When you’re fresh out of college and land your first professional job the first thing that crosses your mind is probably relief. The second is likely if your new salary will be enough to cover your bills. But the salary amount is usually where a lot of first-time professionals stop paying attention to their compensation package.
Unlike in countries such as Australia, Singapore, and the United Kingdom, there are no federal laws in the United States that say young people must be taught financial literacy in school (though that is slowly changing on the state level). What that means is that many first-time professionals don’t understand how maxing out their 401(k) contributions now can lead to massive financial gains when they retire. Or how contributing to an HSA, while it may cost you money now, could save you thousands one day. Or what the difference is between taking stock options or RSUs.
So to help you understand the more complex aspects of your compensation, we reached out to a handful of working professionals to see what they wish they would have known about and done differently when they first entered the workforce.
Gross pay is the amount of money you make before taxes and other deductions are taken out. Net pay is what is actually deposited into your bank account each pay period after taxes and other deductions are taken out. So if your annual salary is $35,000 you’ll actually only see $28,000 of that (assuming your tax rate is 20% and you have no other deductions) hit your bank account during the year. That means budgeting your year for $35,000 in spending will see you come up short. This is important for things like housing costs: Affordable housing is considered to be under 30% of your income, but that’s based on gross income, not net.
“Thanks to my interest in personal finance blogs, I knew that my gross and net pay wouldn’t be the same before I started my first job. I was well aware I’d have to pay federal taxes, FICA taxes and state taxes. I even used an online paycheck calculator to estimate how much these would be,” says Lance Cothern, personal finance blogger at Money Manifesto. “Unfortunately, I forgot to factor in a few important deductions that made my paycheck even smaller than I initially thought it would be. While I knew I’d be getting benefits at my job, I forgot to incorporate the deductions to pay for those benefits in my calculations. As a result, my paycheck was around $100 less than I expected it to be.”
“Another gross versus net pay issue I quickly ran into involved my sign-on bonus. I earned a $5,000 sign-on bonus. What I didn’t know was federal taxes would be withheld at a flat 25% rate on my bonus (that rate is even higher in cities like New York), making it much smaller than I had expected. While I did get some of that money back when I filed my tax return, I didn’t have it when I got my bonus check.”
You likely know that a 401(k) is a retirement savings plan provided by your employer. The benefit of a 401(k) is that any money you choose to have automatically deducted from each check won’t be taxed now. So if your tax rate is 20% and you put $100 every pay period into your 401(k), you’ll actually get the full $100, whereas if you opted to take the $100 in your bank account right now, you would only get $80 after taxes are taken out. You only pay taxes on 401(k) when you withdraw the money in retirement. Another benefit is sometimes an employer will match your 401(k) contributions–which means you’re getting free money every pay period.
“I actually remember my first boss explaining that one of the company benefits was a 401(k) with matching contributions. I didn’t know what that meant, but from what I could gather, it lowered my paycheck, which didn’t sound like much of a benefit to me,” says Arielle O’Shea, NerdWallet‘s investing and retirement specialist. “I called my older brother from the hallway outside my office to ask what it was and whether I should sign up. He quickly said ‘yes’ with a brief explanation; I quickly ignored his advice and told my boss ‘no, thanks.’ I wanted and needed all the money I could get.”
“In hindsight, the biggest problem with this was not that I missed out on investment growth and matching contributions for the year I was at that job, though that pains me a little bit now. The biggest problem was that because I didn’t start saving for retirement at that first job, I didn’t care when my next job didn’t offer a formal retirement plan. And I wasn’t about to start saving in one on my own. It took me three or four years and a job in personal finance to finally open a Roth IRA,” she explains.
“Start saving for retirement with your very first paycheck. It’s much easier to do it from the beginning than it is to start later and adjust to a lower income. If there’s a waiting period for your company’s 401(k), as there often is, decide how much you’re going to contribute and put that away in an IRA each month until that waiting period is over. That has two benefits: You start saving and investing right away, and when you do become eligible, you’re not suddenly reducing your paycheck to start contributions—you’ve been living with that reduced paycheck all along.”
“It’s okay to start small—use a retirement calculator to figure out how much you should be saving, then work your way there. One easy way to do that is to increase your retirement contributions each time you get a raise.”
A health savings account (HSA) is kind of like a 401(k) for medical expenses, in that any money you have deducted from your check and put into your HSA isn’t taxed. The money in that HSA is then invested in anything from mutual funds to bonds, so its total value grows over time–giving you even more money. HSAs are usually available for anyone enrolled in a high-deductible health plan (HDHP). You can take the money out from an HSA at any time provided you use it to pay for your health insurance deductible or qualified medical expenses.
“When I started my first job I didn’t know anything about health savings accounts. It turns out that HSAs are one of the most tax-advantageous accounts you can have. I wish I had known that the money you contributed was tax free, that the money grows tax free, and that if you withdraw the money for qualified medical expenses, you don’t even have to pay taxes when you take the money out,” says Money Manifesto’s Cothern. “When using a regular retirement account, you either have to pay taxes up front or pay taxes when you withdraw the money.”
“If I had been able to contribute to an HSA, I could have avoided paying taxes altogether on some of my earliest earnings. Using what I know now, I would have let it grow to pay for my inevitable medical expenses when I retire. Unfortunately, I didn’t qualify for an HSA because I decided against the high deductible health insurance option and instead opted for more comprehensive health insurance package that cost me more per paycheck. I ended up not using the insurance at all, so I would have been better off picking the cheaper high deductible health insurance plan and putting the difference in the cost between the plans into an HSA.”
Many companies offer employee stock purchase plans (ESPPs), which allow you to use from 1% to 10% of your salary to buy your employer’s stock at a discount to its current stock price–usually around 15% off. So if at the set purchase date your company’s stock is worth $100, you get to buy each share for $85–and can sell it the very next day for the full market price, if you wish. In addition to ESPPs, some companies also offer new hires restricted stock units (RSUs), which are guaranteed to be at a certain fair market value when they visit (i.e., when you are allowed to sell them).
“I’m still kicking myself for not fully looking into the difference between stock options and restricted stock units (RSUs),” says Felicity, an early retirement blogger at Fetching Financial Freedom. “My husband works at a company that gives a choice of stock options or RSUs for bonuses. Not fully understanding the terms because of legal jargon, we chose a mix of both–a decision that ended up costing us around $10k compared to 100% RSUs.”
“Stock options give a high return when a stock grows but are worth nothing if there is no growth, whereas RSUs guarantee a minimum value even if the stock price dips. Generally speaking, RSUs are often a better choice if you are not planning on staying with the company for a long time and/or if you work for a large organization. If you work for a startup, stock options will likely still be the better choice due to the growth potential. Consult a professional and make sure you know the tax implications of your specific situation before making any decision.”
Travel, meal, and housing allowances are simply payments a company makes to employees to cover their travel expenses when going on a trip for company work. For example, a company may give you a $50 food allowance each day you are away from home to cover your food costs–you just need to remember to file your receipts to get reimbursed up to the company’s limits.
“I used to think of workplace travel opportunities as a luxury and would be very controlled with spending while on the company’s dime. Sometimes that meant skipping meals in order to save the company money. I also used to continue to work in my hotel room even after normal work hours. I felt like I ‘owed’ the company more of my time as a token of thanks for the travel opportunity they had granted me,” says Alex Williams, personal finance blogger for CheapGirlSaves.com.
“I used to be nervous about being seen as ‘taking advantage’ of the fun chance to get outside of the office. Now, I see it as my work is taking me away from home. It makes better sense to get to eat breakfast as it’s a part of my regular workday routine. Now when I travel for work I allow myself to eat the meals that are allotted and close the laptop when the work day comes to a natural end. There’s no point in forcing myself to not enjoy the experience that just comes with the territory.”