As a dad that is about to send my oldest son into the “real world” for the first time, I’ve become overly aware that many people, including my son, don’t have a great grasp on all of the costs of living on your own. Of course, my son has chosen an expensive city like Nashville to call home for a few years and wants to experience what a big city fully feels like, so he is aware his costs will be high. As we worked through a budget, that knowledge didn’t take away from the shock of how little he would bring home from each check and how little would be left over after the bills were paid. I’m conservative by nature, so I may have built in a little cushion in the budget and ensured that he would do the right thing and start contributing to his 401k on day one. That still didn’t lessen the blow of telling him he will basically spend every dollar he brings home for his first year.
However, he is not alone in wondering, “Where did all my money go?” I’m going to make a quick summary of where the money goes, so you can help your kids and grandkids not be surprised when that first check comes.
Taxes
Welcome to the world of taxes. Here’s a breakdown to help you understand what’s being taken out of your paycheck – and why your take-home pay is less than your salary:
When you hear “$60,000 a year,” it’s easy to assume you’ll be seeing around $5,000 a month in your bank account. But what you actually take home – your net pay – is what’s left after several required deductions, primarily taxes.
1. Federal Income Tax
This is the big one. The U.S. has a progressive tax system, which means the more you earn, the higher percentage your income is taxed. Your employer withholds this tax based on the information you provide on your Form W-4 that you complete upon starting work. It’s a form designed to help withhold the correct amount of tax based on your income and family situation. The current Federal Income tax rates range from 10%-37%.
2. State Income Tax
Not all states have this, but forty-one states and Washington DC do. Just like Federal Income Tax, if it applies, a portion of your income goes to the state for withholding taxes. Rates and rules vary widely depending on where you live.
3. Social Security Tax
This funds retirement and disability benefits for millions of Americans. It’s a flat 6.2% of your gross income (up to a certain annual limit-for 2025 that is $176,100), and your employer matches that amount.
4. Medicare Tax
This funds health care for people over 65 and those with certain disabilities. It’s 1.45% of your gross income, and again, your employer matches it.
As you can see, even if you do the base amount of Federal Income tax at 10% and state income tax at 3%, you will have over 20% of your paycheck gone before you even decide on elective costs that I’ll discuss next. That takes your gross $5,000 a month to below $4,000 and that’s a big impact on the budget.
Elective Costs to pay through your paycheck
Aside from taxes, your paycheck might also have deductions for:
- Health insurance premiums – It may seem like a luxury, but the negative financial impacts of not having it can be life changing.
- Retirement plan contributions (e.g. 401(k))-Another one that may seem like a luxury when the budget is tight, but in ways you can’t afford not to take advantage of the probable employer match along with the importance of starting early and taking advantage of the time value of money.
- Union dues or other professional fees
- Transit or parking benefits
Some of these elective costs will be pre-tax, which means they reduce the amount of income you pay taxes on.
What Should You Do
Budget based on your net pay, not your gross salary. A simple budget will allow you to allocate your monthly expenses quickly, so you can make your first major financial decisions. You get to choose how much you spend on rent, a car, going out with friends and entertainment, but at the end of the day you can only spend what you take home. If you spend more than you bring home, you will quickly find yourself in a debt hole that is difficult to get out of.
Budgets and taxes are just part of adulting – and the more you understand them, the better decisions you can make about your money. You are in control but sometimes you need help, so find a trusted friend or professional to help you along this path.
