What most of us have accepted as a fact of work is shockingly frustrating for young people just starting out. My kids refer to this irritating transition as “adulting”, the period where you are expected to move from childhood to adulthood, which includes taking control of your financial life.
There’s a lot to learn when you start paying your own bills, starting with what’s taken out of your paycheck. With that in mind, I’ve decided to dedicate my occasional column to Financial Adulting 101, focusing on the basics of money.
I will keep the adult columns as simple as possible because my own experience of three has shown me that giving too much information at one time can cause them to tune out. After I explained FICA to my kids, for example, I tried to talk about other sections of their paycheck, and they were like, “I’m out.”
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So, let’s start with a paycheck primer.
“It’s important to know where your funds are going and why you’re paying them,” said Eric Bronnenkant, head of tax at Betterment, a digital investment advisory firm. “Most people lump all taxes in one bucket.”
On your payslip, you’ll find a section related to FICA, or the Federal Insurance Contributions Act, which funds the Social Security and Medicare programs.
Or those funds may be listed as separate payroll taxes. One is for Social Security Old-Age, Survivors and Disability Insurance (OASDI), which benefits the elderly, workers who develop disabilities and families in which a spouse or parent dies. The other is for Medicare, which provides health care for Americans 65 and older.
When you start a new job, you are required to fill out a W-4 form, also known as the IRS’s Employee Withholding Certificate, which allows your employer to withhold federal income tax from your paycheck. If too little is kept, it is usually due government money when you file your tax return and a penalty may be due. If too much tax is withheld, a refund is usually due.
In 2020, the W-4 was updated to simplify the form to reflect changes to the tax code under the Tax Cuts and Jobs Act of 2017. The form has five steps, starting with entering your personal information and filing status and ending with you signing the form. Steps 2 to 4 must be completed if you have multiple jobs, plan to claim dependent tax credits or have other adjustments for additional income.
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Here is a breakdown of the taxes being withheld:
OASDI: The federal Old Age, Survivors and Disability Insurance program, also known as the Social Security tax. It will take 6.2 percent of the first $160,200 of your wages for 2023. So an individual earning that much this year would contribute $9,932.40 to OASDI. The person’s employer contributes the same amount. If you’re self-employed, you pay the full OASDI tax rate of 12.4 percent, although you also get a deduction for half of what you pay, according to IRS spokesman Eric Smith.
Medicare: This represents 1.45 percent of your taxable wages, with an additional tax of 0.9 percent applying to some high earners. Unlike the OASDI tax, there is no limit on the amount of income subject to Medicare taxes. The self-employed are also responsible for paying the full Medicare tax, half of which is also deductible. Medicare is also available to some people younger than 65 with a disability or end-stage renal disease.
Federal withholding: The amount of income tax withheld that goes to the federal government. It is based on how much you earn and the information you give your employer on your W-4.
Withholding by the State: Any state and/or local taxes withheld from your pay. Some states, such as Florida, do not collect personal income taxes.
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Here are some salary terms you should know.
Total gross: The total of what you have earned for the current pay period or YTD (year to date) before any withholdings or deductions.
Employer paid benefits: Benefits paid by your employer, such as matching contributions to a retirement savings plan such as a 401(k).
Deductions before tax: Any money exempt from income taxes, including medical or dental insurance, or money you chose to put into a flexible spending account or workplace retirement plan. The pre-tax deduction reduces your taxable income and, therefore, the amount of money owed to the government.
Deductions after tax: Deductions that are not exempt from income taxes and FICA. These include life insurance, long-term disability insurance, union dues or charitable contributions taken from your paycheck.
Net pay: The earnings you ultimately get to take home after all taxes and deductions.
You can complain about the payment in the Social Security system because you have heard that it may not be long enough for you to claim benefits.
This is a big financial problem. Reserves for the Old Age and Survivors Insurance Trust Fund (OASI), which pays retirement and survivor benefits, is projected to fall short and will not be able to pay full benefits in 2034 , according to the most recent fiduciary report for the Social Security and Medicare trust funds. At that point, only 77 percent of benefits will be payable.
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Worst case, benefits are cut or taxes are raised, but Social Security is too vital to too many Americans to eliminate. In 2022, 55 percent of seniors reported that Social Security was their main source of income, according to Gallup.
When my nephew received his first paycheck decades ago, he complained about FICA, saying, “I was robbed.”
“No, Tom,” I had countered. “You have been taxed.”
Bronnenkant describes FICA as “a retirement program designed to reduce the risk of poverty in your old age.”
You may not like FICA, but your older self will appreciate the income.