Category Archives: budgeting

Understanding Your Paycheck

Quite often we find ourselves focused on what to do with the money we have, and we often don’t take the time to look and see what we have taken out before we even see the money.  Eventually when tax time rolls around, we see it as a time of feast or famine where we might get a little bit of extra money to splurge with. While that definitely isn’t the responsible behavior we like to encourage, there is a time and a place for that discussion. More important to the discussion is understanding how your paycheck works, and how to make sure you set up your deductions so that you only pay the correct amount of taxes, no more and no less.

First, take your paycheck and subtract your pretax deductions (Health Insurance, Retirement Plan, FSA, etc.) then, follow these steps:

1)      Multiply your income by the Social Security tax rate. As of 2013, the rate is 6.2 percent. For example, if you earned $3,900 per month, you would pay $241.80 in Social Security taxes.

2)      Multiply your income by the Medicare tax rate, which is 1.45 percent as of 2012. Continuing the example, if you had a monthly paycheck of $3,900, $56.55 would be withheld from your paycheck for Medicare taxes.

3)      Multiply the number of personal allowances you claimed on your W-4 form. Each allowance decreases the amount of your paycheck that is subject to income tax withholding. As of 2012, the annual value of each personal allowance is $3,800. For example, if you claimed three allowances, the total value would be $11,400.

4)      Divide the value of your personal allowances by the number of pay periods per year. In this example, since you are paid monthly, there would be 12 pay periods per year; you would divide $11,400 by 12 to get $950.

5)      Subtract the value of your allowances from step 4 from your paycheck to find the amount of income subject to tax withholding. Continuing the example, you would subtract $950 from $3,900 to get $2,950.

6)      Use the federal tax withholding tables to find out how much money is withheld from your paycheck for federal income taxes based on your filing status. For example, if you were single and had a monthly income subject to withholding of $2,950, you would have $379.40 withheld for federal income taxes.

7)      Repeat with your state and local income tax withholding tables if you live in states or localities that charge an income tax. These tables are available from your state or local department of revenue.

If you want to speed up the process, there are also paycheck calculators online. Paycheckcity provides a calculator that is generally accurate up to about $10 per paycheck, which is accurate enough for estimation, but you should always be aware that they are normally subject to your company’s HR department’s own calculations and can vary slightly based on the software they use.

Until Next time, go snack on some debt!

Managing Your Finances: Accounts With A Purpose

 

When it comes to personal finance, most people only have one or two bank accounts: either just a checking account, or a checking and a savings account.  For some people, this is fine, but more often than not, it makes it very easy to get into financial trouble, either due to a forgotten transaction, or an account not being updated at the right time.

Rather than dealing with the headaches of having to account for everything, and hoping that nothing was forgotten that could cause an overdraft with your car payment, rent, or any other bills, it probably is a good idea to look for a local credit union or two and open an account. In addition to easier budgeting with dedicated accounts for each bill, there is an added bonus that these accounts offer: access to lower loan rates, and higher interest rates on your deposits.  Taking advantage of both of these can make a huge difference in your monthly balance sheet, especially when you want to get out of debt faster.

This method of account management can be called things the silo method, or the envelope account method.  The fact is it’s just more of an advanced version of the envelope method, where you keep your money in cash, and use envelopes to budget your monthly expenses.  This method provides an additional layer of reporting for you, allowing you to see exactly how you spend your money by utilizing online banking tools, while also keeping things in a setup where you can begin scheduling automatic payments on your bills and build an emergency fund on auto pilot.

The most difficult step for most people here is going to work and requesting the new direct deposit sheets from HR. Normally, it only takes a few minutes to fill out the forms, and many companies even have an online option now, making it easier than before.

With setup complete, let’s take a look at a case study:

Dexter receives $1000 bi-weekly in take home pay from his job at the Miami Police department. He has two condos, each with a monthly mortgage payment of $300, a $30 electric bill, a $40 gas bill, two credit cards with a monthly average spending of $100 on each, $150 in student loans, and $175 in his car payment. Here’s his plan:

Check 1 Check 2

Mortgage

$300 $300

Gas/Electric

$40 $40
Credit Cards

$110

$110

Student Loan/Car $175

$175

Remaining $375

$375

 

 

 

 

Now that he has a plan, he sets up his direct deposit to go to each of the accounts, with the higher bill as the amount deposited each paycheck.  This leaves him with a buffer for when the bills like gas or electric are a bit higher, while also giving him the opportunity to build up his emergency fund and pay down his installment debts.

Savings vs Debt Paydown

JC Writes:

My girlfriend is currently sitting on about $5,000 in savings while she has about $5,000 in credit card debt. With an interest rate on the card around 20%, it really bothers me that she hasn’t paid it off, while providing the reason that she’s scared something might happen, and she’ll have nothing in savings.  How can I explain this to her? There has to be an emotional part of this, but I want to show her that she can be debt free and get on with life.

This is a bit of a doozy. We’ll be the first ones to admit that providing unsolicited advice to somebody else face to face on what to do with their finances, no matter the good intentions can often result in hurt feelings. While you can take solace in the fact that you are right that she should be kicking every cent she has at that toxic debt, it’s also important to remember that she also has a fear in the back of her mind that a financial crisis of some sort could hit, and she doesn’t want to be left holding the bag.

One thing your girlfriend should understand is that by carrying this debt while she has the money to pay it off in savings, she is losing $875 per year, assuming she is getting 0.5% interest in her savings accounts.  Keeping this up for 5 years would nearly destroy her savings, and leave her with nothing to show for all of the effort.

This is the kind of situation where the emergency fund comes into play. With the smaller emergency fund of about $1,000, your girlfriend can use $4000 and pay off 80% of the debt, letting her keep some peace of mind, while also managing to save her about $720 in interest in the next year.  After this, the next step would be to tackle the remaining $1000 of credit card debt as aggressively as possible. If she puts $200 a paycheck towards it, she’ll be free from it in 5 paychecks, and she can work on re-building her emergency fund back up to $5000.  This would likely be the best of both worlds, because it would provide a second benefit to her of ensuring that she has the money available from the budget to not only take care of her expenses, but also to save money for the future,  After her 5 paychecks, she probably wouldn’t even miss the money from her paycheck, and she could go on  to applying to to her retirement savings.

 

Until next time, go snack on some debt!

 

 

So, What IS “The Plan” For Personal Finance?

The plan will be different for everybody, and the problem with many “personal” finance gurus is that they deal in “general” finance rather than personal finance. While the advice is generally pretty good, it often overwhelms people, much like drinking from the fire hose.  The general advice you’ll hear is (in this order):

  1. Build a small emergency fund (~$1000 or 1 month’s expenses).
  2. Fund your retirement plan to your employer’s match.
  3. Pay off your debt
  4. Fund an emergency fund with 6+ months of expenses.
  5. Fund a Roth IRA to the annual Max
  6. Bump up your retirement plan savings to the annual maximum.
  7. Save into any tax-advantaged plans you have available
  8. Open a taxable investment account and invest in Exchange Traded Funds (ETFs) that track the market as a whole.

Most people have trouble with step 1, and will be lucky to get through step 3. Step 4 is a pipe dream for quite a few people, and the idea of maxing out not just one, but TWO retirement accounts sounds like grounds for an intervention because there is a lot of crack being smoked.

Let’s look at the near worst case scenario

So, what are you to do in this situation? How can you get through all of this when you’re only bringing home around $600 every two weeks? The answer a lot of people will get when they are honest with themselves is that sacrifices will have to be made. Whether it’s cable TV, the new iPhone, or your free time, if you are in this situation where you have this little cash coming in AND you have debt, you probably are either deluding yourself that if you keep on the treadmill things will get better, but the fact is that interest every month when you don’t pay off your cards is speeding that treadmill up, and eventually you’ll fall off.  An overdraft or two, and suddenly you’re eyeing a payday loan place just to solve the problem. Stop. Now. If you’re in this situation, let’s back up the cardiac arrest, take a few deep breaths and give you a rational plan to deal with this:

  1. Gather up all your monthly bills and pay stubs, pull up your online banking, too.
  2. Look at what you spend your money on, and decide what you want to cut.
  3. Keep cutting until your bills and expenses are less than your pay.
  4. Next, make calls to all of your credit card companies, and ask for lower interest rates.
  5. Add up all of your minimum monthly payments and monthly recurring bills.
  6. Open a new checking account, preferably without a debit card.
  7. Set up your direct deposit to go to two accounts: one for half the amount you got in step 5, and one for the remainder.
  8. You’ve now built a self-funding small emergency fund.
  9. The remaining money should cover your expenses (groceries, gas, etc).
  10. At the end of every two weeks, the night before payday, take any remaining money, and pay it on your highest interest account. You’ll pay down your debt a little faster and start to see some progress.
  11. If you’ve made it this far, and you’re still having some trouble making ends meet, go back to step two, and be honest with yourself.  Cutting cable TV alone will save you between 600 and 1200 a year.

“My situation isn’t THAT bad…”

If you just read the last section and didn’t cringe a bit because it hit a bit close to home, then you likely grew up with some good financial habits, or have had the income to mask some problems. So, let’s ask you a few questions:

  • Are you carrying any interest-charging credit card debt? How Much?
  • Do you have a car (or any other type that isn’t student) loan over 5%?
  • How much are you saving each month?

If you have more credit card debt than what you could pay off in your next two pay checks, after expenses, and you’re saving (rather than investing) money above a small emergency fund, congratulations, you’re throwing money away. Anything with an interest rate is considered to be “toxic” debt, and you should eliminate it quickly. 5% is used, because it’s generally accepted that returns on investment will be over 5%, so you would miss out on returns by paying off debts with interest rates under 5% faster than necessary if you were to use investments to do so.

I know you thought you were getting off easy, but you’re still in close to the same boat as the near worst-case folks, but likely without the constant fear of overdrawing your bank account.  Knowing this, you still need to budget, and get rid of the debt you’re throwing money away on. Your plan of attack should be to get organized (see above), and pay off the highest interest accounts first, working your way to the lowest accounts. If you can work without separate accounts feel free, but it will likely be easier to set things on auto pilot.

“Hah! Look at those suckers! I’ve got stuff together, straight cash for me!”

Oh?  You’ve eliminated all your toxic debt and are saving now? Have you optimized your spending habits to make it so credit card companies are providing you with interest free loans AND paying you for the privilege of having you use their card?  If not, you’re still leaving money on the table, just like those “suckers.” We’ll cover this more in the near future, but for now, if you’re at this point, life’s pretty good. Go check on your retirement accounts, and see if you can contribute a bit more in there for now, and we’ll get to the rest soon.

Until next time,  go  hunt down some debt!