This following is a post by MPFJ staff writer, Jeff. Jeff writes about sustainable living and finances at his website, Sustainable Life Blog. Jeff really enjoys traveling with his wife as much as he can, to wherever he can.
Have you ever heard the saying “pay yourself first”?
If you’ve ever had a job, I’m sure that you have. I’ve been having that information pounded into my head for about 15 years now, ever since I got my first job as a lifeguard. My parents said it to me, and so did relatives that were older and trying to steer me towards good habits. I appreciated the advice and I took it heart, building up a nice savings before going off to college (which I promptly spent most of).
15 years later though, even after I’ve set up automatic withdraws from my checking to my savings account on every payday, I look at my check and notice that I’m still not being paid first. If you’re not sure what I’m talking about, grab your most recent pay stub and have a look at it and you’ll see what I’m talking about.
(I’ll use some made up numbers here, but the picture is the same). Lets say that I make $65,000 per year, and get paid monthly. Here are the people that get paid before I even have a chance to pay myself first. For this, lets assume I’m a single male living in a state with no income tax (All numbers monthly).
- I pay federal income taxes of $987.52
- I pay medicare taxes of $78.54
- I pay Social Security Taxes of $227.50
- I’m single, so my employer pays for my share of the health insurance. If I wasn’t, a percentage of my check would be going to cover my health insurance premiums.
- This totals up to $1,293.56
Despite taking the advice I was given, there are 3 (or 4) people getting paid out of my wages before I do. Since I would rather keep more of my money than let them have it, I’ve been trying to figure out ways to put my name ahead of all those other groups siphoning money from my check. If you’re interested in that as well, here’s what you can do.
How to Pay Yourself First
The first (and probably most important thing you can do is contribute to a pre-tax retirement account, such as a 401k or a Traditional IRA. Most employers have a 401k option, and you can contribute to that account to the tune of $17,500 in 2014, or $18,000 in 2015 and beyond.
Even if you can’t fully fund your 401k each year, every dollar that you set aside will be a dollar that is truly going to you first. Once your 401k deduction gets taken out, then your taxes will follow (SSA, Medicare and Federal Income Taxes), but the taxes will be computed on a lower income. Using the above example, and assuming we will begin contributing the maximum to our 401k in 2015, here’s what it would look like. Your income would drop from 65,000 per year down to 47,000 per year, which would then be the basis for calculating the above taxes. Here’s how it would shake out:
- Federal income taxes will be $636.98
- Medicare & Social Security Taxes of 299.66
- Total is 936.64, less than just the income tax rate in the above scenario
The income tax is a lot lower because it is based in a sliding scale, while medicare and social security taxes are at a fixed rate. In this situation, we are truly paying ourselves first, instead of paying the government first and paying ourselves second. Now, if you’re already maximizing your 401k contributions and are looking for more ways to pay yourself first, there are a few other options, but you’ll have to check with your employer. If you don’t have the opportunity to have a 401k with your employer, a 457 or a 403b plan will serve the same purpose. If none of those are available to you, then you’ll be able to use a traditional IRA, though the limits are much lower ($5,500, or 6,500 if you’re over 50).
Other Ways to Pay Yourself First
There are a few different ways to keep the good times rolling, and they may (or may not be) offered by your employer.
In addition to retirement benefits, you may also be able to pay for a few more things with pre-tax dollars, lowering your tax liability even further. In IRS terms, these are called Section 125 plans, but are more commonly called cafeteria plans. You may be able to deduct expenses related to some (or all) of the following things:
- Health insurance expenses
- Commuting or Parking (if you’re traveling on public transit)
- Dependent care (day care)
- Adoption (expenses related to adopting a child)
- Group term life coverage
- Health Savings Accounts
Obviously, not all of these will be useful to you, but if your employer offers them all and you’re already paying for things such as day care and commuting, it’s in your best interest to pay for those with tax free dollars so that you can lower your tax liability.
Even though we are paying for everything with pre-tax dollars, it’s still wise to pay yourself after the government takes their cut because of early withdraw rules for 401k’s and other retirement plans.
How about you all? How much do you pay for with pre-tax dollars vs post-tax?
Share your experiences by commenting below!
***Photo courtesy of http://www.flickr.com/photos/76657755@N04/6881508144/in/
