Recently, an acquaintance of mine was whining about his paycheck. He was complaining about all the deductions that were taken out. I asked him if it was because of his benefits or retirement contributions. He didn’t know and didn’t care to know. He just assumed it was all taxes and wanted to complain.
His frustration was about a very common complaint. I can think of many times where people around me have bemoaned the amount of money taken out of their checks.
One of my pet peeves in life though is people complaining about their circumstances. If you don’t like how something is, do something about it.
Unhappy about the deductions coming out of your paycheck? Do something about it!
What can I do about my paycheck?
Well quite a lot, actually! Especially this time of year.
During open enrollment season, many employers allow all kinds of changes to be made. The key thing is to effectively leverage your tax deductions and employee benefits package. It just takes a little bit of time and effort to sift through all your options and try to understand how your choices influence your take-home pay.
It’s totally normal for it all be a little overwhelming.
Some of the options available to you will likely decrease your take-home pay (*gasp*). But, is that really such a bad thing, though? Nay. I would argue that if done right it can actually be a super strategic personal finance move.
To be clear, I am not recommending that you actually earn less money (Unless you want to, then, by all means, go for it). Maximizing your income and earning potential is one of the single best things you can do for meeting your financial goals.
However, I am recommending that you strategize how that money gets to you. That may include tactics that lead to a smaller check on payday, but someone who is savvy in personal finance will realize that does NOT always mean less money coming to you. In fact, it often means keeping more of your hard-earned money.
Factors that influence your take-home pay
Here is a list of some factors that influence the difference between gross and net pay. This is not a comprehensive list by any means. Other deductions may influence someone’s paycheck such as child support or wage garnishments, but my goal is to focus on common benefits that many employees are eligible for and can act upon.
- Salary/Wage – This is the most influential piece in your overall take-home pay, but is also the hardest one to change once it’s set. Beyond scheduled increases, asking for a raise, or getting a promotion, there isn’t much you can do to change this so I won’t focus on it here.
- Tax deductions – these are the options that you selected on your W-4 when you were hired. These influence how much money your employer sends to the IRS on your behalf.
- Retirement Contributions – Your paycheck can be influenced by the amount you contribute and whether you select a Roth option.
- Insurance Deductions – if you have employer-sponsored insurance, the monthly premiums are likely deducted from your paycheck. Some employers allow you to decide if your deductions are taken out pre or post-tax.
- Health Savings Account (HSA) – a savings account where you can set aside money pre-tax for eligible health care expenses. To use this you must be enrolled in a high-deductible health insurance plan.
- Flex Spending Accounts – These are accounts where you set aside a pre-determined amount of pre-tax money that you expect to spend on eligible expenses.The most common ones are for medical and daycare expenses. If you don’t submit a reimbursement for the amount you elected to set aside though, you don’t get that money back.
- Employee Stock Options – If you work for a publicly-traded company, you may be eligible to purchase a set amount of company shares at a special price. The details behind these can be quite complicated and situation specific, but they can be tax-advantaged.
How can a smaller paycheck be better?
- Lower taxes. The benefits that I just listed can be paid for with pretax deductions. Essentially, you apply the money to your benefits before the government looks at how much you make. Therefore, they tax you on less money and you pay less in taxes.
- More net income. When you are paying less in taxes, you are keeping more of your hard-earned money.
- Lower benefit costs. When you pay for your benefits with pretax dollars, they are cheaper. This is because when you don’t have to account for taxes you need less money overall to cover the benefit premium.
- Prioritizing YOU. Or another way of saying it, you are paying yourself first! By using payroll deductions to save in the tax advantages accounts listed previously, you are setting that money aside before you have a chance to spend it. Savings becomes the first priority rather than an afterthought. By contributing to these accounts with pretax dollars, again you have more money to save.
Let’s take a look at an example.
Let’s use Emily as an example. Emily lives in Florida and makes $50,000 per year (We’ll use a state that doesn’t have state income tax to keep the numbers simpler). She is single, paid monthly, has no dependents, and claims 1 federal allowance on her W-4. Using a Salary Paycheck calculator, this is an example of what her takehome pay would look like:
She has quite a bit of money to work with each month!
But she’s not saving for retirement. And she hasn’t covered her healthcare costs. Let’s assume she’s pretty healthy and doesn’t have many medical costs. So, let’s say she pays $45/month for a high-deductible health plan and puts $100/month in a savings account to cover unexpected medical expenses. If you subtract those from her net pay, her grand net pay is $3148.64. She is also paying $554.27/month in federal taxes. That’s $6651.24 over 12 months.
Now, let’s look at Emily’s scenario with pre-tax contributions. In this scenario her situation in the same, but she contributes 10% to retirement, pays her $45/month insurance premium with pre-tax dollars and puts the $100/month into an HSA.
By using pretax deductions, her net pay is now $2874.81. It’s $273.93 less than her grand net pay in the first scenario, but in this situation, she is also saving $416/month for retirement. Note how it’s not $416 less! Here, she is paying $422.52/month in taxes ($5070.24). She saves over $1500 in taxes by taking advantage of pre-tax contributions.
So, as you can see Emily’s paycheck is smaller in the second scenario, but she is saving more money and paying less in taxes. Ultimately, that will get her ahead in the long term.
How can you take advantage of this?
Many people use the ‘set it and forget it’ mentality when it comes to their paychecks. They sign up for their benefits without fully understanding them and often never revisit their W-4 selections.
That is exactly what NOT to do, especially if you’re unhappy about your current paycheck.
Take the time to understand your options. Should you change your insurance plan? Has your health changed? If you have a lot of medical or daycare expenses – are you eligible for a flex spending plan? Has your family status changed since you looked at your W-4 (you can change that at any time)? Do you think you can contribute a little bit more to retirement (or start contributing)?
Really, all it takes is a little bit of effort. If you feel like you need help, reach out to your human resources office or a tax advisor. It could be worth it. A little bit of effort and planning can lead to a lot more money in your pocket.
Applying this in my own life
I’ve been trying to do a better job of understanding my benefits (and my husband’s) and trying to come up with a plan to use them most effectively. The hardest part is that it takes time. These are not simple things.
Sometimes I’ve had to read an explanation three or four times before I felt like I truly understood it. But for me, that is worth the effort because I know that it’s what is required to make the best financial plan for my family.
This year, I used very few pre-tax deductions. I had a PPO health insurance plan and didn’t use any flex spending accounts. We were also following a Dave Ramsey-esque debt payoff plan and I minimized my retirement contributions so we had money to throw at debt (although I couldn’t bring myself to give up the employer match!).
Next year, I plan to maximize my pre-tax deductions. I am switching to a HDHP and plan to max out an HSA. I am also using a flex spending account for daycare expenses since I had a baby this year, and my goal is to max out my 457 account for the first time ever next year!
When I used the salary paycheck calculator to see how that would affect my take-home pay and I cringed a little bit when I saw it at first. But, I double-checked our budget, made sure we could still cover all our bills, and then reminded myself that if financial freedom is my goal, this is what it takes.
By giving myself a smaller paycheck this way, I don’t complain because I know I’m in control. I am maximizing my savings, minimizing the amount I am paying in taxes, and prioritizing my savings ahead of spending so there is no chance of it being spent on other things. This is when a smaller paycheck is better.
What do you think? Have you ever complained about the amount taken out of your paycheck? Have you ever tried to maximize your pre-tax deductions? Let me know in the comments!