Breaking Down Your First Real-World Buck
The following column from Jennifer Pagliara, CapWealth Senior Advisor, appeared in The Tennessean on June 9, 2017. Read it at The Tennessean here.
Along with pride, you may also feel apprehension, and rightfully so. From experience, I can tell you that the transition from school to “the real world” is not always a smooth one. It can be a shock to be on your own, with no mom or dad to fall back on.
It can also be a shock to learn how far your dollar goes: not far at all.
Let’s break down your new paycheck to see how it’s diminished before it even gets in your hot little hands. I’ll also offer advice on what to do with your paycheck before you start spending it.
Before you get paid
If you haven’t had a paycheck up until this point, you’re in for a rude awakening. Whatever your annual salary is, that’s definitely not the figure ending up in your bank account. Here’s where it goes before it goes to you.
Federal Income Tax:
The federal government takes a cut of your paycheck each tax period (unless you defer it) depending on how much money you make. These tax brackets change depending on whether you are married, file head of household, and other deductions and credits.
There could be potential reform in federal taxes under the new Trump administration, so be sure to follow the news on this. Currently, Americans pay an average of 20 percent of their income in federal taxes, including income, Social Security and Medicare taxes. If you make $40-50,000, that average is more like 11 percent
FICA Social Security:
FICA stands for the Federal Insurance Contributions Act, a payroll tax which funds Social Security and Medicare. Social Security, as you have probably heard, is a program that we pay into to receive benefits when we retire and for those with disabilities. By law, 6.2 percent of your gross income goes to Social Security.
This tax is used to subsidize health insurance for people 65 and older and those with disabilities. You pay 1.45 percent of your gross income to Medicare.
State Income Tax:
In this respect, you’re lucky — maybe. Tennessee is one of only nine states that does not take additional tax from your paycheck. Instead, Tennessee has state sales tax of 7 percent. Combined with local sales taxes, Tennessee has one of the highest sales-tax rates in the country. So they get you post-paycheck.
Some cities levy income taxes. Nashville does not. However, Metro does have a 2.25 percent sales tax, making the combined sales tax rate for Nashvillians 9.25 percent.
This stands for State Disability Insurance. Some states have a mandatory tax to benefit people who become injured on the job or have to take family or medical leave. Tennessee doesn’t have an SDI tax.
After you get paid
Federal, state and local governments have taken their bites. Now I’m going to advise something crazy. Set aside even more to begin building the foundations for a financially secure lifetime. I’ll also briefly solve — for most situations — a common dilemma for young workers: do you build an emergency fund, invest or pay off loans first?
Life happens. Broken-down cars, rent increases, lost jobs and worse. Squirrelling away some savings in an emergency fund —3 to 6 months’ worth of expenses — can really save your bacon when life throws you a curve ball. For that reason, I say this is your first saving priority.
Next, I cannot stress enough the importance of beginning to save for retirement now if it’s at all possible — even if it’s $25 or $50 each pay period. History shows that 6-7 percent annual return is a reasonable expectation on stock investments. Moreover, many employers offer a 401(k) match. Finally, you’re young and the power of compounding interest is on your side, so make the most of time you can never get back.
Paying off student loans:
According to the Department of Education, interest rates on federal loans to undergraduates have ranged from 3.4 percent to 6.8 percent over the last decade. When you pay off a student loan, you’re earning a “return on investment” roughly equal to the interest you no longer have to pay. If you expect to exceed that ROI with your 401(k) or other investments, then do that second and pay off loans last.
Jennifer Pagliara is a financial adviser with CapWealth Advisors.