Paychecks 101

The word Payday circled in red marker on a calendar to remind you of the date you receive your wages, income and earnings so you may budget your finances26

Everyone always remembers their first paycheck and asking themselves, “Who’s FICA, and why is he taking all of my money?” If you’re like most people, the number that really matters to you is the bottom line: money in the bank! You may even throw out the rest of your pay stub. However, it is so important to review your pay stub and be able to analyze the information you find there to spot potential errors.

While your paycheck may not always give you the physical wealth you were looking for, it will give you a wealth of knowledge about your finances. Carefully reviewing pay stubs is a step we at DWM take with all of our clients to ensure they’re clear on available benefits, tax rates, employer matches, withholdings, and more.

So, without further ado, here’s a comprehensive guide to reviewing and analyzing your pay stub.

 

Important Terms and Definitions

 

First, to help you better understand the different acronyms within your pay stub, let’s take a look at a few of them and their definitions:

 

YTD: Year-to-date

PPD: Pay period

REG: Regular hours worked

OT: Overtime hours worked

HOL: Paid holiday hours

VAC: Paid vacation hours

PTO: Paid time off

FT or FTW: Federal tax withheld

ST or STW: State tax withheld

LT: Local tax withheld

SS: Social Security tax

MED: Medicare tax withheld

FICA: Your employer’s portion of the Social Security and Medicare taxes

WC: Workers’ compensation contribution, typically paid by your employer

 

Additionally, there are a number of terms you will need to know:

 

Gross pay: This is the total amount you earned during the given pay period (pay period discussed below). It includes your wages or salary, plus bonuses and tips if applicable. Most pay stubs will also include how much you’ve earned year to date.

As almost all areas of your pay stub relate to gross earnings, this number is usually located on the first line of your pay stub with the remaining figures telling you how much of those earnings were withheld for taxes and other uses.

Pre-tax benefits: Some benefits may appear on your pay stub as pre-tax income. For example, if your employer pays for some or all of your childcare expenses, travel expenses, or your parking pass, these may show up as taxable benefits.

 Net pay: Also known as “money in the bank,” this number is what you receive as your paycheck after taxes, insurance premiums, retirement contributions, and other deductions have been taken out.

Pay Period: By looking at the dates on your pay stub (usually located at the very top of your pay stub), you can tell if you’re being paid monthly, weekly, or bi-weekly. This helps to know if you need to multiply your current pay by 12, 52, or 26 to determine annual salary. If you are using a mid-year pay stub, you may multiply your current pay by the number of pay periods remaining and add this to your year-to-date figure, mentioned earlier.

Federal income tax: Your pay stub will show how much money was taken out of your gross pay for federal taxes. The exemptions you claimed on your W-4 form determine the amount withheld for federal taxes.

With recent changes to income tax brackets in 2018, federal income tax withholding is an area you should review thoroughly. To see if you are currently withholding enough or too much, go to https://www.irs.gov/individuals/irs-withholding-calculator.

State income and local tax: If you live in a state that requires that you pay an income tax, that number will also be determined based on your W-4 exemptions.

Social Security tax: The federal government requires that every employee and employer pay a tax for Social Security purposes. You, as the employee, pay 6.2 percent of up to $128,400 in wages for 2018. So, if you earn $100,000 per year, your Social Security tax comes out to $6,200 for the year. This tax makes it possible for you to receive Social Security benefits when you retire.

Medicare tax: Similar to the Social Security tax, the Medicare tax is mandatory for employees and employers alike. You’ll pay a 1.45 percent tax on wages up to $200,000 ($250,000 if married) for 2018. There is an additional 0.90 percent, 2.35 percent overall, tax on wages over $200,000 ($250,000 if married). Medicare tax exists so that you can benefit from the program when you come of age.

 

Understanding Your Benefits

 

Now that the hard part (taxes) is out of the way, it’s time to understand your benefits.

Insurance premiums: If your benefits include insurance like health, dental, vision, life or disability, your employer may require that you pay for at least a portion of the plans’ premiums. That cost will come out of your gross pay automatically, and how much you pay shows up on your pay stub. Be sure to take some time to understand your insurance policies, as well!

Flex spending account (FSA) or health savings account (HSA): If you opted to participate in an employer-sponsored FSA or HSA, you’d typically see a deduction for these on your pay stub and also note whether your employer has made a contribution (free money!).

Contributions to your retirement plan: This figure is how much you agreed to contribute to your employer-sponsored retirement plan. Common retirement plans include 401(k), 403(b), and 457 plans. If you get a match (more free money!), this number is on your pay stub, too, which shows you how much your employer contributed.

You can divide your employer’s contribution by your gross pay to determine what percentage they’re contributing to your retirement. If you know your employer matches your contributions up to a certain percentage limit, this is a good area to see if you are reaching your full contribution potential and whether you need to adjust accordingly.

 

Now What?

 

Final step! Now that you’ve reviewed each aspect of your pay stub, you have probably come across one or two items you’d like to change. Unfortunately, you can’t do anything about Social Security and Medicare taxes, but you can increase or decrease your federal and state tax withholdings by updating your W-4 form. This can be done by contacting your HR department.

If you’d like to review your pay stub, DWM is always happy to be your second set of eyes and ensure that your pay stub reflects your best interest.

Big Macs and Donald Trump

Big Macs are becoming a real bargain everywhere in the world… except for the United States. This is because most emerging market currencies have taken a big hit since the election of Donald Trump, whereas, the dollar is as strong as it has been in almost 20 years. Not only has Trump raised expectations of an increased strength of the dollar, but many foreign countries have had problems of their own as well, leaving emerging markets lagging behind.  The Turkish Lira, for example, is one of the worst performing currencies so far this year due to terrorist bombings, economic slowdowns, and a central bank reluctant to raise interest rates to defend the currency (The Economist, Big Mac Index of Global Currencies). Emerging market struggles paired with a surging US dollar has led the Lira to be undervalued by 45.7% according to the Big Max Index.

You may be asking yourself “what on Earth is the ‘Big Mac Index?’” At least that’s what I asked myself the first time I heard it. You may be surprised to hear the Big Mac index is exactly what it sounds like: the cost comparison of a McDonalds Big Mac burger from one country to another. It is a fun, educational, and interesting way to learn how the world is valuing cost of goods on a country by country basis. The Big Mac index is built on the idea of purchase-power parity, meaning in the long run currencies will converge and rates should move towards equalization of an identical basket of goods & services.

In the United States a Big Mac costs $5.06 versus 10.75 Lira, or $2.75, in Turkey. The Mexican peso is even more undervalued at 55.9% versus the US dollar, meaning, a Big Mac only costs $2.23 in Mexico as of January 15th, 2017. The Big Mac index allows us to take complicated subjects, such as international commerce, and make it relatable and understandable.

One drawback of the Big Mac index is it does not take account of labor costs. Of course, a Big Mac will cost less in a country like Mexico because workers earn lower wages than workers in the US. So, in a slightly more sophisticated version of the Big Mac index, labor is included. This typically devalues the US Dollar (USD) compared to other countries around the world because our income is higher. For example, in the traditional Big Mac index, the Chinese yuan is 44% undervalued to the greenback, but after labor adjustments, it is only 7% undervalued. When this adjustment of labor cost is made, it makes it nearly impossible for the USD to trade at a premium against the Euro. This is because Europeans have a higher cost of living and lower incomes than Americans (The Economist, Big Mac Index of Global Currencies). Typically, the Euro trades around a 25% premium against the USD according to the Big Mac index. However, since the election of Donald Trump, even with the labor cost adjustment, the Big Mac index currently finds the Euro UNDERVALUED to the dollar. The US dollar is so strong, it is currently trading at a 14 year high in trade-weighted terms.

 A strong dollar may sound great, but it has many disadvantages. In the United States specifically, a strengthening USD can lead to a widening trade deficit with decreased exports and increased imports. This has a negative result on domestic businesses that operate in foreign countries as well as anyone servicing debts tied to the US dollar. President Trump has publically stated he feels international commerce is rigged against the United States. Whether he is right or wrong, as the trade deficit grows, so does the likelihood of him imposing tariffs on imports from China and Mexico in hopes of bringing balance to trade. If we put a tax on imports, it will lead to something called “protectionism,” or the practice of shielding the United States’ domestic industries from foreign competition. Some feel this is a strong policy because it will keep businesses in the United States and, according to Trump, will prevent us from being taken advantage of. However, it is fairly accepted in macroeconomics that protectionism is a poor/outdated policy because corporate globalization has led to international supply networks that promote convergence and integration throughout the world. Simply put, the countries that are the best at developing goods, develop them, and other countries benefit from the best products at the lowest prices. When something like protectionism takes place, it disintegrates these networks and adversely affects trade-dependent states and the domestic country itself (in this case the United States). The import tax will ultimately drive up prices for domestic consumers who would otherwise benefit from world prices that are significantly lower. This will lead to an increase in trade of intermediate goods and inward investing into value chain niches.

The reason the Big Mac index is so interesting is because it can explain a complex subject like macroeconomics with something as simple as the cost of a hamburger. By knowing the price of a Big Mac on a country by country basis, we are able to understand a significant amount about the world economy and the repercussions the US will face based on the actions we take moving forward.

The Big Mac index is telling us one thing for certain: the US dollar is abnormally strong, which makes the near future uncertain. It is important to have a well-diversified portfolio with an appropriate asset allocation and a competent, experienced fiduciary like DWM to help guide you through times like this.