It’s tax season, and I’ve been looking at a lot of W-2 forms.
If you’re an employee, you get one of these every year. Your employer sends it to you and the IRS. It shows your annual wages and the amount of taxes withheld from your paycheck.
If you have someone else prepare your taxes you probably don’t give it a second glance- you throw it in the pile of things to give to your preparer. (By the way—that email from your tax preparer, the one you’ve been ignoring? Answer it. Now!)
I could write a book about all the information on a W-2 form. OK, maybe not a whole book, but at least a chapter!
But today I want to focus on Boxes 5 and 12. Spoiler alert: this topic has some math. If you hate math, never fear, just read on and do your best. There will not be quiz.
Let’s take a mythical taxpayer named Mary T. Moore.** Mary is a TV news producer who lives in Minneapolis. She is single.
Let’s take a look at Mary’s W-2:
In Box 5 labeled “Medicare wages” it says $52,000. She grosses $1,000 every week.
NOTE: This box does not include any pre-tax contributions you make toward your health insurance or a Medical Flexible Spending account.
Now look at Box 1 labeled “Wages, tips, other compensation”: It says $48,000. Why the difference? The answer is in Box 12 Code “D”: It says $4,000. This is the amount Mary contributes to her 401k plan. For Federal income tax purposes, she only gets taxed on $48,000. She does pay Medicare tax on the full $52,000.
Other Box 12 retirement plan codes include “E” for 403(b) plans and “G” for 457 plans.
Go get your W-2. Please. I’ll wait.
Take a look at Box 12– do you have anything coded “D”, “E” or “G” in Box 12? I hope so. Take that number and divide it by the number in Box 5, and then multiply by 100. This is the percentage of your salary that you are contributing to your employer retirement plan. Ideally this should be at least 10%. In Mary’s case it is 7.7%.
Mary decides she’d like to increase her retirement savings. She is going to contribute another $20/week to her 401k plan. This comes out to an additional $1,040 per year. This will get her pretty close to the desired 10%. But amazingly, her pay is only going to go down by $14/week. This is the magic of pre-tax savings! She will pay less tax; so the take home “cost” to her isn’t the full $20/week; it’s 70% of that.
For you math geeks: [100%- (25%marginal tax rate Federal + 5% marginal tax rate State)]
If you are in a higher tax bracket, the difference between your reduction in pay and your contribution will be even larger! Bottom line: pre-tax savings can be a powerful retirement planning tool!
But don’t take my word for it—you can plug in your numbers on this handy paycheck calculator. This calculator allows you to see the effect of changing your 401k contribution on your take home pay.
I bet Mary doesn’t even miss that $14/week! With the few clicks of the mouse on her 401k’s website she’s taken a big step toward achieving financial independence. Maybe she’ll even let her coworker Murray in on the secret. 🙂
If you are already participating in your employer plan it is easy to increase your contribution by going online. If you are not participating, call your HR department to find out how you can get started. If 10% right away seems too daunting, start with a smaller percentage, and every time you get a raise earmark a portion of it to your retirement plan.
If your employer matches some of your contribution you want to at least contribute enough to get the full match. The match is free money that you are leaving on the table if you don’t participate.
The maximum you can contribute in 2015 is $18,000/year. If you are 50 or older you can contribute $24,000/year.
Do you see a Code “DD” in Box 12? Most employers were required to report it this year. This is total cost of your employer-sponsored health coverage- including the amount paid by both you and your employer. It’s usually a big number. You don’t get taxed on this. The biggest DD Code I saw this year was nearly $28,000 for family coverage.
** A nod to one of the greatest sitcoms of all time.