Understanding your paycheck
The difference between what your job says you make and how much money you have to pay bills is far less than you might realize. Most working individuals are in W2 employment, in which you are an employee for a company, and this comes with certain taxes. I will discuss these taxes and help you understand your paycheck.
To discuss taxes, we must first define gross income, the amount of money you make before any taxes are taken out (what your employer says you make). You will pay federal income tax each paycheck, which is a percentage of your gross income. Currently, the national average federal income tax rate is 13-16%. In addition to federal income tax, if you live in a state with state income tax, you will pay this as well. State income tax can be either a single-rate tax structure or a graduated-rate tax structure. A single rate tax structure will tax the same percentage regardless of income, whereas the graduated rate will have an increased tax rate as income increases. Every employee will also have FICA (Federal Insurance Contributions Act) taxes. The two FICA programs specifically are Social Security and Medicare. Social Security tax is 6.2% of your gross income, and your employer pays another 6.2%. If you are self-employed, then you will owe both portions. In 2021, only $142,800 of your gross earnings is subject to this tax, but this will undoubtedly increase over time. Medicare tax is 1.45%of your gross income without a gross earnings cap. Your employer contributes another 1.45%, and if you are self-employed, you will pay both portions. There may be other taxes on your income depending on your region, but these are the most significant.
As you can see, the average working American in a state with no state income tax will remain with 80 percent of their gross income after taxes. (100-13-6.2-1.5). High-income earners at the highest tax bracket in a state with no state income tax will have 55 percent of their gross income remaining after taxes (100-37-6.2-1.5).
I understand that this is not a very exciting topic, but I discuss it to get you to think differently about just how much money you have. Start to think in terms of how much money you have left. If your company says you make 60K a year, at a minimum, start living like you make 50K because, as you now understand, this is how much money you actually have. For a physician with a gross salary of 275K, at a minimum, start living like you make 157K a year, because this is how much money you actually have.
In my next blog post, I will be discussing budgeting and the 50/30/20 rule.
