Financial Planning for Life After College: A Complete Guide

Introduction and Problem Statement

It has frequently been said that the end of college is not an end at all, but rather the beginning of life's journey. Because life is a journey rather than a race, it is important to make some plans ahead of time so that the path is known and the destination understood to the extent possible in advance. When most people set out on a journey to destinations unknown, they usually secure a map ahead of time to avoid getting lost. Likewise, a map of an individual's life journey can help a person stay on course and avoid the pitfalls that await the unwary along life's roads. At any rate, with such a life map in hand, the journey through life will be more predictable and progress easier to chart.

Growing old and retiring is a phenomenon of growing importance in economic life. As a result of the establishment of Social Security in 1935, the increase of private pensions after World War II, and the general rise in living standards since the Great Depression, an extended period of retirement has come to be regarded as a normal end to a successful career. Furthermore, as a result of innovations in healthcare technology and medicine, longevity has been increasing while retirement ages have been declining. Retired people therefore represent a growing proportion of the population. When the baby boom generation began retiring, this proportion rose at a sharper rate. "Faced with the prospect of changes to retirement plan provisions, many workers will probably prefer lower early retirement benefits rather than pushing back the age at which retirement can commence" (Rappaport & Schieber, 1993, p. 148). Consequently, trends in retirement have raised important questions about the financial soundness of the main institutions that provide income to retirees and their families, such as Social Security, other public and private pension plans, and Medicare (Aaron & Burtless, 1984). Identifying effective means of ensuring a sound retirement early on just makes good business sense today.

The purpose of this study is to develop a comprehensive and viable financial plan for a graduating college student that will grow and change as he passes through the different stages of life. The key points addressed in this financial planning regimen include goal setting, saving, debt management, insurance needs, career planning, and retirement planning, and how each of these is impacted as the student moves from single to married to family to retired.

The demographic composition of the United States is changing in fundamental ways. Beyond the ethnic shifts taking place in the country, there will be far more people retiring in the years to come than ever before. The graduates of today are faced with a dual burden: inheriting this growing retired segment of workers while trying to provide for their own personal well-being and that of their families. In order to achieve a satisfactory standard of living as life progresses in this changing environment, younger workers are going to have to hit the ground running.

It is widely recognized that early planning is an important part of the retirement planning process. According to McKinney (2003), "A well-planned estate allows you to decide how your property will be administered during your lifetime and distributed after your death." Today, many Americans are affluent at midlife and are naturally looking forward to a comfortable retirement. These individuals already enjoy sizable pensions, investments, and an accumulation of assets such as homes, second homes, and other valuable property. "They need not worry about outliving their assets and may be more concerned about protecting their wealth through tax-saving strategies, estate planning and setting up trusts for their heirs" (Genovese, 1997, p. 13).

Those adults who have not begun to plan, however, may learn the hard way about what is involved in the process when they are forced to assist their aging parents with financial and estate decisions. "While many older adults have well-organized financial affairs, other adult children find parents' plans and records in disarray. They may get 'on the job' experience as they try to untangle their parents' affairs after a health or financial crisis" (Genovese, 1997, p. 13). While practical experience may be the best teacher, the importance of saving for retirement is reinforced for many people who are alarmed by their first experience with the costs of home care, retirement community living, or nursing home care. Genovese reports that a private nursing home costs $40,000 per year or more, depending on the part of the country and the type of facility. Another factor that can shock first-time estate planners is the realization that their parents may outlive their resources or face spending down their assets to qualify for Medicaid when they enter a nursing home.

Career. For the purposes of this study, the term "career" refers to employment in an occupation that will ultimately lead to retirement along a predictable career path in a profession of the individual's choosing. For those who fail to make the distinction between life's "calling" and a "career," the results can be disappointing or even disastrous. According to McGee (2003), people who do not pursue employment in an occupation they will enjoy are going to pay for it the rest of their working lives. By defining career success in terms that also embrace personal satisfaction, self-worth, the type of lifestyle demanded by the occupation, and what benefits can reasonably be expected from pursuing such a career path, the individual will be in a better position emotionally and psychologically — and perhaps even financially — when the journey is over.

Goals. A "goal" as discussed in this study is "the object of an action; it is what a person attempts to accomplish." Goals include such efforts as "attempts to sell more products, to improve customer service satisfaction, and to decrease absenteeism in a department by 5 percent" (Ivancevich, 1995, p. 219).

Goal Setting and Career Planning

Professional. According to Black's Law Dictionary (1990), a professional is "one who is engaged in one of the learned professions or in an occupation requiring a high level of training and proficiency" (p. 1210).

In 1978, Locke presented the now-classic paper "The Ubiquity of the Technique of Goal Setting in Theories of and Approaches to Employee Motivation," and ever since there has been growing interest in applying the goal-setting technique to a variety of settings. Locke's view of an individual's conscious goals and intentions was that they were "the primary determinants of behavior" (p. 36); in other words, a universal characteristic of intentional behavior was that it "tends to keep going until it reaches completion." As a result, when a person starts something such as a new job or project, that person will keep striving toward completion until the goal is achieved.

A study was conducted early on to determine whether goals change work efficiency without affecting the associated physiological cost (Wilmore, 1970). To this end, Wilmore conducted a series of experiments to determine whether goals enhanced the accomplishment of a physical task and found that "goals should be behind every performance if maximum performance parameters are to be stimulated" (p. 37). The results of Wilmore's experiments indicated that "physical performances without set goals will not produce the best form of physical response. As has been demonstrated by champion athletes, every task of training and competition must be oriented to some particular explicit goal that will focus the athlete on functioning with the greatest efficiency in performance. A physical activity at training without a goal-orientation is a wasted opportunity for improvement" (1970, p. 38).

Goal setting therefore appears to be an essential component in the effective application of physical effort. In organizational settings, the following issues have been identified as constraints to the effectiveness of the goal-setting technique; many of these also apply to the individual goal-setting process as it relates to career planning:

Goal setting seems easy, and many people assume that they have the intuition and inherent skills to set and use goals effectively; however, it has also been shown that training in specific goal-setting skills can be very effective. The career planner should therefore seek to establish goals according to goal specificity, goal difficulty, and goal intensity. Locke defines these components of the goal-setting process as follows:

For a recent college graduate in search of an effective planning technique, goal setting provides a method that is responsive to individual needs as well as those of the organization involved. Goal setting also provides solid techniques for accomplishing goals. "Research has shown that specific goals lead to higher output than do vague goals such as 'Do your best'" (Locke, 1978, p. 38). The results of goal setting as a motivational tool are overwhelmingly positive. The studies by Locke and others have shown time and again that setting specific goals leads to better performance than do vague value goals. In fact, in 99 out of 100 studies reviewed by Locke and others, specific goals provided better results (1978).

According to Needles and Powers (1998), in order for people to succeed in accomplishing their goals, they must be able to control their expenses and provide for savings. There are a number of approaches available for the young, middle-aged, and older saver today that may be applicable depending on individual needs and circumstances.

Saving Strategies and Retirement Accounts

According to Springstead and Wilson (2000), a traditional Individual Retirement Account (IRA) is a personal savings account that offers tax advantages for setting aside funds for retirement. "Annual contributions of up to $2,000 are fully tax-deductible for workers not covered under employer-sponsored pensions, for single workers with earnings under $32,000, and for married workers filing jointly with earnings under $52,000" (p. 34). In addition, workers may make nondeductible or partially deductible contributions. Investment earnings for all contributions accumulate tax-free and are not taxed until funds are distributed. The Taxpayer Relief Act of 1997 created Roth IRAs, which differ from traditional IRAs in that contributions are made with after-tax dollars but distributions are tax-free.

According to Beech (1997), there are a number of options available when considering retirement plans, including the retirement plan option called Savings Incentive Match Plan for Employees (SIMPLE). A survey by Fidelity Investments, the nation's largest mutual fund company and a leading provider of financial services, found that fully 80 percent of small business owners believed it was important to help employees save for retirement, but only 35 percent of them currently offered an employer-sponsored retirement plan. "Some business owners don't make this offer because they are overwhelmed by the choices, the expense of employer contributions and the time it takes to implement and administer these plans" (Beech, 1997, p. 28).

In the 1970s, Congress first started allowing taxpayers to contribute to individual retirement accounts (IRAs); thereafter, IRAs became highly popular in the 1980s (Bledsoe, 1998). Tax year 1998 was the first year a Roth IRA could be established. At that time, approximately $21 billion was placed into mutual funds via Roth IRAs. Since that time, the Internal Revenue Service has issued additional guidance that has affected the landscape for those interested in pursuing a Roth IRA as opposed to alternative financial vehicles, such as traditional IRAs, simplified employee pensions (SEPs), savings incentive match plans for employees (SIMPLEs), and Keogh plans, as well as Section 401(k) plans, all of which are available and offer tax deductibility to qualified taxpayers (Moore, 2001).

By March 2003, the Roth IRA had been in place for five years. Appleby suggests that this is a significant milestone for the Roth IRA, as 2003 was the first year a "qualified distribution" could occur from any Roth IRA. The Taxpayer Relief Act of 1997 created the Roth IRA, which was made effective for tax years beginning in 1998. According to Sabelhaus, the Taxpayer Relief Act of 1997 changed policy toward Individual Retirement Accounts in a number of ways. For example, income limits for eligibility for traditional deductible IRAs were increased, a new "backloaded" Roth IRA was introduced, and education expenses and first-time home purchases were added to the list of allowable reasons for withdrawing funds from IRAs before retirement without penalty. Since 1997, additional modifications to IRA law have been suggested, including more reasons for non-penalized withdrawals and changing minimum distribution requirements for taxpayers older than 70½ (Sabelhaus, 2000).

Prior to 1998, taxpayers who wanted to fund an IRA could make either a deductible or non-deductible contribution to a Traditional IRA. Distributions from Traditional IRAs are generally treated as ordinary income and may be subjected to income tax as well as an additional early withdrawal penalty if the withdrawal occurs while the IRA owner is under the age of 59½. The Roth IRA, on the other hand, allows "qualified distributions" to be free from tax and penalties (Appleby, 2003).

Workers should choose a Roth IRA over a traditional IRA if they meet the following criteria:

However, a Roth IRA has some strict rules that should be taken into consideration as well:

The positive side for taxpayers is that although contributions to a Roth IRA are not deductible, withdrawals are tax-free after age 59½. However, there is another tax-advantaged way to pre-fund a taxpayer's child's education that is superior to a Roth IRA — the Tax-Free Education/Retirement Plan (tax-free E/R plan). According to Blackman, the reasons a tax-free E/R plan is better than a Roth IRA are two-fold: (1) earnings do not count, whether an individual has zero earnings or earns millions; and (2) withdrawals are always tax-free no matter when taken and can be used for any purpose, such as a college education, home purchase, or retirement. Further, individuals can start a tax-free E/R plan at any age, and annual contributions (which are actually premiums for a specially designed life insurance policy) have no limit (Blackman, 2003).

Mary Beth Franklin and Alison Stevenson of Kiplinger's Personal Finance advise that the basic limit for a Roth IRA is $3,000; however, taxpayers age 50 and older are able to save $3,500. If an individual is not covered by a company retirement plan, all contributions to a traditional IRA are deductible. A write-off is also available to taxpayers who are covered by company plans and whose income is less than $34,000 on an individual return and below $54,000 on a joint return; however, it is phased out as income rises above those levels (Franklin & Stevenson, 2002).

If a taxpayer elects the Roth variety, he or she will receive no up-front tax deduction; however, the individual's earnings will be tax-free in retirement. The right to contribute to a Roth is gradually phased out as income levels rise between $95,000 and $110,000 on a single return and between $150,000 and $160,000 on a joint return. As a result, the sooner taxpayers make these contributions, the sooner their earnings will be protected from taxation (Franklin & Stevenson, 2002). According to Donald Jay Korn, the economic conditions of the early 2000s represented a good time to convert from a traditional IRA to a Roth IRA (2002).

Notwithstanding the opportunities available for frugal investors, saving for any type of retirement alternative can be an enormous challenge for some people, particularly younger workers who will likely be earning lower wages. Further complicating things for younger people is the fact that there are high costs associated with raising young children. For these younger workers, a new incentive was recently added in the form of a tax credit for savers who contribute to a company plan or IRA. This incentive credit ranges from 10 percent to 50 percent of what is deposited (up to $2,000 a year, depending on income and filing status). For instance, Franklin and Stevenson use the example of a married couple with an adjusted gross income of $30,000 or less receiving a 50 percent credit (2002).

The credit is reduced to 20 percent when AGI is between $30,000 and $32,500, and to 10 percent when income is $32,500 to $50,000. Single taxpayers have the sliding scale cut in half: the credit is 50 percent if income is $15,000 or less, 20 percent if income is $15,000 to $16,250, and 10 percent if it is between $16,250 and $25,000 (Franklin & Stevenson, 2002). The net advantage to the taxpayer in this case is pronounced. For example, in the case of a married couple with an AGI of $34,000, one of whom puts $2,000 into a company retirement plan while the other contributes $2,000 to a traditional IRA, the $4,000 in contributions reduces the couple's AGI to $30,000, saving $600 in taxes and thereby qualifying them for the 50 percent credit, saving another $2,000 (Franklin & Stevenson, 2002).

In reality, the couple will not realize the complete $2,600 in savings because they will not owe that much in tax. Nevertheless, this approach allows the couple to save $4,000 for retirement at an out-of-pocket cost of less than $2,200. It should be noted that the saver's incentive credit is not available to those under age 18, full-time students, or anyone claimed as a dependent on another person's return (Franklin & Stevenson, 2002).

Other changes in the tax code that became effective in 2002 also made it practical for a business that employs only the owner (or only the owner and his or her spouse) to have a 401(k) plan allowing participants to save up to $40,000 per year on a tax-deferred basis.

According to Springstead and Wilson (2000), salary reduction plans are one type of employer-sponsored defined contribution pension plan. "These plans include 401(k) plans for the private sector, 403(b) plans for the nonprofit sector, and 457 plans for state and local governments" (p. 35). Under these plans, employees contribute a portion of their salary tax-deferred to a qualified retirement plan; such contributions are limited by the tax code to a maximum amount, which changes annually. Employers ordinarily match some portion of the employee contribution, and investment earnings accumulate tax-free until withdrawn (Springstead & Wilson, 2000).

The Thrift Savings Plan (TSP) is a voluntary defined contribution plan for federal employees that was initiated in 1986. As with 401(k)-type plans, contributions are not taxed as income, and they accumulate — along with investment earnings — tax-free until withdrawn. Employees in the Federal Employees Retirement System (FERS) may contribute a maximum of 10 percent of their earnings to the TSP, with the federal government matching up to 5 percent. Civil Service Retirement System (CSRS) participants, who are not covered by Social Security, may contribute 5 percent of their earnings to the TSP but do not receive matching contributions. The federal government makes a 1 percent contribution to TSP accounts for all employees covered under FERS, regardless of whether they elect to participate (Springstead & Wilson, 2000).

The types and levels of insurance coverage will clearly change over the course of an individual's life. A single person riding the bus to work and living in an apartment will have drastically different insurance needs than the head of a large household with two mortgages, several vehicles, and numerous dependents. In addition, there are several types of insurance coverage available today that might be appropriate even for younger workers, since the earlier this type of coverage is secured, the more benefits will be realized in the future.