A disclaimer to start: These tips do not apply to everyone. Each person's financial situation is unique, and parts of what I am about to write may or may not apply to the reader. However, the purpose of this post is to give a simplified view of how I approached my finances and hopefully provide some advice along the way. For this post, I would assume we are comfortable earners in stable jobs, and we are looking for ways to save up and invest for the future.
To start with, we will go over some basic deductions that may appear on your pay statements, along with an introduction to retirement accounts and their advantages. The aim of this exercise is to understand terms in the US financial system. I will have a separate post about actionable items.
Assuming you are a full-time salaried employee, you would have access to your pay statement through your company portal or a provider such as ADP.
Your statement would have a section termed 'Earnings' that shows the pre-tax earnings (a.k.a, Gross pay). This section shows what the company paid you. Let us assume this is $5000
Somewhere on your statement would be a line item that says "Your federal taxable income," followed by a number, say $4000. Notice that this number is lower than the Gross pay. The part of your statement that makes the difference is under a section called 'Deductions.'
There would usually be several entries under deductions. Some of these are 'pre-tax' deductions (e.g., 401k contributions, and life insurance). They contribute to reducing your taxable income, which means that you don't give taxes on every dollar your company pays you.
So the keywords are as follows :
What you see in your bank account is your net pay. One might imagine that taking steps to minimize deductions and maximize net pay is the best way to go. But, things are a bit more nuanced than that. Assuming you can afford it, the financially astute thing to do is to put the right amounts of contributions in suitable buckets to maximize returns over the long term. Even if it means a slightly lower net pay in the short term.
You will see further in this article how pre-tax deductions are a way to plan and save for your future. The tax system is built in a way to encourage saving for retirement and medical expenses. Opting for those deductions benefits you in the long run and helps save money on taxes in the present.
We will look at some of the standard pre-tax deductions and how they can be beneficial to us.