Q Hi Rick:
I am a recent graduate from graduate school. I have a couple financial questions I hope you can help me with. My situation is that I have approximately $80,000 in student loan debt. Sixty-thousand dollars of that is at eight percent and the remainder is at six percent. I have begun making payments. Unexpectedly, I am going to receive an inheritance of between $60,000 and $65,000. My main question is what I should do with the inheritance. Some of my friends think I should use it to put a down payment on a home while others think I should pay off my debt. I should also mention I have about $5,000 in charge card debt that I will definitely payoff with this inheritance. I am still living at home and my parents told me I should write you for some advice. Therefore, what would you recommend I do with the inheritance? Also, I am curious as to how much you think someone like me in their mid-20s who is just starting out their career should start saving for retirement.
A Dear Todd:
First of all, congratulations on your achievements and starting off your career. As I have told people many times in the past, the greatest investment you can ever make is towards a good education and therefore, congratulations to you.
In reviewing your situation, I love the idea that you are going to pay off your charge card. Charge card interest can drain someone and that is why it’s always important to make sure you use your charge card properly. As far as I’m concerned, charge cards should be used as a matter of convenience, not to finance a purchase.
For as long as I’ve been in the financial world, I’ve always been a believer that other than a mortgage on someone’s home, debt should be kept to a minimum at best. Debt has a way of strangling someone and reducing their options into the future. I believe that someone who is debt free has much greater flexibility that will help them into the future. Therefore, my recommendation to you is to pay off the student loan debt and put off the idea of a home for a while.
One thing many people are confused about student loan debt is they think that the interest is 100 percent deductible; that is not the case. Student loan interest is capped at $2,500 per year. In fact, if you make more than $65,000 a year you start losing your ability to deduct student loan interest. Therefore, in the case at hand, by paying down the debt you’re getting almost a guaranteed eight percent a year.
With regard to retirement, my general rule for someone starting off their career is they should be saving 10 percent of their gross. I know this is a large number; however, I am not sure what the alternative is. The reality of the situation is the fact that people are living longer and as a result, it will cost them substantially more to live in retirement. Think about this. If you go back 100 years, retirement wasn’t an issue because life expectancy was around 60 years of age. Fast forward today, it’s not unusual for people to live 20 and 30 years into retirement. Now just think where we will be 40 years from now when someone who is just starting their career today is beginning to retire. With the advancements in medicine, 40 years from now it won’t be unusual for someone to live 40 years in retirement. Therefore, to have the resources to be able to enjoy your retirement, it makes sense to begin saving now. The 10 percent number is what I believe you would have to save in order to put yourself in a position where you can afford to enjoy a long and happy retirement.
I recognize the 10 percent number scares many people; however, it should not. The 10 percent is a goal. If you can only start with four or five percent, that’s fine. The key is to start saving for retirement as soon as you can and to constantly look for ways to increase your retirement savings. As far as I’m concerned, you cannot afford to save too much for retirement.
There’s no question that we live in the greatest, richest country in the history of the world. However, there’s nothing worse in this country than being old and poor. Therefore, my advice to all recent college graduates is to begin to save for your retirement as soon as possible and to set 10 percent as your goal. The sacrifices you make today will definitely pay dividends well into the future.
Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at email@example.com