Income from a Job

The amount you receive each pay period can be frustrating because it is often less than what you might expect. There's no getting around certain things that reduce your take-home pay, like FICA taxes. But you have control over other amounts that are taken out of each paycheck such as:

While these reductions may seem to be money you are losing, in reality they help ensure your long-term financial stability in the later stages of your financial journey.

The amount withheld from your paycheck in taxes is determined by the income tax rates set by the government, your income and filing status and how you fill out the IRS Form W-4.

IRS Form W-4. When you start a new job, you'll be asked to complete a Form W-4. Your employer uses that form to know how much federal income tax to withhold from your pay. The goal is to have enough money withheld to prepay what you will owe in income taxes by the end of the calendar year.

If you are single and have just one source of income, your withholding is essentially set. But if you have multiple jobs, investment income, a spouse who is employed, or dependents, it is important to use the instructions and calculator provided with the W-4. They will help you determine the appropriate amount to withhold each pay period.

You should always update your W-4 if your financial situation changes.

Health insurance coverage is another essential benefit that you may be eligible for as an employee. In most cases, you pay just a portion of the monthly cost of coverage and the company you work for covers the rest.

Because paying for health insurance yourself can be extraordinarily expensive, it almost always makes financial sense to choose a plan available through your job, even if it means that paying your portion of the monthly premium will reduce your take-home pay. If an employer-provided plan is not an option, you can investigate buying coverage through the health care marketplace run by the state where you live.

Building financial stability—and wealth—can depend largely on how you save and invest for retirement. While retiring may be decades away, the decisions you make now can play a significant part in your financial story and in building long-term financial security.

You may have heard about 401(k), 403(b), 457, and Thrift Savings (TSP) plans. These are all types of employer-sponsored retirement savings plans that offer tax advantages as an incentive to deduct money from your income to build retirement savings. True, your contributions to these plans reduce your take-home pay. But your earnings and sometimes your contributions are tax-deferred, which can reduce your taxable income. If these retirement plans are available to you, they are among the most effective ways of building long-term financial security.

One of the keys to wealth accumulation is maximizing available benefits. A prime example is employer matching programs. Many employers who offer retirement savings plans match a portion of the contributions you make, usually as a percentage of what you contribute, up to a limit, or cap.

Maximizing your employer's match is a perfect example of how to increase your earnings and your wealth by taking full advantage of a benefit available to you.

It's sometimes called “not leaving any money on the table”, and it's just one of many smart moves you can make in building financial security and wealth.

Tax deferral allows you to postpone paying taxes on certain earnings until some point in the future, typically when you start to make withdrawals. When you contribute pretax income to a tax-deferred employer retirement plan, you reduce your salary by the amount of your contribution, which also reduces what you owe in income tax for the year.

You do pay that tax eventually when you begin taking money out—typically after you retire, or, if you need the money, after you turn 59½. If you withdraw before you reach that age, in most cases you'll owe an early withdrawal penalty of 10% of the taxable portion of the withdrawn amount. You'll also owe tax on what you withdraw at the same rate you're paying on your ordinary income at that time. But if you're withdrawing when you're no longer working, your tax rate will likely be lower than it was when you were working full-time.

Employers who offer a tax-deferred plan may also offer a Roth account as part of the plan. If you choose this alternative, the money you contribute is taxed up front. But you won't owe any tax on withdrawals, as long as the account has been open at least five years and you're 59½ or older.

Some employers allow you to split your contribution between a regular tax-deferred plan and a Roth account. That way, you can get some of the benefits of each, both reducing your taxable salary and being able to make tax-free withdrawals later down the road.

Compounding occurs when money you earn on your investments is added to the original investment, forming a new, larger account balance. Future earnings are based on that larger amount: In the case of interest income, the interest rate is multiplied by that larger amount, meaning you earn more. As that amount continues to get larger, the potential for growth increases.

That's because the full amount you contribute compounds because the plan automatically reinvests any earnings from your plan investments back into your account. (Remember, you don't pay income tax on the balance in a tax-deferred account, so there's more that can potentially grow.)

With compounding, time is money. The more years that you contribute to your plan, and the more years any earnings continue to increase your account value, the larger your account has the potential to grow.