Got Your First Job? Understand Your Paycheck
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Let's be honest: The best part of starting a new job is getting that first paycheck!
But you might be surprised to see that your paycheck is smaller than you expected. What gives?
Unfortunately, you rarely get to keep every dollar you earn. Welcome to the wonderful world of taxes.
What you earn = gross pay
Not "gross" as in "ew." "Gross" as in "total."
Gross pay is what you earn before any money has been taken out for taxes or other things (more on those later).
It's calculated by multiplying your hourly pay rate by the number of hours you worked during the pay period. This might be what you expected to see on your first paycheck.
Learn about tax-smart strategies.
What you keep = net pay
Depending on how much money you earn, you might owe taxes to the federal government and to your state. Once you're a bit older, you might also pay for medical insurance or contribute to a retirement savings account. If you do, your employer will take all those taxes and any expenses (called deductions) out of your paycheck, too.
What's left over is your net pay, and it's the amount you actually get to keep. This is the number you should use in your budget to figure out how much you can afford to spend on needs, wants, and savings.
What's up with taxes?
So, which taxes will you have to pay? Let's take a look.
Income taxes
The state and federal governments take a percentage of your income to help pay for things you probably use all the time, like your school, the public library, and even the airport.
But not everyone owes the same percentage of taxes. The more money you earn, the higher your rate.
And some people don't owe taxes at all. You might not, either, if you make less than what's known as the standard deduction. This is the amount every person filing taxes gets to subtract from their gross income before calculating how much income tax they owe. And it usually changes every year.
If you know you'll earn less than the standard deduction, you can choose "tax-exempt" on your federal and state tax forms. That means your employer won't take out any income taxes from your paycheck.
Be sure to get help from your parents or a trusted adult when filling out your tax forms. Taxes can be complicated—even for tax pros.
Payroll taxes
Ever heard of Social Security? It's like one big retirement program that most workers—even you—are required to contribute to.
As part of the Federal Insurance Contributions Act (FICA), Social Security is considered a tax, but it's actually a benefit to you—and everyone else who contributes to it. Once you retire, you'll receive monthly payments based on how much money you paid into Social Security over the years.
Medicare is another FICA retirement benefit you're required to contribute to each paycheck. It's a health insurance plan for retirees, and you'll be eligible for it once you turn 65.
Other taxes
Your state may collect other taxes, like those to cover unemployment or disability benefits.
What are deductions?
These are optional payments to take advantage of benefits offered by your employer.
Retirement savings
Many employers offer what's called a 401(k) plan. If yours does and it allows you to contribute (some have minimum age requirements), you should really consider it. It's never too early to start saving for retirement.
But, why? Retirement is so far away!
Well, even contributing just a few dollars per paycheck can really add up over time. Especially if your employer offers to match part of your contribution. Most employers offer a match of 3% to 5% of your pay. That's like free money. But you only get it if you contribute at least that much, too.
Medical insurance
You're probably still covered by your parents' medical insurance. But once you start working full time, you might be able to get your own insurance through your employer. Some employers even pay some of or all of the costs.
Knowledge is power
Now that you understand taxes and deductions, hopefully you won't be surprised when you get your next paycheck.
More important, knowing how much money you get to keep from each paycheck makes it easier to set a budget and understand what you can really afford. This is called "living within your means," and it's key to building healthy spending habits and achieving your financial goals.
Your next steps:
- Look at the pay breakdown on your most recent paycheck and circle all the taxes and deductions. Discuss anything you don't understand with your parents.
- Talk to your parents about the taxes and deductions they pay. Are you surprised by how much (or little) they get to keep?
- Learn about creating smart spending habits and using credit cards wisely.
Learn about tax-smart strategies.
This material is intended for general informational and educational purposes only. This should not be considered an individualized recommendation or personalized investment advice. The securities, investment products and investment strategies mentioned may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decisions.
All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
For illustrative purpose(s) only. Individual situations will vary. Not intended to be reflective of results you can expect to achieve.
Investing involves risk, including loss of principal.
This information is not a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager, Estate Attorney) to help answer questions about specific situations or needs prior to taking any action based upon this information.