Grad Guide to Decoding Your Benefits
We answer your questions on everything you wish you had learned in school -- but didn't -- about making the most of your health insurance and job-related benefits.
Q. I just got my paycheck, and I don't know whether to laugh or cry. Where did all my money go?
A. While it comes as no surprise that Uncle Sam gets first crack at your hard-earned money, somehow it doesn't quite sink in until you see what's actually left for you to take home. For example, $3,000 of "gross" monthly income is whittled down to less than $2,300 "net" income after federal taxes and Social Security and Medicare payments are taken out. That's not counting state taxes (which can range from 0% to 12% of your gross income) and any money you might have withheld from your paycheck for benefits. Learn more from H&R Block about deciphering your pay stub, then find out whether you're having too much withheld from your check.
Q. What's up with that tax form I have to fill out on my first day of work?
A. It's called a W-4, and it's where you tell the government how much tax to take out of -- or "withhold" from -- your paycheck. You write down how many allowances you wish to claim. Basically, the more allowances you claim on your W-4, the less tax will be withheld. If you claim zero allowances, you will have the most tax withheld. Don't even think about asking your human resources reps what to fill in here. They'll just smile and say, "It's up to you."
But we're here to decode the mystery. For most recent grads with fairly simple tax lives, if you put down "2" allowances, you'll underpay, meaning you'll owe the IRS money come next April. If you put down "0," you'll probably overpay, getting you a big refund at tax time. (Sounds tempting but this isn't the smartest idea ... you basically gave Uncle Sam an interest-free loan. Learn more about the drawbacks of giant refunds.) Generally, most recent grads should aim for "1." But to be sure, try our easy-to-use withholding calculator. And if you've already filled out your W-4, don't worry. You can revisit your HR department at any time to make a change.
Q. How can I get short-term health insurance to cover me until I get a job?
A. Your parents' health plan typically covers you if you're a full-time student until you turn 25. More than 20 states now require insurers to cover dependent children on their parents’ policies until the kids are in their mid twenties -- and sometimes up to age 30 -- even after they’ve graduated (see Health Insurance for New Grads). But if you don't live in one of those states, you'll need to buy a policy to bridge the gap. Shop for a student health plan at eHealthInsurance.com. You'll need to apply before you graduate, but you can keep the coverage as long as you need it. If you have run out of time to apply, you still can get coverage through short-term providers such as Assurant and Golden Rule. These policies typically last from 60 to 180 days. See Health Insurance for Twentysomethings to learn more about the pros and cons of each type of policy.
Q. Do I really need health insurance?
A. You may be a young strapping specimen of perfect health, but, yes, you need health insurance. Why? Two words: What if. What if you came down with a life threatening illness? What if you unexpectedly became pregnant? What if you got injured in an accident? All of these things could annihilate your finances if you didn't have insurance to cover the bills. In fact, according to a recent Harvard study, about half of all people who file for bankruptcy do so because they can't afford to pay their hospital, doctor or prescription bills. Bottom line: You're taking a terrible gamble if you go without.
Q. My job doesn't offer health insurance. How can I buy my own coverage?
A. The cheapest and easiest way to get health insurance is through your employer. But if your job doesn't offer it, or you're self-employed, you still can find affordable health insurance on your own. Start by comparing policies in your state on eHealthInsurance.com. You could also enlist the services of an insurance broker who knows the offerings -- and the laws -- in your particular area. You can find a broker through the National Association of Health Underwriters. Find out more places to buy your own coverage when you're on your own.
Q. What should I look for in a health plan?
A. First, find out if there are any deductibles that must be met before the plan starts covering costs. And once the deductible is met, what percentage of costs will the plan pay? Will you have any co-payments? What will it cost to see a doctor outside the plan? Is there a lifetime limit on what the plan will pay? Then, evaluate your health, family and financial situation.
If you're single and in good health, you can save money by opting for a low-cost, high-deductible plan that provides coverage primarily for major procedures. A health savings account is a good vehicle for managing your medical costs under such a plan because it allows you to stash enough pre-tax cash to cover your deductible. To qualify for an HSA, your policy must require a minimum deductible of $1,150 for singles or $2,300 for families. If you have small children, you might want to pay a little more for a plan with low or no co-payments so you won't have to shell out cash for the frequent visits to the doctor.
If you or a family member has a chronic disease that requires expensive treatments, it's important to find a plan that covers a large percentage of costs and that has a high lifetime limit on payouts so you won't have to foot big bills.
Q. What's an HMO and a PPO?
A. HMO is short for health maintenance organization. These plans are inexpensive: You pay a flat monthly fee, perhaps a small co-pay on each visit, but they generally carry little or no deductible. Meaning, you don't have to rack up $1,000 in medical bills before insurance coverage kicks in. An HMO will cover you from the start. However, you can only choose a doctor who participates in the plan or else you'll have to pay for the visit out of your own pocket. And if you ever want to see a specialist, you have to get permission from your primary care doctor. If you're young and in good health, an HMO might be a good -- and inexpensive -- choice for you. (Learn more about HMOs.)
PPO is short for preferred provider organization. These typically cost more than an HMO and may carry a deductible, but in return you get more flexibility in your choice of doctors. You're still encouraged to see doctors within the network -- those who have contracted with the insurance company. But you usually don't need to get permission from your main doctor to see a specialist. And if you choose to see a doctor outside of the plan, you don't have to pay the full bill out of pocket like you would with an HMO. You're only responsible for the difference between the non-member's bill and your PPO's discounted rate. If you have children or a medical condition that requires frequent trips to the doctor, a PPO might be the plan for you. (Learn more about PPOs.)
Q. What is a flexible spending account? Do I need one?
A. Your employer may offer a flex plan that allows you to set aside pre-tax money to pay for routine expenses, including out-of-pocket medical costs and childcare. If the idea sounds a bit obscure, consider this: For every $100 you don't stash in the account, you lose $25 if you're in the 25% tax bracket, whittling your spending power down to a mere $75. But, if you stash that $100 in a flex account, you keep the full $100 to spend on anything from a new pair of glasses to over-the-counter cold medicine.
If you have children and you pay someone to watch them, you really should sign up for the plan. But whether you need to sock money away for medical costs is a little iffy. If you don't spend much -- if any -- money on health care each year (see the IRS's full list of qualifying expenses), you probably can take a pass because you lose any money you've saved in a flex account that you don't spend by the end of year. Poof. Gone. So you don't want to participate unless you're absolutely sure you'll use all or most of the money. Use our calculator to figure out how much money you should set aside.
Q. What's a 401(k)?
A. A 401(k) is a savings plan that allows you to automatically invest part of your paycheck in mutual funds, bonds and company stock. Your choices will be limited to the specific investments your company offers through its plan, but you get to choose (up to specified limits) how much and where to put your money. Your 401(k) contributions also come out of your paycheck before taxes are applied, reducing the amount of money Uncle Sam can tax. And 401(k) returns grow tax-deferred until you withdraw your money in retirement. Also, many employers offer a match on your contributions -- say, 50 cents for every dollar -- up to a certain percentage of your salary. Sweet! So what's the catch? Well in this case, you can't withdraw the money while you are employed before age 59½.
If you leave the company and make withdrawals before turning 55, the money will be taxed at your normal rate, and you will be charged a 10% penalty. But if you leave the company, you can easily roll over the money into your new employer's 401(k) plan, or into an IRA (more on that later). All in all, the 401(k) adds up to a pretty awesome deal. Learn more about how to invest in a 401(k).
Q. Wait! Back the truck up. What's a mutual fund?
A. Sorry, didn't mean to get ahead of ourselves there. If you've ever pooled your money with your friends to buy a few pizzas and drinks, you understand the concept of mutual funds. They combine several investors' money to buy a variety of company stocks that may be too expensive for the individual to purchase alone. This allows you to diversify your investments (you can get pepperoni, ham and pineapple, plus sausage and olives) while keeping costs low. Each mutual fund usually selects certain types of stocks, such as large companies with big growth prospects (a meat lover's assortment) or companies that operate overseas (exotic pizza toppings).
When you're picking your first fund for your 401(k), you might want to start with one that is representative of the overall stock market for the ultimate in diversification (a pizza buffet!), such as an S&P 500 fund. Learn more about mutual funds.
Q. Is investing in a 401(k) enough? What about an IRA?
A. A 401(k) is certainly a good start, but if you want to maximize your savings, you should also consider saving in a Roth IRA. This is not offered through your employer -- you set one up directly with a mutual fund company, broker or bank. This is another type of tax-advantaged savings account. You can save up to $5,000 in 2009 in an account, and you won't owe Uncle Sam a dime in taxes, even when you withdraw it in retirement. The Roth IRA comes with a couple extra perks beyond the 401(k), too. You can take out your contributions at any time without taxes or penalties -- you just can't touch the earnings until you turn 59½. You can invest in almost anything, including any mutual fund of your choice (not just the handful offered by your employer's 401(k) plan), bank CDs, stocks and real estate. You can also take out up to $10,000 to buy your first home without owing tax or penalties. Learn more about why you need a Roth IRA.
Q. So should I invest in a 401(k) or an IRA first?
A. If your employer offers a match on 401(k) contributions, you should invest as much as possible to take full advantage of that free money. You'd be an idiot to pass that up. After that, sock your money in your Roth IRA. However, if your employer doesn't offer a match on 401(k) contributions, max out your Roth IRA and then turn to your 401(k).