In the previous post we learned how how important it is to commit to paying yourself first through savings and investment, and the wonderful effect compound interest will have on those savings over the long haul of the Money Marathon.
Of course, you can’t save and invest every dollar you earn. There are expenses you’ll have to plan for. A place to live, food in your belly, shoes on your feet – maybe even some fun – are costs that you have to plan for, but how much can you afford to spend on these things? To figure this out, you have to start with understanding how much money you have coming in from your job (or your own biz!)
I Got a Job Making $50,000. Isn’t my Take Home Pay $50,000?
Lets say you are the average college graduate in 2019, and you start out making $50,000 per year to begin your career. You might think your take home pay, which is the amount of money that actually goes into your bank account from your paycheck, is simply $50K divided by the number of paychecks you receive in a year. Since most people get paid bi-weekly (every 2 weeks, or 26 paychecks each year), or semi-monthly (2 paychecks each month, or 24 paychecks each year), you might think the amount you’d get deposited into your bank each payday is either $1,923.08 or $2,083.33 (you can do the math).
Unfortunately, both of these paycheck totals are far too optimistic. Neither takes into account the very real impact that both taxes and personal benefits have on the amount of money deducted from your paycheck before you see a dime of it.
I won’t go into great detail about taxes or benefits, but its important to know that everyone with a job must pay federal income and social service taxes (Social Security, Medicare) and most people pay state taxes (a few states don’t have an income tax, but CA does). Secondly, personal benefits generally consist of your costs for health insurance and pre-tax retirement contributions (often referred to as a “401k” or “403b”). There can be other benefits too, but at this stage in your Money Marathon, health insurance and retirement contributions are the biggies. Health insurance is required by federal law and contributing to your pre-tax retirement fund is something you don’t have to do, but really must do, especially if your employer will give you “free money” to fund your retirement. Many employers do, and you’ll learn more on this in a later post.
Your brain may hurt from that last paragraph, but don’t fret it for now. The details of what makes up your tax and benefits costs aren’t important at this point, but knowing that they significantly reduce how much money you put in your pocket each pay period is!
So, just how much should you expect your paycheck to be reduced by taxes and benefits? Consider the following reasonably accurate example for someone like you in 2019 who makes ~$50K a year, living in CA, paid semi-monthly (2 paychecks each month):
- Gross Paycheck: $2,083
- Insurance Benefit Deductions
- Medical Insurance: ($120)
- Dental/ Vision Insurance: ($25)
- Retirement Deductions
- (401K) contribution: ($208)
- Tax and Social Services Deductions
- Federal Tax: ($159)
- State Tax: ($47)
- Social Security: ($120)
- Medicare: ($28)
- Net Paycheck: $1,376 (Take Home Pay)
Ouch! Instead of $2,083 deposited into your bank account on payday, you’ll actually receive only $1,376. This is a reduction of $707 and roughly 34% from your gross paycheck amount. While this is just a theoretical example, it’s fairly representative of real world as you’ll see the percentage reduction vary between 27% and 40% for most folks making around $50K, depending on where you live and your family status.
This 34% reduction is not all bad news. You smartly chose to put 10% of your gross, pre-tax income ($208) into your 401(k) retirement account and that is also ultimately your money, even if you can’t use it for now. While it may feel like wasted money when you are perfectly healthy, you’ll also be glad you have health insurance if you get sick. Taxes? Well, taxes mostly just stink, but even they have some value to the greater good.
In the end, the point is is that your incoming cash for your expenses and savings combined is not $50K annually. Its actually about $33K (its exactly 24 x $1,376 = $33,024 annually, and $2,752 per month for detail sticklers), and understanding this right up front is important to ensure you don’t overestimate how much you can save and what’s left over for expenses.
Now that you know that your take-home pay is $2752 per month, lets go back to what I we said about saving in the previous post: “…10% into your pre-tax retirement account and 20% of your take-home pay into savings…”
You’ve already smartly put the 10% ($208) pre-tax into your 401(k) retirement account. Now we need to allocate the 20% out for your take-home pay to savings for investment. This amounts to ~$550 each month, leaving you with $2,202 per month for expenses.
…and that’s it. After paying the tax man, social services, your insurance costs and accounting for your commitment to save, you have just about half of your gross paycheck left to pay for all of your expenses. The “average” college grad with their first job might think they have over $4K per month to spend on day-to-day living, but you as as smart Money Marathoner know its a lot less than that.
Now that you know what you really have to pay the bills, its time to come up with a game plan for making that money go as far as you can each month. It won’t be easy, because living is hard on the wallet, but with a commitment to establishing a budget and little ingenuity, you’ll be able to pull it off just fine.
The Money Marathon 