When it comes to getting paid, I guess you could say I’m a pretty trusting guy. I only peek at my pay stub once every three or four months because I have no reason to believe it’ll change. I’m salaried, I get paid via direct deposit and I have faith that my employer isn’t trying to pull one over on me.
So imagine my surprise when, back in early February, I happened to look at my pay stub and found that it had gone up. By a whole $36.50. Had my boss given me a cost-of-living raise and forgotten to tell me?
Nope. Instead, I was seeing the effects of the new tax plan, which put most people in a lower tax bracket. So my salary hadn’t changed, but my take-home pay had. And while it wasn’t big bucks, I knew my personal spending habits well enough to know that if I let it sit in my checking account, I’d wind up squandering it on coffee.
Coming Up With a Game Plan
Determined not to lose my tax break to lifestyle inflation, I decided to put that extra money toward two of my larger financial goals: Paying off my student loans and saving for retirement.
While it may seem like too small an amount to make a dent, an extra $18.25 a week adds up to roughly $950 a year — nothing to sneeze at. Because I get paid biweekly, I have about $79 in savings each month to put toward my goals. So I send an automatic transfer of $39 a month to my Roth IRA, and apply the other $39 as an extra payment to my student loans.
I absolutely hate student loans, so much so that I even started a website dedicated to helping myself and others pay them off as quickly as possible. So I tend to put extra money toward paying down my principal. I currently have about $28,000 in student loans, which charge an average interest rate of 6.8%. If I made only the minimum monthly payments from here on out, it’ll take me six years to pay them off completely. But by directing an extra $39 a month to my principal, I’ll shave about 6 months off the life of the loan and save $592 in interest!
That’s a much better use of the money than buying a few extra cups of coffee a week.
Taking Advantage of Compound Growth
Here’s why I didn’t apply all my tax savings to my student loans: I didn’t want to squander time that could be used to help my money grow for my other big goal: retirement.
But what good would my $39 a month really do? It turns out, quite a lot.
If I invest $39 a month for 40 years and see a hypothetical 8% growth on average, I would have a little more than $121,000 by the time I want to retire — and more than $100,000 of that would be from growth. Even if I averaged a more conservative 4% growth a year, I’d walk away with nearly $44,500 when all is said and done. And if, after I finished paying off my student loans, I directed those funds toward retirement and it grew at 8%, my nest egg would be even bigger: about $204,000.
What if I used all my tax savings to pay off my student loans before saving anything toward retirement? Though I'd pay off my loans about a year ahead of time and save a little more than $1,000 in interest, I'd be forfeiting a whopping $40,500 in investment growth by waiting those five years to get started.
One thing to note: Not all taxpayers may have seen a change to their paychecks. And if you did, it’s a good idea to check the IRS’ new withholding calculator to make sure you’re still withholding the right amount of taxes — you don’t want to be surprised come tax time and find out that a fatter paycheck meant you owed Uncle Sam. (If you’re confused about all this, get in touch with a tax pro to know for sure what your new tax situation will be like.)
But the point of my story is this: Even a seemingly small bump in your paycheck could make a big difference for your future. So take a look at your next pay stub — if there’s some extra there, see how you can make that money work for your future rather than letting it slip between your fingers.
This article is not intended as legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.