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4 Money Tips for New Workers

March 24, 2016
401(k), Investing, Personal Finance, Roth IRA
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By Heather Castle

Learn more about Heather on NerdWallet’s Ask an Advisor

So you landed a new job. Congratulations! You’re making money. But do you know what you should be doing with it? Most people don’t learn about money management in school. There are many things to consider, such as evaluating your employee benefits, deciding how to invest your hard-earned money and saving for an emergency.

You don’t want to learn these financial lessons the hard way, through unnecessary — and expensive — mistakes. Here are four tips to help you manage your exciting new income.

1. Understand your employee benefits

If your company offers a benefits package, take advantage of it. Step one is to talk with someone in your company’s human resources department. They can help you understand which benefits — like health, disability and life insurance and retirement savings plans — would be best for you.

Generally speaking, if you aren’t married and don’t have children, you probably don’t need a lot of life insurance because you don’t have someone who is financially dependent on you. However, buying long-term disability insurance could be beneficial because it would cover lost income if you were unable to work for an extended time. When you review your health insurance options, weigh the pros and cons of a high-deductible plan with lower monthly costs against a lower-deductible plan with higher monthly costs.

But remember, everyone’s situation is different. So don’t just ask a co-worker — talk with your HR department or consider working with a financial planner to maximize your benefits.

2. Make the most of your 401(k)

You may be eligible for an employer-sponsored 401(k) retirement plan. With a 401(k), you contribute money you have earned before taxes, and you pay taxes when you take the money out. The idea is to contribute to the plan throughout your working years and then draw on these funds once you retire.

Many companies offer to match a percentage of your contribution. If you don’t take advantage of a match, you’re leaving money on the table. Each company has its own rules about how much of its employees’ contributions it will match and when. Make sure you understand the rules and contribute enough to get all the cash you’re eligible to receive.

While it’s important to save for retirement, it’s also important that you’re not stuck with high-interest student loan or credit card debt. If you have debt with high interest rates, work out a strategy in which you don’t contribute as much to your retirement plan so you can pay down that debt. However, I suggest still contributing at least as much as necessary to receive the maximum company match.

Just as with your other corporate benefits, when it comes to your 401(k), start by connecting with your HR department to see what your company’s rules are. If you have questions about how much to contribute, there are many calculators to help you understand what your take-home pay will be at different contribution levels.

3. Determine your risk tolerance and invest your 401(k) funds accordingly

Risk tolerance simply means how much risk are you comfortable taking with your money, based on your personality and your time horizon. Understanding your risk tolerance will help you determine how to invest your 401(k).

The general concept is that higher-risk investments, like stocks, tend to make higher returns over the long run, compared with lower-risk assets like bonds. If you have a low risk tolerance, you’d want a smaller portion of stocks in your portfolio. If you have a greater risk appetite and a long time until you need the money, you may be able to consider holding more stocks.

Another option for your 401(k) is to choose target-date funds. These funds have a mix of stocks, bonds and cash with a risk level based on how long you have until retirement. They are set up to have more exposure to risky investments when you are young and then, as you approach retirement, they automatically scale back this allocation to a more conservative mix.

But remember that all investing has risk, even with less risky assets. This is why it’s so important that you understand what level you’re comfortable with. If you’re unsure, take a risk tolerance assessment.

4. Create an emergency savings fund or open a Roth IRA

In addition to putting money in a 401(k), I also recommend you set aside money in an emergency fund. Emergencies can include needing to fix your car, an unexpected medical bill, a period of unemployment and many other scenarios.

An emergency savings account is important because it will help keep you from taking on debt. However, if you have debt with high interest rates, I suggest paying that down before focusing on an emergency fund. Once you have paid down your debt, you can continue to make the same payments to your emergency savings account and build it quickly. Ideally, you should have between six months and one year of expenses saved up.

One way to create an emergency savings account is by funding a Roth IRA. With a Roth IRA, you contribute money you’ve paid taxes on, but all withdrawals are tax-free after age 59½. However, the beauty of a Roth IRA is that if you need to access your money sooner, you can withdraw the money you’ve paid into the account without incurring any penalties or taxes. (Any investment earnings those deposits have made, though, will be taxed if withdrawn early.)

I recommend holding your emergency funds in cash within the Roth IRA to avoid the risk that you might have to sell investments at a loss if you do need the money. Once you have enough emergency savings in cash in the Roth IRA, you can invest anything above that amount.

This could be a good strategy for people to start with if they don’t have the money to both invest in a Roth IRA and save in an emergency fund. That way, if you don’t need the money, you can keep it in the Roth, invest it, and it will continue to grow tax-free until you use it in retirement. Using a Roth gives you a bit more flexibility now in terms of choosing how to use the money and helps you take advantage of this type of account to fund it for the future.

>> MORE: How to open a Roth IRA

But remember, if you are using the Roth as an emergency fund and a retirement fund, the retirement portion would be invested and you should not use it unless absolutely necessary. It’s critical to understand that if you withdraw any earnings in the account prior to age 59½, you could be faced with a penalty and taxes. Also note that you must have earned income to contribute. And while the maximum allowable contribution is $5,500 in 2016, be aware that there are income eligibility limits for high earners.

>> MORE: The best Roth IRA account providers

Smart steps

These four guidelines will help make sure you’re handling your first paycheck wisely and creating good money habits you can use throughout your working years. Even if you’re in your 30s or 40s, it’s not too late to take a closer look at your finances or start a new retirement account. By following these tips today, you’ll be taking care of yourself and preparing for a comfortable future.

Heather Castle, a former vice president of investments at Stifel, will be launching her own firm, Castle Wealth Advisors LLC, in April.

This story also appears on Nasdaq.