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Saving Money

Intro to Real Life

What grads need to know about managing a paycheck, repaying student loans and more.

Congratulations, parents of new college grads. Your kids earned their degrees, broadened their horizons and maybe even acquired marketable skills. And the best part for you? Now they get to pay for everything themselves.

Well, maybe.

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About half of all 18- to 24-year-olds live at home, according to the Census Bureau, so there's a good chance your offspring will land back on your doorstep for at least a while. Many parents are happy to help their kids look for a job and get their financial bearings. The trick is to guide without coddling.

The Solomons of Clifton, Va. -- parents Jackie and Cecil and daughter Caroline -- think they've found a happy medium. Caroline, 21, is graduating from American University, and her parents have invited her back home for a year. The game plan: Caroline finds a job. As soon as she starts earning money, she saves what she would have spent on rent to put toward renting a place of her own. "As long as she can cover her bills and not run around in a fig leaf, I'll be happy," says Jackie.

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Caroline is already off to a promising start. Along with her degree in anthropology, she is heading home with a manageable amount of student-loan debt -- about $8,000 -- and a single credit card with a zero balance.

Jackie and Cecil say they have always talked openly about money with their daughter. "No long, prosaic conversations," says Jackie. They just offer guidance when needed -- a role they're happy to continue.

THE BIG PICTURE

One big surprise new grads face is how expensive it is when they don't live on Mom and Dad's dime, says Brian Jones, a certified financial planner in Fairfax, Va. And that first paycheck doesn't go nearly as far as they think it will.

For example, if your child is a single filer claiming one withholding allowance, a salary of $35,000 shrinks to about $28,000 after federal taxes, Social Security and Medicare are subtracted. And that doesn't include state taxes or deductions for workplace benefits, such as medical insurance or a retirement plan. All told, your grad is likely looking at annual take-home pay of $25,000 (use the paycheck calculator at PaycheckCity.com).

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To divvy up that income, start with these basic guidelines, which can be adjusted for your child's situation: 30% for housing; 15% for food; 10% each for utilities, transportation, debt repayment and savings; and 5% each for clothing, entertainment and miscellaneous purchases.

Keeping track of expenses for at least a couple of months doesn't have to be a drag. Caroline Solomon simply jots down her expenses in a notebook. She figures that if she watches her pennies, she'll have enough dollars to splurge on things she really craves -- in her case, designer handbags. "I ask myself, What kinds of big things will I not be able to do if I spend money on little things?" says Caroline. "That helps me stay focused."

FINDING INSURANCE

Health insurance may not be high on a young adult's list, but making sure kids are covered is a priority for most parents. Depending on your insurer and the state in which you live, a dependent child could be dropped from your family policy upon graduating or turning a certain age -- usually between 21 and 25 (up to age 30 in New Jersey).

If new grads don't have coverage through a job, they still have plenty of options, often at affordable rates. First, contact your benefits office and ask about COBRA, the federal law that allows an adult child to remain on a parent's policy for up to 36 months beyond the cutoff age. This may be your best bet if your child has a preexisting medical condition.

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COBRA coverage can be expensive; it typically costs between $200 and $500 per month, says Sam Gibbs, of eHealthinsurance.com. New grads in good health could save substantially by buying their own individual coverage.

A student policy or short-term coverage to bridge the gap between graduation and a job with health benefits used to be the go-to solution for new grads. But, says Gibbs, an individual policy with a high deductible -- $1,100 for a single person -- can cost as little as $50 to $150 per month in states with competitive health-insurance markets (that excludes New York and New Jersey). Such plans carry no time limit, and benefits can be tailored to fit your child's needs. Compare rates at eHealthinsurance.com, or contact an independent insurance agent through www.nahu.org.

RELATED LINKS

Tax Breaks for 20-Somethings

Gifts to Give Grads a Head Start

Cost of Living Reality Check

Recession-Proof Careers

By purchasing insurance with a deductible of at least $1,100, your new grad qualifies for a health savings account. She can make pretax contributions to the account and use the money tax-free to cover deductibles and other out-of-pocket medical expenses. Any unused money rolls over from year to year. If your child is strapped for cash on an introductory salary, you could give her the money to seed the HSA.

Unlike health insurers, auto insurers won't boot your child off the family policy. Typically, your insurance needs to list all licensed drivers who live in your household.

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If a new graduate has a car and an insurance policy of his own, his rates will be higher. But more insurers are offering discounts to young adults who sign up for safe-driver programs. Fireman's Fund even allows grown children to piggyback on parents' discounts.

In general, premiums fall as young drivers approach age 25. And it pays to shop at Web sites such as InsWeb.com and Insure.com or through an independent agent.

When kids are finally living on their own, they should have renters insurance to protect their belongings. A policy costs just $100 to $200 per year.

RETIRE? ME?

Young adults may turn a deaf ear to the r word. But they're likely to be offered a retirement plan at their first job, so let the numbers do the talking: If a 22-year-old contributes $150 per month to an account that earns 8% annually, she'll amass $676,000 by age 65. And if her employer throws in a 50% match for every dollar she contributes, she'll have a million bucks. But if she waits until age 30 to start investing, she'll need to save twice as much for the rest of her working life to catch up.

It's unrealistic to expect most kids right out of college to save a big chunk of their salary for retirement. But even small contributions can have a big payoff, especially if a new graduate is getting free money from an employer.

If your child's employer offers a choice between a traditional 401(k) and a Roth 401(k), go for the Roth. Contributions to a Roth aren't tax-deductible. But younger workers are in lower tax brackets, so the tax break is less impressive anyway. Also, unlike a traditional 401(k), withdrawals from a Roth 401(k) are tax-free in retirement -- when your child will almost certainly be in a higher bracket.

If his employer doesn't match 401(k) contributions or offer a Roth 401(k), your grad is better off maxing out a Roth IRA outside the workplace first. In 2008, your child can contribute up to $5,000 to a Roth, assuming he earns at least that much but not more than $116,000. As with a Roth 401(k), withdrawals from a Roth IRA are tax-free in retirement.

Again, if your newly minted grad doesn't have the spare bucks (or the desire) to save for retirement, you could seed an IRA.

Your child may also have the option of using pretax money to fund a flexible spending account to tap for out-of-pocket medical bills -- everything from insurance co-payments and deductibles to contact lenses and teeth whitening. For someone in the 15% tax bracket, diverting just $500 per year into a flex account saves nearly $140 (assuming a 5% state tax and 7.65% Social Security tax).

REPAYING DEBT

Among students who borrow for college, the median amount of debt at graduation is a little more than $19,000, according to the College Board. If your former student still owes money on Stafford student loans with a variable interest rate, come July 1 she may well benefit from the largest interest-rate drop in the history of the education-loan program, says Mark Kantrowitz, of Finaid.org.

Kantrowitz projects that grads who consolidate their variable-rate Staffords after that date will be able to lock in a rate of about 3.9%, more than three points below the current rate of 7.2%. (Many private lenders have stopped participating in the consolidation-loan program. Borrowers can consolidate through the federal government at www.loanconsolidation.ed.gov.)

Federal education loans also come with exceptionally flexible repayment terms. In cases of unemployment or other economic hardship, for example, your child will likely qualify for a loan deferment, which buys a respite of up to three years. During that time, he won't have to make payments, and interest won't accrue on subsidized Stafford loans (for more details, go to www.projectonstudentdebt.org).

In addition, the federal government offers several repayment schedules, including repayment plans pegged to income. These plans are particularly helpful to students who intend to pursue lower-paying careers, and they forgive any remaining debt after 25 years. In fact, a new loan-forgiveness program will discharge any remaining debt after ten years of full-time employment in a public-service job.

CREDIT-CARD TRIPWIRES

By keeping student-loan payments manageable, young adults can free up cash to pay off more-expensive debt, such as credit-card balances. The last thing you want your child to do is throw in the towel and default on her student loans (or any other debt) and wreck her credit score. That could cost her thousands of dollars in higher interest rates or car-insurance premiums, or prevent her from getting an apartment, a car or even a job. All your child needs to do to maintain a good credit score is pay his bills on time and keep his balances below 25% of the credit limit -- or $1,250 on a card with a $5,000 ceiling.

If your young adult doesn't already have a credit card, it's becoming easier to get one. For instance, she can build her own payment history at Payment Reporting Builds Credit (www.prbc.com), an alternative credit bureau that gathers data on rent and regular payments for cable, cell-phone, insurance, utility and other recurring expenses. (See Rent Your Way to Good Credit.)

The surest way your child can get credit is to apply for a secured card at a Web site such as Credit.com or CardTrak.com. With a secured card, he makes a savings deposit equal to the credit limit. After paying his bills on time for about a year, he can qualify for an unsecured card.

Parents often want to co-sign for a car loan or an apartment. Resist the temptation. If your child falls behind on the payments or wrecks the joint, your credit is in jeopardy. And once you're on record as a co-signer, you usually can't get off the hook as long as the loan remains outstanding.

NEXT: Tax Breaks for 20-Somethings