On the path to adulthood, the next step for college grads is a full-time job. Since many college grads haven’t yet passed Paycheck Breakdown 101, they may be shocked to learn how quickly their paycheck shrinks before it’s deposited.
Your Paycheck Breakdown Explained
If after your first pay period, you are asking yourself, where did all my earnings go? Paycheck Breakdown 101 is the right course for you to be enrolled in. Here we’ll cover federal incomes taxes, state income taxes, Social Security, Medicare and 401(k).
After you receive your first pay stub, you will notice a vast difference between your gross pay (the total amount earned) and your net pay (the total amount earned after deductions). Compare your personal paycheck breakdown on your pay stub against the percentages below.
Federal income taxes
Usually on day one, employers ask new hires to complete a W-4 form. This important document determines an employee’s tax withholdings, which are based on an employee’s marital status and withholding allowances claimed. A W-4 can be changed at any time for an increase in allowances, but if the amount of allowances decrease you have 10 days to update the form. Each withholding allowance reduces the amount of taxable wages and results in less federal income tax withheld from a paycheck.
State income taxes
State income taxes are deducted from your paycheck, too. Each state applies its own tax rate. New York's personal income tax system has eight different income brackets. The top rate is 8.82 percent of gross income.
By law, all working Americans must contribute to Social Security, which provides supplemental income to retirees. Currently, the Federal government requires all employees to contribute 6.2 percent of their gross income into the Social Security fund. Your employer matches that with a 6.2 percent contribution of your gross income.
Every American worker must contribute 1.45 percent of their gross income to Medicare, which provides health insurance for retirees. Every employer then contributes an additional 1.45 percent on behalf of each employee.
We suggest you fully understand your paycheck breakdown before setting up a 401(k). Contributions to retirement savings plans, such as a 401(k), may also be deducted from your pay. A 401(k) is an employer-sponsored retirement plan. Workers can save and invest a percentage of their pre-tax salary. Employees can choose how much they want taken out of their paycheck and how their funds are invested. Many employees have programs that match the 401(k) contributions of their employees.
How to Spend Smartly
Recent college grads should attempt to adhere to the 50/20/30 guideline when learning how to spend and save money.
Fifty percent of your income should be devoted to fixed costs like rent, utilities and car payments.
Twenty percent of your income should be directed toward ensuring your financial health. Use this money to pay back debt, save for retirement or build an emergency fund.
Since expenses vary from month to month, you should earmark 30 percent of your take home pay for flexible spending on things like restaurants, shopping, and entertainment.
At DeFreitas & Minsky, we specialize in all aspects of tax returns on Long Island. If you need advice about business tax planning and preparation or would like any more assistance, don’t hesitate to call DeFreitas & Minsky Certified Public Accountants at 516.746.6322 for more information.