AN010: The Quickest Way to Free Money
There's magic money hiding in your paycheck. Here's how to find it.
Remember the shock at your first paycheck and it seemed much less than you expected? You knew you were being paid by the hour, and multiplied your hourly rate by hours worked. So why was it so much less? And what were all those weird letters on the pay stub?
Yes, your introduction to taxes and mandated deductions was likely confusing to your younger self. Maybe you still don’t understand what all those deductions are for — or more importantly, how some can bring you great financial benefits. Let’s take a look.
Those Pesky Required Deductions
A certain part of each paycheck is set aside for government programs and taxes. There’s Federal tax (calculated based on 7 tax brackets and your filing status), along with state and local taxes, depending on where you live and earn the income. FICA (Federal Insurance Contributions Act) deductions support Social Security and Medicare, and are calculated at 7.65% and matched by your employer. Amid that stack of paper you filled out on your first day was a W-4 form, stating how much withholding your company should take out of your pay for taxes.
Of course, nobody likes to pay taxes. But you can work some magic if you pay attention. Remember, taxes are paid on earnings after certain deductions are made. So, the more you reduce your earnings with pre-tax deductions, the lower your taxable amount.
Pre-Tax Magic
There’s an entire set of pre-tax deductions that can reduce the amount of tax you owe. If you’re working full-time, you’re likely familiar with some of them, including a Health Savings Account (HSA) and flexible spending. Some employee medical and dental insurance, and group term life insurance plans are also pre-tax. If you live in an urban area, some companies offer a pre-tax commuting benefit for transit and parking.
All these pre-tax benefits can add up. For example, the transit passes you buy through a company program (pre-tax) will end up costing less than the same passes you’d buy from your take-home pay. How? Because they are a pre-tax deduction, you’ve reduced your taxable income and pay lower tax. That savings goes directly to you, not the government.
Money In Your Pocket, Not Theirs
Most important, contributions to your retirement fund are also pre-tax deductions. The magic arrives when you realize that contributing more to a retirement account or other pre-tax benefit often changes your take-home pay very little. Because you’re reducing your taxable pay, the tax is lower — which often means that tax savings can be put into your retirement fund instead. Plus, if your company offers an employer contribution — matching your contribution in whole or part, up to a certain ceiling — it’s like free money in your pocket.
The best way to explore what pre-tax benefits may mean to your retirement fund is to pull out a recent pay stub and play with an online paycheck calculator. Fill in the fields, then start experimenting with increasing the retirement deduction. You’ll be surprised at how little your take-home pay may change even as you increase your contributions. That’s money going straight to your future instead of taxes.
A quick call (or online search) to your company’s HR department can also help you discover other pre-tax deductions available to you. There’s wiggle room in that paycheck — and now you know how to find it.
Remember:
• Pre-tax deductions lower your taxable earnings, therefore reducing your Federal taxes
• Playing with an online paycheck calculator is an easy way to get more for your money
• Women with a wealth mindset max out their employer match contributions, knowing that it’s free money for their retirement account
My challenge to you this week:
What pre-tax benefit are you going to maximize this week?