Although your child may not be filing her own return this tax season, it is an opportune time to have an introductory conversation about taxes. There are families on both ends of the transparency spectrum. Some never talk about taxes, whereas others walk their children through their tax return line by line. One place to start the conversation is with your child’s first pay statement.
Do you remember receiving your first paycheck or having your first paid job? This exciting moment in your child’s life can also be the ideal teaching moment when she realizes the amount she was getting paid per hour is not the amount she is taking home!
Depending on the type of job, she might not have all these items on her pay statement, but these basics are important to review.
1. Starting at the top right, what is the pay period start date, end date and pay date? Typically, paychecks are delivered every two weeks.
2. Identify the gross earnings. This may be the number she expected to take home. Is she paid hourly, and is there overtime? Or is she on a salary instead?
3. Following gross earnings, we arrive at the deductions. Deductions are subtracted from the gross earnings before any taxes are removed. This is a reminder that deductions are a good thing, as they lower the amount of earnings subject to tax. A few examples of a deduction include a contribution to a 401(k), health insurance payments (medical, dental or vision) or a health savings account (HSA) contribution.
4. Although your child may not be enrolled in a 401(k) program yet, it is important to explain the benefits and prepare for when it does show up on her pay statement. Not only is a contribution to a 401(k) a deduction and therefore lowers her taxable income, but if there is a company match, this is essentially free money toward her retirement account. If she can, she should always contribute to her 401(k) and make sure she is giving up to the match amount at minimum to receive this added benefit.
5. We’ve finally reached everyone’s favorite topic: taxes! Generally, three types of income taxes are subtracted from the gross pay: federal, state and local taxes. Depending on where you live, there may also be a city tax. For example, if you live in New York City, there is an additional New York City income tax. There is also a Social Security tax and Medicare tax.
6. The bottom line of the pay statement is the net pay, which, after subtracting the deductions and taxes, is what remains for your child to take home.
Understanding a pay statement and being prepared as it becomes more complex is a valuable learning at a young age. BBH has worked with countless families to help start these conversations.
If you have questions, please reach out to your relationship manager or email us at CW&W@bbh.com for more details on our Next Gen Program focused on preparing the next generation for financial independence.