What I wish I knew about personal finance at the beginning of my careerFeatured
I've been a software engineer for a few years, and these are the things about personal finance that I wished I knew at the beginning of my career. These are topics that I've personally encountered at my employer in the U.S., so some may not apply to you depending on your employer. Taxes and your incomePre-tax vs. post-taxDeductions on your paycheck are separated into pre-tax and post-tax. Pre-tax deductions are taken from wages before taxes are withheld, so they reduce the amount of income on which you will be taxed. Post-tax deductions are taken from your wages after taxes are withheld. For example, if your monthly wages are $100, and your pre-tax 401k contribution is 5% and your effective tax rate is 10%, then you will deposit $5 into your 401k, and pay $9.50 (10% on the remaining $95) in taxes. Any post-tax deductions will be made against the remaining $85.50 ($100 - $5 - $9.50). Tax brackets, marginal and effect tax ratesFederal income tax is progressive, meaning that tax rates increase as taxable income increases. Tax rates depend on your tax filing status and income, and the IRS releases new figures every year[.](https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2020)The standard deduction for 2020 is $12,400, which is the amount that your taxable income will be reduced by if you choose to take the standard deduction instead of itemizing your deductions.For example, if you make $50,000 a year, then your taxable income is 50000-12400 = 37600 after the standard deduction. You will pay 10% tax on the first $9,950, and 12% tax for the income between $9,875 and $37,600. The next marginal rate is 22% for incomes over $40,525 but this doesn't affect you because your taxable income is below this amount. Each of these percentages (10%, 12%, 22%) are marginal rates, and your marginal rate is the highest rate that applies to you, which is 12% in this $50,000 example. In comparison to the marginal tax rate, your effective tax rate refers to how much tax you actually pay, and can be calculated using the marginal rates on different buckets of your income: (0.12 * (37600 - 9875)) + (0.10 * 9875) = $43144314 / $50000 = 8.63%There are many federal income tax calculators sites that can run these calculations for your situation. In addition to federal taxes, the state you live in may also tax your income. You can check the specific rates on your state's website. Payroll tax limitsSome taxes have a maximum limit, so you will not pay beyond that limit within the year. One example is the Social Security payroll tax, which will tax you 6.2% up to $137,700 of income, which means you would not have paid more than $8,537.40 during the 2020 year. So if your income is higher than $137,700, you will see $0 taken from your later paychecks for Social Security tax after you have maxed out.Employer-sponsored retirement accountsA 401(k) is an employer-sponsored retirement account. You can contribute a percentage of your pay to this account. There are three types of 401(k)s: Traditional, Roth, and non-Roth after-tax. The main difference between these different types of 401(k)s is the tax treatment. You use pre-tax dollars to fund your traditional 401(k), and you will be taxed when you withdraw from it. You use post-tax dollars to fund your Roth 401(k), and you will not be taxed when you withdraw from it. You use post-tax dollars to fund your non-Roth after-tax 401(k), and you will also be taxed when you withdraw from it. This tax treatment makes the non-Roth after-tax 401(k) very similar to a taxable account, so it would be more beneficial to use this as part of a Mega Backdoor Roth 401(k) conversion. The 2020 limits for the combination of your Traditional and Roth 401(k) is $19,500. The limit for the total contribution from both the employee and the employer for 2020 is $57,000, which includes employer matching and any contributions in the non-Roth after-tax 401(k). Employer 401(k) matching is a great benefit. An example of a matching rule is that your employer will match 50% of your 401(k), up to 8% of your contributions. This means that if you make $100,000, and you contribute $8,000 to your 401(k), your employer will add $4,000 to your 401(k). If you do not contribute anything to your 401(k), you will not get any employer matching. Deciding how much to contribute to your 401(k) and which one to put it in is a personal decision. Contributing to a traditional 401(k) reduces the taxable income for that year, so you will pay less income taxes. Contributing to a Roth 401(k) uses dollars that have already been taxed, so that means your gains can grow tax-free and will not be taxed when you withdraw. If you want to exceed the standard $19,500 per year contribution, you can do so with a Mega Backdoor Roth 401(k) conversion if your plan allows it. To do this, you make additional contributions above the $19,500 limit to your non-Roth after-tax 401(k), and then immediately convert that into a Roth 401(k). 401(k)s are employer-specific accounts, but there are other types of retirement accounts as well! Similar to the 401(k)s, there are also traditional and Roth IRAs, as well as a Backdoor Roth IRA conversion mechanism. Other employer based accountsHSA is a Health Savings Account and it usually accompanies an HDHP, or a High Deductible Health Plan. In this health plan, you will pay a lower monthly cost, but pay more per healthcare visit in the form of a deductible. Your employer will be depositing money to your HSA account that you can use to pay for your health expenses, including co-pays, medications, and even non-prescription items like period products and sunscreen. You can also contribute to your HSA directly via paycheck deductions, and the HSA is a special type of investment vehicle because it is triple-tax-free! This means that 1. you contribute with pre-tax money, 2. gains within your HSA do not get taxed, and 3. your withdrawals will not be taxed if they are used for healthcare purposes. Unlike an FSA, HSA funds never expire, so you can theoretically get LASIK eye surgery in 2020 for $5000, then wait 10 years until 2030 to reimburse yourself that $5000. Within those ten years, your balance could have gone up if it were invested in the stock market. ESPP is an Employee Stock Purchase Plan, which is an employer-run account in which employees can purchase company stock at a discounted price. Your company will set the discount rate, usually between 10-20% of the stock price, and they might also guarantee that they will lower your purchase price if the stock goes below the original purchase price when it is time to purchase. In many cases, this is a great benefit with guaranteed capital gains. Taxes can be a bit complicated for ESPP since you will be taxed on the discount rate and your actual capital gains. Sales proceeds from ESPP can be a qualifying disposition or disqualifying disposition, taxed at a short-term or long-term capital gains rate depending on the length of time between your grant date, buy date, and sell date. Make sure you adjust the cost basis for your ESPP shares when you file taxes so that you don't pay more taxes than necessary! The documents for your adjusted cost basis should be in the brokerage account that handles your ESPP.RSUs are Restricted Stock Units, which are granted to you but do not all vest immediately. Sometimes there is a "cliff", which is the period of time before any stock vests at all. You can vest stock on an annual, quarterly, or monthly cycle. When your RSUs vest, it means they are now yours to sell. When you own stock of a company that you work at, you will most likely be subject to insider-trading regulations, which prevents insiders, usually including employees, from buying or selling stock at specific dates near earnings announcements. These dates are called blackout periods. If you want to sell your stock, make sure that the planned dates are not in a blackout period. Personal finance is a broad topic and this covers some of the bigger topics that might apply to a corporate job at technology companies. If you're interested, definitely look into other areas as well, including saving, budgeting, and investing. Disclaimer: I am not a financial advisor and none of this is financial advice.