when applied to savings, it can be equally devastating when applied to debt. In most other cases, however, it is better to begin saving for retirement as soon as possible.

After someone makes the decision to save, they have to determine what method of saving is best for their unique situation. This means evaluating where they are in their life and career, and where they expect to go. For most young adults this might seem like a veritable shot in the dark; how can they expect to know where they will be in fifty years when they barely even know where they’ll be in five? Thankfully, for most Americans there are three main plans to consider: Employer-sponsored plans (such as 401(k)s and 403(b)s), Traditional IRAs, and Roth IRAs.

Individual Retirement Arrangements, or IRAs, are tax-advantaged savings accounts that an employee can contribute to on a limited basis even after maxing out employer-sponsored plans like 401(k)s or 403(b)s. Traditional IRAs are tax-deferred, which means contributions aren’t taxed until money is withdrawn. Roth IRA contributions, on the other hand, are fully taxable, but their earnings and withdrawals are generally tax-free. Employee-sponsored plans are tax-deferred, like Traditional IRAs, but may receive contribution matching by the employer. This difference makes one method of comparison immediately evident: A Roth is preferable to a Traditional or 401(k) if you expect to be in a lower tax bracket when contributions are made than in retirement. The opposite is true if you expect to be in a lower tax bracket during retirement.

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This is most apparent when applied to an example. Say you deposit $5,000 into a Traditional IRA or Roth IRA at age 20, when your income tax is 15%, and leave it there for 50 years at an average annual return of 4%. You withdraw the entirety of the account at age 70, when your income tax is 30%. The initial after-tax contribution to the Roth IRA will be $4,250, which will grow to $30,203 over 50 years. The initial contribution to the Traditional IRA will be $50,000, which will grow to $35,533.42, but after a 30% tax on withdrawal will only put $24,873 in your pocket. The same comparison would be true between a 401(k) and a Roth.

Of course, this is a very simplified view of retirement plans that only addresses the tax benefits of each account type. Other factors such as AGI, debt level, and actual projected retirement income should all be considered when determining how to save for retirement. For more information on how best to supplement retirement savings in your specific situation, contact a financial professional.

Investing v. Paying Off Debts

If you’re like most 20-something Americans, odds are that you’re in debt. Student loans, car payments, and credit card debt can add up incredibly quickly, taking a bite out of every paycheck you receive. For many Americans this debt can seem unmanageable; in fact, a study by the American Psychological Association shows that money trouble is one of the leading stressors of American youths. With this in mind, it may seem that the logical course of action is to pay off all debts as soon as possible. In this economic climate, however, with low mortgage rates and sky-high credit card interest, it’s often more complicated than that. Sometimes, the more prudent decision is to hold onto your debts and invest the borrowed money.

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It should be noted, before discussing whether to invest or pay off debts, that in some circumstances you should do neither. The first priority for most Americans should be establishing an emergency fund: enough money to pay for 3-6 months of expenses in the event of income loss. It should also be noted that making the decision to invest your money instead of paying off debts assumes that you will continue to make your regular payments toward the debt. The profit from investing borrowed money disappears very quickly once you start adding late payments and interest accrual. So, you’re a young adult with debt and disposable income. Should you invest the extra income, or pay off your debts?

The short answer is that it depends.

The long answer is that both interest rates and available investment vehicles must be taken into account when making this decision. For instance, if you’re deciding between paying extra toward a mortgage with 3% interest, or investing in the market where you could receive a conservative 7% return, you should invest. Ignoring taxes, the borrowed money will be earning a return above what you need to pay back, netting you a 4% return. Conversely, if you’re paying 12% interest on a credit card loan and can only make 8% in the market, you should pay off the credit card before investing. However, what if the investment vehicle you would use is a 401(k) or a Roth IRA? On a relatively small loan, employer matching on 401(k) contributions could make the monetary benefit of investing much greater, even if the interest rate is lower than the debt rate. It may also reduce your taxable income for the year, saving money on taxes. Similarly, investing in a Roth when you’re in a lower income tax bracket may be more profitable in the long run than paying off a relatively stable debt with a higher interest rate.

Luckily, the disparity between consumer and non-consumer debt interest rates tends to make this decision easier. In 2015, the average 30-year mortgage rate was 3.85%, while the average credit card interest rate was an exorbitant 12.09%. With a conservative 7% return in the market, the choice is clear: pay off consumer debts, and invest with your non-consumer borrowings. Often, that rule of thumb is enough.

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Of course, this is only from a mathematical perspective. In reality, most Americans should prioritize saving at all points in their life; otherwise, people will always find reasons not to save. Even with a high-interest debt and a limited cash flow, it is usually best to put most of the money toward the debt while still contributing the rest toward your savings. The percentage that goes toward debt or savings should change based on how serious the debt is, but the best habit is to always save first.

Entering the World of Social Media

Clean and Neat Social Network Buttons-128x128 (1) Thirteen years ago I opened the doors of Harbor Light Planning. Since then, I’ve done everything possible to avoid social media for business purposes. Why? Good question. I think for the majority of the time, I didn’t have the time. Since I didn’t have the time, I didn’t want the extra responsibility to create content, but more so, I didn’t want the added level of compliance complexity using social media brings into the fold.

I’ve watched social media grow to a point where it has become impossible to ignore. I still don’t have a twitter account, I don’t use pinterest and I use facebook for purely personal purposes. So, why start now?

I recently decided that my time as a solo practitioner was not doing all I can do for the financial planning industry. Our industry has done a great job getting the word out how important it is for everybody to employ a fee-only financial planner. Our industry has done a great job educating young people about how great a career in financial planning can be. The disconnect comes in that most fee-only financial planning firms are extremely small. Therefore, not providing enough financial planning college grads with job opportunities, or ability to learn from those more experienced. I was lucky enough to be hired by a firm, to learn, to grow, to become successful (with them or on my own). Now has come the time to pass on my 25+ years of experience in tax and financial planning to the next generation of planner.

A few months ago, my practice of one doubled in size to become two. In all honesty, to double in staff size brings a need for new clients. Which types of prospective clients will be the right type of client for our newest staff? Well, most clients like to work with someone like them, and most planners also like to work with someone like them. Although it’ll be at least year before Kyle will be ready to service clients on his own, he deserves clients that can relate to him and vice a versa. The ideal client demographic for his age, use social media, a lot.

Stay tuned for information on our New Journey’s program designed specifically for the young professional.