5 Financial Lessons to Know After Landing Your First Job by Joanie B. Stein, CPA
Posted on August 04, 2021
Congratulations! You graduated college, secured a job and are entering the real world of financial independence. Before forging ahead and spending your first paycheck, take a moment to understand some basic lessons in financial responsibilities that you probably did not learn in school.
Lesson 1: You Owe the Government Money
Under U.S. law, all money earned by U.S. citizens and resident aliens generally is considered taxable income, meaning that you must report those earnings to the Internal Revenue Service (IRS) on your annual income tax returns, which are typically due on April 15 of each year. The amount of taxes you owe on those earnings depends on various factors, including, but not limited to, your gross salary, your marital status and any income you earn from investments.
The taxes you pay the government help to fund the Social Security and Medicare benefits programs and pay the expenses required to keep the country running. This can include costs to maintain the military, build roads and railways and provide citizens with public school education, police enforcement, public transportation and even government-provided healthcare for those in need.
Lesson 2: Your Paycheck Will be Less Than You Expect
With the U.S.’s pay-as-you-go system of taxation, employers typically withhold federal income taxes from workers’ wages and pay those amounts directly to the government on their employees’ behalf. By contrast, if you are self-employed, you bear the burden of paying your estimated federal income and self-employment tax liabilities to the government every quarter.
The amount of Social Security and Medicare taxes you pay are based on fixed rates set by the government, while the amount of federal income taxes an employer may withhold or deduct from your regular paycheck depends on the information you provide on IRS Form W-4, Employee’s Withholding Certificate. In addition to asking for basic information, such as your name, social security number and marital status, the W-4 also asks if you would like your employer to withhold additional taxes from your pay to more closely match your tax liabilities, especially when you hold more than one job or you earn additional income from investments or other sources other than your job. Generally, the more tax withheld from your pay throughout the year, the greater the chance you will receive a tax refund from the government. While you may consider an unexpected tax refund to be akin to free money, the fact is that too much tax was taken from your pay and you missed out on an opportunity to invest that money and benefit from compounding interest.
Lesson 3: Your Employer’s 401(k) Savings Plan Can Mean Free Money to You
Retirement is probably the last thing you are thinking about when you begin your career. However, by failing to participate in your employer’s 401(k) retirement savings plan you could lose out on significant tax benefits and potentially free money that will grow with compounding interest in the future.
With a 401(k) plan, you elect to defer a portion of your salary toward a retirement savings. The deferred amount is automatically subtracted from your pay and removed from your taxable income in the years of contribution. Those savings, including dividends, interest and market gains, continue to grow tax-free until you take withdrawals in retirement.
For 2021, the maximum amount of pre-tax dollars employees may contribute to their employers’ 401(k) plans is $19,500. While this may seem like a lot of money based on your modest first-year salary, you should, at the very least, make enough of a 401(k) contribution each year to qualify for an employer’s match, if one exists. Under those circumstances, for every dollar you contribute to a 401(k), your employer will contribute a matching amount up to a set limit.
For example, consider a worker earning $40,000 and receiving a 100 percent match on up to 6 percent of his or her salary. If the worker contributes 6 percent of his or her annual salary ($2,400) to a 401(k) plan, the employer will contribute a match in the same amount ($2,400). Not only will the worker gain an addition $2,400 tax-free on top of his or her current salary, he or she will ultimately yield 12 percent savings for the future.
Lesson 4: Failing to Prepare a Budget May Prepare You to Fail
Whether you spent your college years relying on financial assistance from the bank of mom and dad, or you graduated with significant student loans, do not allow the excitement of receiving your first paycheck to overshadow the importance of planning a budget to manage your finances.
Calculate how much money you will earn each month, net of taxes, and work backward to determine how much you can afford for basic necessities, such as rent, utilities, transportation, gas, groceries and insurance. Be sure to consider repayments of student loans, contributions to 401(k) plans and amounts required to help you build an emergency fund to pay for all of life’s unexpected expenses, such as a much-needed car repair. A portion of whatever amount is left over can be allocated to “fun,” including dining out and entertainment, whether it be tickets to a sporting event, concert or other leisurely activity.
Lesson 5: Build Credit and Use it Wisely
Most recent college grads lack a solid credit history, making it challenging for them to secure a credit card or loan in the near future. With a job and verifiable income, you may qualify for a credit card with low spending limits. Alternatively, you may ask a parent to add your name as an authorized user on his or her account.
The important thing to remember is that a credit card is not free money; rather, high interest rates will apply to unpaid balances, and the amount you owe can increase fairly quickly making it more difficult to pay off outstanding debt. Instead, use your credit card to pay for your budgeted necessities and be prepared to pay the balance in full and on time each month. Over time, your credit score will increase, and you will be in a better financial position in the future.
Entering the workforce is an exciting time filled with countless opportunities to build and preserve wealth for the future. However, recent graduates should proceed cautiously with full knowledge of the potential pitfalls that can occur with financial independence.
About the Author: Joanie B. Stein, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where she works with individuals and closely held businesses to implement sound strategies that are intended to preserve wealth and improve tax-efficiency. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or at firstname.lastname@example.org.