If you’re a new graduate, you’ll want to make the most of your new earning power. Here’s how!
It’s that time of year. New graduates are pouring into the job market, clutching their degree certificates and hoping their first job will make all that stress at finals worthwhile.
Unfortunately, if you’re a new graduate, there are a few unpleasant financial realities you need to get your head around before you start.
Here, I’m going to have a look at exactly what you can expect when it comes to paying tax, paying back that mammoth student loan and generally getting your finances in order.
Hopefully, you’ll then be able to make the most of your new earning power!
The tax man
As soon as you enter employment, the tax man will pop out of the woodwork and start claiming part of your salary as Income Tax.
The amount of Income Tax you pay is worked out using different tax rates and a series of tax bands.
If you, like most new graduates, start off earning under £40,835, you’ll be charged the basic rate of tax, which is currently set at 20%. But if you’re lucky enough to earn above £40,835, anything above this amount will get taxed at a hefty 40% rate.*
Your employer will usually take Income Tax from your wages throughout the year and send it to HM Revenue & Customs (HMRC). This is called the Pay As You Earn (PAYE) system of collecting tax.
However, if you're starting your first job and you don't have a P45, your employer will give you a P46 instead. They’ll also allocate a tax code to you and work out the amount of tax you should be paying. Then, HMRC will process your P46 and, if necessary, change your tax code.
It’s all pretty mundane stuff, but it’s important that you get your P46 handed back to your employer as soon as possible. Until your correct tax code is sorted out, you’ll be placed on a temporary, ‘emergency’ code.
And if you end up paying too much tax while under this temporary code, you’ll have to try and claim a refund from HMRC. Not ideal at a time when every penny counts!
Here’s a useful guide to the basics of the tax system.
National Insurance
You pay National Insurance contributions (NICs) to build up your entitlement to certain social security benefits, including the State Pension. The type and level of NIC you pay depends on how much you earn, and whether you're employed or self-employed.
If, like most new graduates, you’re an employee earning between £105 and £770 per week, you’ll pay 11% of your salary as 'Class 1' NICs.
Here’s some more information on National Insurance rates and allowances.
Student loan repayments
This is the third main way in which your new salary will be whittled down before it gets anywhere near your hot little hands.
The good news is, you won't have to start paying your loan back until the April after you graduate. And you won’t have to pay back anything at all until you hit the current ‘earnings threshold’ of £15,000 a year.
Above this salary level, you’ll automatically pay 9% of your earnings through your employer's payroll.
The Student Loans Company offers a special, standard interest rate on its loans, which is tied to rate of inflation.
This means that the amount you have to repay should, in real terms, be the same value as the amount you borrowed in the first place. So - your student loan debt is very likely to be the ‘cheapest’ debt you own as a graduate.
However - try not to ignore it for too long. In this article, my Foolish colleague Szu Ping Chan explains that small repayments may not even match the interest you’re charged - so your debt will actually keep growing. Not good news!
Your bank account
When it comes to current accounts, loyalty doesn’t always pay. Just because you’ve had a student account with a particular lender, it doesn’t mean you need to stay with them as a graduate.
As long as you have proof of qualification and have managed your account within your agreed overdraft limit, there is no reason why you can’t leave to find a better deal elsewhere.
Remember last year’s HSBC versus Facebook showdown? In credit-crunched Britain, some lenders are slicing chunks off the overdrafts they offer graduates. With this in mind, shop around for an account that still offers a decent interest-free overdraft.
The Royal Bank of Scotland and Lloyds TSB Graduate packages, for example, both offer up to £2,000 free in year one, then £1,500 in year two and £1,000 in year three.
Just try and make sure you get rid of your overdraft before it stops being interest-free.
Making ends meet
If you can’t find work start after graduating, don’t panic. If you’re available for and actively seeking work, you’re entitled to Jobseeker’s Allowance (also known as unemployment benefit or ‘the dole’).
For people aged 18-24, the individual weekly allowance is currently £46.85. It probably won’t cover all your bills, but it will make your situation a little easier and slow the rate at which your debts grow.
Here’s more information on the benefit - and how to claim it - from the Department for Work and Pensions.
Start saving early
But perhaps you’ll walk straight out of university and into a full-time job. If you do, it’s worth considering starting a pension straight away.
Retirement may seem a very long way off, but contributing a few pounds every month could make a huge difference in years to come.
Check out what your employer is offering. Most likely, there will be a voluntary contribution scheme set up. Your employer may be willing to pay into it on your behalf. Some companies will even match your contributions, although that largely depends on their benefits policy.
This Fool podcast shows you just how much of a difference it makes if you start contributing to a pension straight after university.
Ultimately, it’s all about getting into good habits and not burying your head in the sand when you do get into a financial scrape.
If you budget carefully and don’t go mad with your new-found wealth, you can start hacking away at that student debt. That way, it won’t still be hanging round your neck when you’re old and grey.
Good luck!
*In the current tax year the personal allowance has been changed to £6,035. This amount is free of income tax. Beyond this, you can earn a further £34,800 before you have to pay higher rate tax at 40% bringing the total to £40,835.
