Why is my paycheck less than I figured it would be?
Understanding the difference between disposable income and discretionary income can save workers the frustration of running out of money before the end of the month.
Landing their first “real” job is an exciting milestone for teens. Finally, a consistent stream of money in their wallet!
But wait, how much of their earnings will actually end up in that wallet? According to Michigan State University Extension, too often are teens startled and disappointed that the amount of money in their paycheck isn’t what they thought it would be.
Let’s take Dane. A junior in high school determined that he can work ten hours a week so he applied at three businesses. He was thrilled when the owner of the grocery store called to offer him a job. The owner said he would get Michigan’s minimum wage of $7.40 per hour and be paid every other week. Dane was especially glad to hear that after a three month trial period, if all went well, he would get a raise to $7.60 per hour.
On his first day of work Dane received a shirt with his name embroidered on it that he was to wear over his T-shirt. He worked hard and learned a lot those first two weeks. He already knew what he was going to buy with his earnings. So he was especially surprised and frustrated when he picked up his paycheck at the store because it was for considerably less money than he had expected. Why?
Not surprisingly, Dane calculated he would bring home $148.00 (10 hours x 2 weeks x $7.40 per hour). What did Dane overlook? Dane forgot to deduct federal taxes, state taxes and contributions to Social Security and Medicare. In addition Dane hadn’t remembered that his new employer had told him he had to pay for the embroidered shirt and that $5 would be deducted from each paycheck until the $25 shirt was paid for.
A few definitions might help Dane understand. The amount that he calculated he had earned is called wages. By law, several deductions are taken out of his wages including taxes (Federal, State and, in some areas, local government taxes), FICA (Social Security and Medicare) and other required expenses. Dane’s required expense is the $25 for his shirt, but for others, there may be deductions for health care, retirement and union dues.
The amount Dane actually receives in his paycheck is called disposable income. For most people a portion of their disposable income is already “spoken for” in fixed expenses. Dane has two such obligations, his monthly cell phone bill and his class ring payment. Others may have to pay rent or mortgage, a car loan, student loan, or utilities. These are payments that happen on a regular schedule. Those payments that happen periodically, like auto insurance and property taxes, are called variable expenses. The amount of money required for these fixed and variable expenses should always be set aside so the funds are available when the bill comes due.
Once these fixed financial commitments are paid, the remaining funds are called discretionary income. Discretionary income is the money that Dane can use however he wants – for entertainment, eating out, buying clothes and gifts. It is only the discretionary income that Dane should dream about how he wants to spend because that is the only money he has earned that is not already committed.
Learning the difference between disposable income and discretionary income can save workers the frustration of running out of money and missing a payment or getting a service cancellation notice. Understanding these concepts at a young age can put Dane on a positive track of knowing how to wisely budget and manage his money.
The Michigan 4-H Youth Development Program has educational materials that can help young people learn to manage their finances. Contact your local MSU Extension office to see if there is a 4-H club in your area that focuses on youth money management.