First, I think congratulations are in order! You just received your first REAL paycheck and kicked off the beginning of what you hope will be a successful career in corporate America. Develop frugal spending habits early in your career and your net worth will steadily rise, month after month. Waste your money through repeated financial mistakes, however, and you will find yourself in a wicked downward spiral that gets tougher to escape with each passing year.
Be smart with your money from the beginning. Here are the five smartest things to do with your first paycheck:
1. Resist expensive celebrations
I get it: When we aren't used to a steady paycheck, we might find ourselves looking for ways to enjoy our sudden influx of cash. That feeling is natural and it happens to all of us. But, there is a major problem with that feeling.
It's a trap! The spending habits that we form early on tend to stick with us throughout our careers. Worse, our celebrations often overflow into subsequent paychecks as we continue to "enjoy," through the acquisition of stuff, our new source of money. Unconsciously, we are telling our minds that this type of spending is okay, and the more we do it, the easier it becomes. Habits are forming. The spiral is taking shape.
I know it is tempting to spend the majority of your first paycheck, but resist that feeling as much as possible. Instead, begin developing smart money habits. What are smart habits? Keep reading.
2. Establish retirement savings
If you aren't saving for retirement yet, it's time to start! Many companies offer 401k savings accounts. Some will match a certain percentage of your salary if you choose to open an account and contribute. If your company offers a 401k, sign up immediately. Not only will this investment account build over the years with consistent contributions, but 401ks also reduce your taxable income. In other words, this lowers your tax responsibility come April 15th.
If your company doesn't offer a 401k, open a Targeted Retirement Account through a financial company like Vanguard. These are long-term investment accounts that are automatically diversified in the stock market, which makes your job as easy as transferring money into them - hopefully on a regular basis. Setup an automated monthly transfer from your bank to keep those contributions going. Over time, this account will grow substantially, leaving you with a sizable nest egg come retirement.
3. Consider a Health Savings Account (HSA)
Health Savings Accounts are separate savings accounts designed specifically for spending on health-related concerns, like deductibles or prescription drugs. An HSA may be a part of your company-sponsored health insurance plan.
They work like this: A portion of your paycheck funds your HSA every month, tax-free. In addition, HSA contributions reduce your taxable income just like a 401k, which helps to decrease your tax responsibility further. In other words, federal taxable income is reduced by the amount of money you deposit into the account over the course of the year.
HSA funds are spent, on IRS-approved items, using a debit card that works at cash registers just like any other type of payment card. For a list of IRS-approved health expenses, see this page.
4. Open a Roth IRA
Yet another savings account? Yes, and here is why the Roth IRA is such a great deal. In traditional investment accounts like a 401k, all capital gains are taxed at the point of withdrawal. They are also "pre-tax," which means they reduce your taxable income by the amount deposited.
A Roth IRA works differently. Roth IRA accounts are "post-tax," which means contributions are made after taxes have been removed from your paycheck and do NOT reduce your taxable income. However, these accounts are not taxed at the time of withdrawal. Every dollar in your Roth IRA account is yours tax-free because taxes have already been taken out (at contribution time). This amounts to a significant tax savings when this money is withdrawn during retirement.
Because this is such a great deal, the government has limited the maximum contribution amount to $5,500 per year - if you are under the age of 50. If 50 or older, $6,500 can be contributed yearly. For more detail on Roth IRA limits, see this page.
5. Set up a plan for the future
Almost a decade and a half ago, I had no financial plan after scoring my first professional job out of college. I finally made good money and felt like it needed to be spent. I had no goals and largely ignored my future. I took advantage of my company-sponsored 401k, but that's it.
Don't make the same mistake that I did. Your first paycheck is more than just money. It symbolizes your first step in the accumulation phase of your life. This is the point where money is made and, hopefully, saved. We are wise to understand that our retirement later in life depends on the decisions that we make today. Take this responsibility seriously.
Where do you want to be in 10 years? Do you have a dream of retiring early? Do you want to become a millionaire? Spouse? Kids? Don't ignore your future. Use your first paycheck as a stepping stone to where you would like to go. It's more than money, it's the beginning of the rest of your life.