“the magic of compounding is hard for her to grasp”
You can find good graphs/charts online which will help with a pictorial especially ones that show the difference between higher rates of return and not.
^^ My government agency matched 10% (two different funds, 5% each), but only up to the max allowed, and not the extra catch up for over 50. My daughter’s employer just gives her 8% into her account after 1 year of employment; she doesn’t have to put anything in to get the contribution. Yes, just an 8% raise for her on Aug 1.
A million different funds, a million different ways employers can match or contribute.
Wow, I sure wish I had had any job that matched ANY part of my contributions. Even without it, I socked away the maximum and it has grown greatly in the years since it was contributed. @LuckyCharms913 – good for you to keep encouraging her saving ways!
Seems like this should be a simple real-world application of what she learned in those courses…
DH and I both have the same employer. We get a 100% match on 10% of our income (this is a 403–same as a 401 but for government non profit employees).
If your daughter is eligible, she absolutely should contribute as much as she possibly can to an HSA. Neither the contributions nor the earnings are taxable now or ever as long as they are used for medical expenses. For public and non profit employees, those contributions are also exempt from social security and medicare taxes.
The savings calculator on bankrate is a good simple one to illustrate the power of compound interest. Have your daughter figure out how little money she would have to save a month to accumulate 1M or 2M over 30 years.
- I would allocate to the 401k up to the full match.
- Next I would fully fund a roth IRA (contributions are after tax- and most people don't know this - you can always access the principal tax and penalty free prior to age 59.5 provided it's not a conversion which it wouldn't be in this scenario)
- Emergency fund
- non-qualified mutual funds (basic stuff like s&p 500, other indexes)
- market based, cash value life insurance totally focused on the investment (least amount going to coverage). I've done this for years - like 20 - and have built up large tax favored amounts of cash value that can be used for anything at any time. Currently paying for S' college with that.
Actually I would move 5 up the list as it works like the roth just without restrictions, but most on CC will argue that point. To each his own. I have the benefit of actually knowing how it works vs. listening to the Suzi Ormands of the world.
It occurs to me that if your daughter is not eligible for an HSA account, she could take advantage of an FSA account. Those contributions are exempt from both income and payroll taxes (i.e, instant 30% plus return on your money for anyone in the 22% tax bracket). The catch is that FSA contributions are not invested as are HSA funds and must be used within the calendar year, with the exception of a $500 rollover allowance. So your daughter would need to conservatively estimate what her medical expenses (including dental, vision and over the counter medications and supplies) will be for the year.
We all have some medical expenses every year…and we should be paying those expenses with tax free funds to the greatest extent possible.
Michelle Singletary, who writes about personal finance for the Washington Post, recommends separating the emergency fund (for job lay-off, losing the roof on your house, other major disaster) from the life happens fund (relatively predictable biggish expenses like new car tires, expensive car repair, your half of the expense for a root canal and crown, etc.). The two funds get built up along the way, with the life happens fund topping out at the new tire/car repair/dental work level, and the emergency fund topping out at what you want to have available to survive a long lay-off. This strategy keeps the emergency fund safe from random life happenings, and trains the saver to re-fill the life happens fund quickly after it has been spent down for those surprise car/dental/misc. bills. Since your daughter can rely on Bank of Mom and Dad for emergency expenses while these kinds of savings are slowly building up, I would encourage her to max out the 401(k) and create a plan that would channel something each month towards emergency and life happens. With a bit of luck, she might never need to call on her private bank at all.
Wouldn’t this be more like a “variable annuity”?
Insurance products (cash value life insurance and annuities) commonly have high costs, which eat away at the tax advantage that may be gained, though some mutual fund companies have gotten into the market with variable annuities that bundle the minimum amount of insurance to minimize the added costs (though still higher than regular mutual funds). Because of the higher costs, they may only be attractive to those who want to get tax advantaged investments beyond the maximum allowable 401k/403b and IRA funding.
No, not an annuity, a life contract. Annuities are great but they don’t solve the liquidity pre 59.5 issue. I’m talking about life insurance. Good old fashioned life insurance. There are products that are in the market, tied to the market, etc. Cost of insurance is cost of insurance. Beyond that, the money is in tax favored investment buckets. The costs are less than taxes and way less than management fees on the accounts once they’re sizable. I’d much rather pay the cost of insurance and admin fees than ordinary income tax and management fees on the fund portfolio each yr. You actually save thousands of dollars each yr once the account is pretty big AND you get a tax free death benefit.
Sorry, didn’t mean to derail the thread.
I tell my kids to contribute up to what the company would match, but not more than that, because when they retire their tax rate maybe higher than when they first graduate from college. I think it is better that they build up their emergency fund and build up other big ticket item funds, instead of putting all of their savings into 401K.
One thing to remember for our kids is that while they’re trying to pour money into their 401(k), they’re also trying to save big bucks for things like a car, a down payment on a house, furniture for the house, and so forth. And maybe pay back their student loans. There are a lot of demands on a young adult’s income.
Paying back loans early is key. I would make aggressive monthly payments (not too much but way more than minimum) and add lumps sum bonuses. Knock them out in a few yrs.