I got a 10% salary increase, but my tax withheld also went up 2%!

[foeplay]

Can someone explain to me why? Did I move into a higher bucket that I don't know about or something? I guess in reality I only got an 8% increase.

 

What sucks is that I was going to increase my 401k contribution by 2%, but now I don't know after this. It feels like i didn't even get that much of a raise

 

I searched for tax withholding schedules but couldn't find an answer.

 

I found the tax bracket here, but the salary increase I got still kept me in the 25% bracket so I am really confused:

25% Bracket $35,351 – $85,650

http://www.bargaineering.com/articles/federal-income-irs-tax-brackets.html

 

Do I now get money back at the end of year or something?

 

I'm mostly looking for an explanation and an e-hug so that next time I can temper my excitement and forecast properly. Thanks CB!

[crofttk]

Can someone explain to me why? Did I move into a higher bucket that I don't know about or something? I guess in reality I only got an 8% increase.

 

What sucks is that I was going to increase my 401k contribution by 2%, but now I don't know after this. It feels like i didn't even get that much of a raise

 

I searched for tax withholding schedules but couldn't find an answer.

 

I found the tax bracket here, but the salary increase I got still kept me in the 25% bracket so I am really confused:

25% Bracket $35,351 – $85,650

http://www.bargaineering.com/articles/federal-income-irs-tax-brackets.html

 

Do I now get money back at the end of year or something?

 

I'm mostly looking for an explanation and an e-hug so that next time I can temper my excitement and forecast properly. Thanks CB!

The 10% increase in income is taxable income, is it not? If you get $6,000 more a year in taxable income then, assuming you're in a 25% tax bracket, you can expect to pay $1,500 more per year in (federal) taxes (if you don't move to a higher bracket).

 

Your disappointment sounds like me and my wife's discussion when I explained to her, after she graduated from college and entered the workforce (after being a homemaker for 25 years), we would only net roughly 60% of her pay after taxes (federal, state, local, FICA) because it would be filed jointly on top of the wages I was already earning and we were in a 28% (or whatever it was) federal tax bracket with my already established income.

 

Check that 401k disappointment though - consider that the 2% extra to the 401k should reduce your taxable income (if you are within any limits on before-tax contributions) by the amount of your contribution. If you could "afford" it, imagine putting all of your raise into the 401k and then you'd have no extra federal taxes (again, assuming you haven't reached any limit on before-tax contributions).

Edited October 10, 2012 by crofttk

[foeplay]

401k just means I will pay those taxes on it later in life. I think I'm better off just maxing my roth and pay more towards my student loans, and increasing my emergency fund. I currently contribute 15% of my yearly income to retirement savings (401k + Roth). Oh well, I guess a little bit of raise is better than nothing! Thanks for the help.

[Seabee]

Though you are in the 25% bracket, you aren't being taxed at 25% on all of your income.

 

The first (5950+3800)=9750 is not taxed, assuming you take the standard deduction

The next 8700 is taxed at 10%

The next 26650 is taxed at 15%

The next 50300 is taxed at 25%

 

So, if your taxable salary is $50,000, your tax will be 6092.5

Give a 10% raise to $55,000, and the new tax bill will be 7342.5, a 20% increase in taxes

The old withholding was 12.18%; the new one is 13.35%

[Kevin20]

 

 

 

Because tax brackets work as explained above, they key point is that EVERY DOLLAR of additional income from a raise is fully taxed at your tax bracket. So right off the top, you only get $75 out of a $100 raise ... and of course that does not include social security tax, any benefit deductions, 401k contributions, etc. Compare that to your previous paycheck -- some money of the total is not taxed (0% bracket), the next block is taxed only at 10%, then next block is taxed at 15%, etc.

 

So the result is that your average or "effective" tax rate is lower than your "marginal" tax rate (your bracket). If you're in the 25% bracket, your average tax rate may only be 10% or 12%, for example. That is, if your current average tax rate is 12%, and you know you'll be taxed at a higher 25% rate on the next dollar of income, then even without doing arithmetic it stands to reason your average tax rate goes up a bit.

 

Since the additional dollars from a raise are fully taxed at your bracket, a raise will always INCREASE your average tax rate, all things being equal. That by the way is what is meant by "progressive taxation".

Edited October 10, 2012 by Kevin20

[crofttk]

401k just means I will pay those taxes on it later in life. ...

Sorry, the thought did occur to me but it didn't surface enough to include that in my response. We all hope that the eventual tax on the retirement distributions is at a lower rate than that 25% marginal rate you would be subject to now.

[foeplay]

since it's an increase in average tax rate for every more dollar you make, how much do you need to make a year to hit 75-100% tax withholding? or is there a max tax ceiling?

Edited October 10, 2012 by foeplay

[Seabee]

since it's an increase in average tax rate for every more dollar you make, how much do you need to make a year to hit 75-100% tax withholding? or is there a max tax ceiling?

 

It's never going to increase past the highest marginal rate, which is currently 35%.

[encoder]

401k just means I will pay those taxes on it later in life. I think I'm better off just maxing my roth and pay more towards my student loans, and increasing my emergency fund. I currently contribute 15% of my yearly income to retirement savings (401k + Roth). Oh well, I guess a little bit of raise is better than nothing! Thanks for the help.

 

I know this is old, but.. assuming constant income tax rates and constant income on your part (eg adjusted for inflation, you take as much a year in retirement as you make now) there is not a lick of difference between pre-tax 401k and post-tax Roth IRA. That is, in both cases, for every $1 in income you defer now, you will have $N in retirement income. That $N is the same for either 401k or Roth.

 

So here's the gambling part:

 

Do you 1) want to bet on tax rates changing substantially, or 2) do you believe you'll be living off a lower retirement income than you make today?

 

For my money, I'm betting 401k is better. I pay a high tax rate. I will take my chances on tax rates in the future. I'd still fund a Roth if I could (I can't anymore) but only after I maxed out my 401k. In my position, with no kids and no mortgage interest deduction, I want to do anything I can to reduce my taxable income. The $17k 401k option is the biggest lever I have to accomplish that.

 

I have 2 reasons:

1) I believe through planning that we can live on a lower earned income in retirement than I make now.

2) We currently live in a highly taxed state (California) and I don't currently plan on retiring here. I can avoid paying 10% CA income tax now and then retire in Sarasota and not pay any state income tax.

 

YMMV, but I thought it to be an interesting enough conversation to want to add to it.

Edited January 11, 2013 by encoder