It’s that time of the year when many families are excitedly getting ready to attend their children’s college graduation. Where has the time gone? It feels like just yesterday that we were dropping them off for freshman year.

Well, time does pass quickly and now would be a really good time to give your graduating children some savings and investment advice. Below are a few things that new graduates should take action on as they move into the next phase of their life:

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Retirement planning is often something that kids will put off until they get a better grasp of their cash flow, but they should understand the concept of compounding returns. If you invest $5,500 per year for 45 years and get returns of 7% per year (average total returns for the S&P 500 since 1900 is 9.7% per year including dividends) the account would be worth just about $1.8 million. If you invest $5,500 for 35 years with 7% return, the account will be worth about $872,000. Quite a difference.

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There are a few options to consider-If the graduate gets a job at a firm that has a 401K plan, they should contribute money to that account on a pre-tax basis deducted directly from their paycheck. If the company has a matching component to their 401K plan, your child should contribute at least the amount to obtain the maximum company contribution. This is free money! For 2018, the maximum contribution that an employee can make to their 401k plan is $18,50

Start an Individual retirement account (Traditional IRA vs Roth IRA) – Your child can contribute to an individual retirement account whether or not they are contributing to a 401K at work. Ideally, they should try to contribute the maximum amount to both each year. The total amount that a person can contribute to all traditional and Roth IRAs combined is $5,500 in 2018

Difference between a traditional IRA and a Roth IRA

Money contributed to a tradition IRA is pre-tax money. This is dollars that are deducted from your annual income which you will not pay income tax on. The money grows tax-free until you start to withdraw money. 59½ years old is the age you can start to take money out of an IRA with no penalty. Any money withdrawn from an IRA will be taxed at the tax rate of the individual at the time they take the withdraw. You are required to start taking required minimum distributions once you hit age 70½.

Money that is put into a Roth IRA is after-tax money. Meaning that you have already paid taxes on the money before you contribute to the Roth IRA. The money grows tax-free in the account the same as in a traditional IRA, but, you do not pay any income tax on any withdraws because you have already paid taxes. Also, there is not an age at which you are required to start withdrawing. There are income restrictions on who can contribute to a Roth IRA (less than $132,000 if single).

An increasing amount of companies are offering a Roth 401k. This option should be the first choice if it is available.

Take a close look at your student loans – Is it a federal loan? If so you may be able to consolidate loans and also may qualify for a “Pay as you earn” (PAYE) program or an income-based repayment plan (IBR). These programs can help the graduate set up a payment plan that is more affordable based on their income.

If it is a private loan, check with the lender to see if there is a possibility to re-finance the loan for a lower interest rate.Oftentimes, a private loan will have a higher interest rate when the student established the loan if they had a lower credit score. Once the graduate establishes an income, their credit score may be higher.

Start paying your loan off as soon as you can. Interest will be accruing as you delay paying your loan!

Set up a budget–Making the transition into the “real world” can be exciting and fun…..but new graduates will quickly realize that a lot of the costs of living that they did not see, will now start to come their way: rent, food, cell phone bills, Hulu, healthcare – it will be a long list. Setting up a budget early after graduation is of utmost importance. Included in that budget should be a certain amount put away for savings, investing, and yes, even retirement.

Please reach out to us at Chatham Wealth Management if you have any questions that we can help with (800) 472-8086.