What happened to my paycheck?

Congratulations you have just received your first paycheck. Time to start making it rain! Except, wait, what's that? Someone didn't pay you all of your money! Your paid "X" amount per hour and you worked "Y" number of hours and yet your paycheck doesn't equal "Z" as a matter of fact it more closely resembles "S."

So what gives? Well, it isn't what gives but rather what takes; DEDUCTIONS.

Most of your "lost" money went to taxes. This amount can be controlled through a Form W-4. You must find a balance between lowering the amount of tax taken from your paycheck and paying enough tax during the year to avoid a large (more than 10% of your monthly pay) tax liability (payment).

Ideally, you want a W-4 that creates something between -$500 (Payment) and a +$3,000 (Return)

Anything more than those numbers creates inefficiencies in your monthly cash-flow. For example, if you had a Return of $6,000 and you could change your W-4 so that you only had a Return of $2,000 that is an extra $4,000 a year, or an extra $333 per month. What could you do with an extra three-hundred dollars each month?

There is more to life than just Taxes:

You may also have Medical Insurance costs DEDUCTED from your gross pay. Under the current law you are required to have medical insurance (your parents could choose to cover you until you turn 26).

Since you are young and hopefully relatively healthy you need to learn the distinction between purchasing additional or higher levels of medical insurance as opposed to being “self-insured.” For example, a relatively healthy, risk-averse 20 something could have a low-level policy that requires $1000 per E.R. visit plus 20% of the total bill. A severely broken bone may result in a bill of $1,500.

However, you could purchase a higher level of insurance for $300 per month. This would eliminate the $1000 E.R. copay. So what should you do? Simple math shows that it would take five months to pay $1,000 into the insurance and that you would have to go to the ER twice a year in order to break even. The higher cost policy is simply not worth it... IF you are risk-averse.

Another possible DEDUCTION is the 401K or Traditional IRA Retirement Plan. As for the 401K you should only participate if it has a matching element and even then, you should maximize the matching contribution but really no more. Extra money toward retirement should be put into an IRA or better yet, a RothIRA. We will demonstrate the difference later in the course.

Questions:

1. What controls the amount of money taken for Federal Income Tax?

2. How much Medical Insurance should you have (Little, a bit, quite a lot)?

3. If you could only choose one type of Retirement Plan, which type should you choose?

Resources:

Lecture Guide

PowerPoint: Reading a Paycheck

Teachers Pay Teachers Files