Earned Income and BenefitsPersonal Financial Literacy - Chapter 2 Section 1

What are sources of Earned Income?•Earned Income

▫Income from sources such as: hourly wages, annual salary, tips, commission, self-employment income.

▫Earned income is subject to income taxes and social security taxes

▫Tax – a required payment for the support of a government May be based on earnings, property values,

or sales price of an item

Wages•Payment for each hour worked•Minimum wage

▫The lowest pay rate allowed by law for each regular hour of work

▫Federal minimum wage is set by U.S. Congress Current minimum wage: $7.25 per hour

▫19 states (+ Washington, D.C.) have minimum wage rates higher than the federal rate

Wages•Standard work week

▫8-hour day▫40-hour workweek▫Hours worked in addition to the standard are

called overtime hours and subject to overtime pay In most states, overtime pay is for work over 40

hours in one pay week. Some states require overtime pay for more than 8 hours in a workday

▫Overtime pay Pay received for hours worked in addition to regular

hours

Wages•Overtime pay must be at least 1.5 times the

regular rate.▫Example: If a worker earns $8 for regular pay,

what would his overtime rate be? $8*1.5 = $12

•Holiday pay▫Some states may require overtime pay on

holidays that you are required to work (PA is not one of them)

▫Some employers will pay overtime pay on select Federal holidays

Salaries• Some people work for a set salary

▫Example: $30,000 annually• Salaried workers do not keep time cards or count

hours worked• Some salaried workers have more flexibility in

the times they work than hourly workers do.• Many salaried workers work more than 40 hours

a week, but do not receive overtime pay• People on salary are generally self-directed

▫Managers, supervisors, professional occupations are generally paid a salary.

Tips and Commissions• Tip

▫A gift of money, often a percentage of the total bill, to a person for performing a service.

▫May be based on the quality of the service provided. Waiter Caddy

▫Tips are subject to federal income taxes▫May be subject to state income taxes

• Law requires some employers to withhold taxes based on tips, even though tips may have been received in cash directly from customers.

Tips and Commissions• Commission

▫A set fee or percentage of a sale paid to an employee instead of or in addition to salary or wages

• Sales commissions are earned only when a sale is made▫No sale = No commission

• Some jobs may be entirely based on commission▫Ex. Real Estate Sales

• Some jobs a combination of base salary plus commission

Self-Employment

•Working for yourself•Entrepreneur

▫A person who takes the risks of being self-employed and owning a business

Advantages of Owning a Business• You get to make the decisions about how the

business is run.▫Choose products and services that will be offered▫Set hours of operation▫Decide what types of customers the business will

target▫Set prices

• Other benefits of being a small business owner:▫Set your own hours▫Keep the profits of the business

Profit – the amount left after all expenses are deducted from the revenues or sales of the business

Disadvantages of Owning a Business• If the business fails, the money invested in the

business is lost▫Most money invested in a small business comes

from the owner and/or the owner’s family and friends

• Difficult to get credit▫Owner may have to use personal credit in order

to get and keep the business running• Long hours• Many different job tasks in order to keep the

business running

Types of Small Businesses•Lifestyle Business

▫One where the owner intends to keep the business small. Provides good income for the owner and his/her

family Exist for the lifetime of the owner Often have no resale value

▫Examples A single doctor/dentist practice A side job that one enjoys (or avocation) while

still working a full-time job

Types of Small Businesses• Venture Business

▫The owners want their business to grow into a large company with unlimited growth and many workers As it continues to grow, it will eventually become a

corporation A venture business owner has an “exit plan” so that the

business can continue operation when the owner decides to leave. Business owner may become one of many stockholders and

no longer have total control of the business Example: Phil Knight started designing tennis shoes in

his garage in Eugene, OR… NOW: Nike

Getting Started in Business•Entrepreneurship may be encouraged by:

▫Culture▫People whose parents owned small

businesses are more likely to start a business than people whose parents worked for someone else.

▫Many entrepreneurs start out working for other business to gain knowledge and experience and/or informal education about how to run a business before they get started.

Getting Started in Business•Small Business Development Center

(SBDC)▫Exist to assist entrepreneurs getting

started▫Sponsored and funded by the Small

Business Administration (SBA)

How can you decide if being an entrepreneur is right for you?•Are you self-motivated?

▫If you can get going and do what you need to do without being told or reminded, you will make a good entrepreneur.

•Do you like people?▫If you like people and can get along with your

customers, you have a good chance of success•Are you a leader?

▫Entrepreneurs are able to get others to follow their lead. They are confident and persuasive.

How can you decide if being an entrepreneur is right for you?•Do you take responsibility?

▫Entrepreneurs take charge and follow through.•Are you organized?

▫Business owners must have a good plan before they get started. They line up their resources, fill in the gaps, and charge forward.

•Do you work hard?▫To be a successful owner, you must set the pace

by example. Business owners work many long, hard hours. They don’t expect others to do that they themselves are unwilling to do.

How can you decide if being an entrepreneur is right for you?•Do you make decisions easily and quickly?

▫Owners must take risks and be willing to accept the consequences. Decisions sometimes have to be made without complete information.

•Are you trustworthy?▫Others must trust you and accept that you

know what you are talking about. This means building trust and long-term relationships.

How can you decide if being an entrepreneur is right for you?•Are you persistent?

▫Business owners stick with it, even when the going gets tough. They finish projects and forget about excuses.

•Do you keep good records?▫Entrepreneurs must account for their costs

and their revenues. They must pay taxes and understand about profitability and cost analysis.

Business Plans•Business plan

▫A document that describes the steps that will be taken to open and operate a business

▫Should show that you are worthy of funding (loans) from government and private sources, such as banks and venture capitalists.

▫Sample business plans can be found on the SBA website.

What are employee benefits?• Benefits

▫Forms of pay other than salary or wages▫Examples:

paid vacation, holidays, health insurance▫Some are paid by the company. For others, the

employee may need to pay part or all of the cost.• When workers are paying for a portion or all of

the benefit, they may want a plan that allows them to choose the options they need in order to save money. This type of plan is known as a cafeteria plan

Employee Benefits• Benefits increase the overall value a worker

receives from a job.• Benefits can increase a person’s disposable income• Disposable income

▫Money available to spend or save after taxes have been paid

• Examples:▫Direct impact: profit sharing plans▫Indirect impact: health insurance through a company

plan may be cheaper than an individual policy

Employee Benefits•Benefits are also important for several other

reasons:▫Workers are not taxed on most benefits▫Some benefits allow workers to buy services at

a cheaper price than they could otherwise. Group insurance costs much less than an

individual policy. Paying a lower cost for insurance increases the worker’s disposable income.

▫Some benefits offered to workers may not be available to individuals Company retirement plans; stock options

Employee Benefits• Some benefits offered to workers may not be

affordable at individual prices.▫Workers with health problems may not be able to

afford insurance at individual rates or may even be denied coverage at all.

• Some benefits help workers reach financial goals.▫Saving money

Company sponsored savings plans Savings is easier because the money is automatically

deducted from the worker’s paycheck▫One type – 401(k)

Pay Without Work• Refers to times when an employee who is not

working will be paid▫Paid vacations

A certain number of work days allowed each year▫Paid holidays

Examples: Thanksgiving Day Christmas Day Labor Day

Employees who choose or are required to work designated holidays are usually paid extra – typically 1.5 – 2 times the regular rate

Pay Without Work• Sick leave

▫Paid time away from work due to illness▫Some companies allow sick time to be used

for illness of a child or other family member

▫Some companies allow sick time to accumulate. This means that employees may be allowed to

save any unused sick time for one year and have it available in another year in the event of extended illness.

Pay Without Work•Personal Leave

▫Paid time away from work for personal reasons

▫If offered, typically 2-3 days per year▫Generally not carried forward to another

year

Educational Benefits• Some employers will pay for, share the cost of,

or pay back (reimburse) money spent on education▫Classes or training related to the worker’s job

Benefit the company and employee Improve the employee’s chances of getting a

promotion or a better job with the same or different company

▫Some companies will pay for classes taken to earn a college degree Typically a percentage, depending on the grade

earned.

Perks•Other benefits that provide emotional

satisfaction or social status rather than money▫Prime parking space▫Office with a view▫Expense account▫Company car

•Perks may or may not be taxable

Insurance• Health Insurance

▫Health insurance is an important benefit▫The price paid for health insurance is called a

premium. Most employees pay part or all of their insurance

premium through payroll deduction▫Benefits of company offered group plan

Group rates are typically lower than individual Acceptance into the program is guaranteed

▫Premiums vary depending on the coverage provided. Plans vary and may or may not include dental and

vision insurance.

Insurance• Group Life Insurance

▫Often available through an employer Premium may be paid by the employer or the employee Some companies pay for a set amount of life insurance.

Usually 1.5 – 2 times the employee’s annual salary▫Employee may be able to purchase additional

insurance at the group rate▫Life insurance paid for by the employee may be

portable. Means that the employee may continue the policy after

leaving the employer

Insurance•Disability Insurance

▫Provides payments to replace income lost when illness or injury prevents the employee from working

▫Short-term disability Up to 2 years Often paid for by the employer

▫Long-term disability Typically covers periods longer than two

years and up to retirement

Insurance•Workers’ Compensation

▫An insurance plan that employers are required by law to provide for employees. Pays medical and disability benefits to

workers who are injured or contract diseases on the job

Benefits may be paid to the worker’s family if the worker is killed on the job.

Retirement Plans• Retirement Plan

▫An account into which employees contribute a portion of their earnings for their retirement; employers may match these contributions

• Defined Contribution Plan▫Example: 401(k)

Pre-tax Employees do not pay income tax on the money in the

account until it is withdrawn Employer may match a percentage Contributions are automatically deducted from the

employee’s paycheck

Retirement Plans•Defined Benefit Plan

▫Also referred to as a pension plan▫Paid by the employer▫Typically, employees must work for a company

for a certain number of years to qualify▫Payment amounts vary depending on:

the number of years worked Worker’s salary Other factors

▫This is being phased out by many companies in favor of a defined contribution plan

Profit-Sharing Plans•Profit-sharing plan

▫A benefit whereby employees may share in the profits of the business

▫The plan may: Pay a bonus of a specified percent of the

employee’s salary if the business meets or exceeds its financial goals

May be paid in cash – taxable the year it is received

May be added to retirement account – taxable when withdrawn by the employee

Stock Option Plans

•Some companies allow employees to purchase company stock at a reduced price.

•Purchase price may be deducted from the employee’s pay

•Convenient way to acquire stock and does not involve brokerage or trading fees

Heath Flexible Spending Accounts•Often called a Flex 125 plan•Allows employees to set aside money to pay

for qualified medical expenses▫Pretax▫Deducted from employees paycheck▫Employee files claims for qualified expenses

to be paid•Main disadvantage – if the employee does

not use the money in the account by the end of the year, he/she loses it (to the employer).

Health Spending Accounts• Can be used by employees with high-deductible health

insurance plans▫ These plans are gaining popularity because they have

lower premiums• HSAs are usually managed by banks or investment

companies• Money earns interest• Typically, medical expenses are paid using a debit card

that accesses the HSA• Money not used can be carried forward to the next year• When an employee leaves a job, they can take their

HSA with them

Optional Deductions•Other amounts withdrawn from an

employee’s paycheck▫Money donated to charity▫Savings account▫Investment accounts

•Employer withholds money from paycheck and sends it to the desired source▫Usually after taxes have been paid on it