Monday, December 17, 2007

Gen X or Millenial?

You heard it here first:

Start now on saving for the future! If you have a 401k plan at work - sign up now! Even if you can't put in very much - just do it. Get started TODAY.

I was talking to a 27 y.o. man last week about this very topic. When I said "If you sign up to put in $100 per month, your paycheck will only go down by about $80 because your tax withholding goes down too." He said "Really?" NO ONE HAD EVER EXPLAINED IT TO HIM. So here it is:

If you put money into a deductible retirement account at work - 401k, 403b, 457, etc. the contribution comes "off the top" BEFORE federal income tax withholding. The contribution (technically called a "deferral") reduces your taxable income. Lower taxable income equals lower tax withholding. Your HR person should be able to show you how your paycheck would change with a given contribution amount. Pretty easy to ballpark it for yourself though:

  1. Pick up your last paycheck stub.
  2. Find the amount for Federal Income Tax withholding.
  3. Find the amount of your Taxable Income.
  4. Divide the withholding amount by the taxable income amount (as my mom used to say: divide the "little number" by the "big number" to get the ratio). The result will be close to 10%, 15%, 25%, 28%, 33% or 35% - these are the withholding rates.
  5. Take the result and multiply the amount you will put into the retirement plan by that percentage.
  6. Subtract that number from the contribution.
  7. The result is the amount by which your net paycheck will decline.
For example, if your withholding ratio is 25%, then for every $100 you put into the plan, your paycheck will decline by $75.

The point here is that it doesn't cost $100 to save $100.

Questions? kimm@sweetwaterinv.com

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