Let’s talk about your paycheck. The first thing I realized after graduation was real life was nothing like I expected. Where was the company car or the corporate jet? Why did I still have to do my own laundry and clip coupons? Why can I barely even qualify to rent an apartment that I’m too embarrassed to show my parents? I’ll tell you why. It’s called entry-level positions. You cannot expect to just graduate and become CEO of some company. Even with a college degree, most of us have to work our way up through the ranks. In fact, the average college graduate overestimates their starting salary by 44%. It takes a lot of work just to remain in the middle class. You start to appreciate all those times your dad complained about “leaving every light on in the house.”
Aside from the first shocker, that you are not quite worth a six-figure salary the day you graduate, you are also experiencing the true costs of life. Rent is almost always more than one would expect. I remember when I first moved to the Washington, D.C. suburbs; I planned to spend $400 per month on rent. After all, my parents’ house payment was only around $300. Then, me being the financial wizard that I was, decided to cushion my budget to allow for a whopping $500 for rent. So, I took a job that paid low, but had potential. The only problem was, the apartments I wanted were well over $1,000 per month. Not only were they too expensive, but I couldn’t “qualify” for them anyway. After looking at various apartments (if you can even call them that) that were less than $1,000 per month, I finally found one that was just $620 per month and only 45 minutes away from my job. So much for financial independence.
Then came the best part. I got my first paycheck! Well, clearly there must have been some mistake. After all, I did the math and unless they were going to give me an extra paycheck every month, there was no way those numbers even resembled the ones we talked about in the interview. I mean, I could have made more money sitting outside the subway station with a “Will work for food” sign!
The first thing I discovered was that, apparently at the interview and the orientation, there was a bit of miscommunication. You see, I thought they were actually going to pay me. The truth is, they overemphasized how much I would make my first year, but they underemphasized that nearly 10% of the promised amount would be made at the end of the year in the form of a bonus. That brings up a serious cash flow issue. See, I couldn’t tell my landlord that I would pay him most of the rent during the year and pay him a 10% bonus amount at the end of the year. I had to spread my payments out evenly every month. So, the low pay and the high rent meant I only kept that job for about two months before I moved on.
But here is the real kicker. Even going by the real amount I should have been making every pay, I only saw about 65% of that. That’s right, for every $100 earned; I only got to see about $65. So where did it go? There are actually several places your money goes once you get paid. It’s depressing in a way, but at least you can be better prepared, and perhaps budget accordingly.
So pull out your paystub and let’s talk about all of the different items listed on the check.
Fed Tax: I think this one is pretty simple. This is the federal tax you pay from each check.
State Tax: Again, a basic concept. This would be the state tax you pay. Usually you will not find a separate locality pay, but it does happen occasionally. Your locality is usually a city such as Baltimore City.
FICA: This is your social security tax. You pay 6.2% of your salary to FICA. It stands for Federal Insurance Contribution Act. Don’t feel too bad though, because your employer contributes an additional 6.2% into FICA also, so really 12.4% of your salary goes into social security, but only half of that is actually pulled away from you.
Med: You have probably heard of Medicare. This is the system that helps the elderly with medical expenses. You pay 1.45% towards Medicare. Your employer matches the same amount.
Health: Your health insurance may be taken from your paycheck either pre-tax or post-tax. Either way it gets taken out of the gross amount and makes your net amount smaller. For most people, their employer actually pays a much larger share of the health insurance cost than they do.
Life: Your employer may offer a life insurance policy. The policy is usually for a small amount, such as two times your annual salary.
Retirement: There are several categories available here. This could be the amount you chose to contribute (such as a 401(k)), or perhaps your employer automatically deducts a certain percentage and places it into an account for you.
FSA: The Flexible Spending Account is an amount you choose to set aside for medical costs.
ESOP: The Employee Stock Ownership Plan is a benefit you signed up for. If you did not, go and speak to someone in your human resource department. The ESOP is money taken from your paycheck and used to purchase company stock. Sometimes the company will match a portion of your ESOP contribution, but they do not have to. An ESOP is another form of savings.
There may be others, depending on what your employer offers in the form of benefits. You may also have stock options or other such benefits that show up on your pay stub. I have given you the most common deductions that decrease your gross pay.
That brings up another point. There are two types of pay that really matter: Gross pay and net pay. Gross pay is actually the larger of the two. Your gross pay is what you make before taxes. If you are an hourly employee, your gross pay is simply your hourly rate multiplied by the number of hours you worked. For a salaried employee, your gross pay is your annual salary divided by the number of paychecks you receive in a year (typically 26). If this is not the case, you may want to inquire about it from someone in personnel.
Net pay is the one that tells you what’s left over after all of the deductions previously discussed. You start with gross pay, then taxes are taken out, and insurance, retirement, and so forth. That’s why your net pay is always so much smaller than your gross pay. As a quick estimate, you can assume your net pay will be between 60% and 70% of your gross pay, depending on how much your insurance costs, and how much you contribute towards retirement, etc. Think of it this way. If you had a fish aquarium with ten fish, that’s the gross amount. But, when you use the net to scoop them out, you may only get six or seven of the fish in your first swoop, thus you netted six or seven fish. That’s like net pay; it’s the amount you net from the total.
Next week we’ll look at exemptions and taxes.
Bill Pratt is a former credit card executive turned student-advocate. He is the author of Extra Credit: The 7 Things Every College Student Needs to Know About Credit Debt & Ca$h. Bill speaks at colleges to educate and entertain students about real-life issues in money, leadership and success. His goal is to help students succeed personally and financially so they can improve the lives of those around them. You can learn more at www.ExtraCreditBook.com.