The old saying of “a dollar saved is a dollar earned” or a “penny saved is a penny earned” are not true. The fact is that you need to factor in the federal as well as state income taxes you pay into everything you do. In other words, you need to earn more than a dollar in order to save a dollar.
The same financial literacy concept applies to spending as well. For example, if you spend $5 on a Starbucks latte, you really needed to work enough hours to make more than $5…as you need to factor taxes into this equation as well.
One of the things we often hear is the saying “A Dollar Saved is a Dollar earned”. That statement is incorrect and it is very unfortunate that more people do not know that or manage their personal finances in such a way. As knowing how taxes work, and considering them in your income as well as expenses, is important to improving personal financial literacy.
Example showing how “a dollar saved is a dollar earned” is false
Let’s walk through an example. Let’s say you are a low to moderate income household and you are in a 25% tax bracket between state and federal government taxes. In order to “bring home” $1 to your family (which is your net pay) you need to earn more than $1 (in gross pay). In fact, if you are in the 25% tax bracket, you will need to earn about $1.34 in order to net $1.
How did we determine this? Well, take the $1.34 and multiply that times 25% (your hypothetical income tax bracket) and that comes to 33.5 cents. Therefore 33.5 cents is how much you pay in taxes. So, the $1.34 in wages, less the 33.5 cents in taxes, means you take home $1 in after tax income.
That means if you wanted to save that one dollar, you needed to earn $1.34. So, a dollar saved is in fact $1.34 earned in this example. Of course the same concept applies to the old Ben Franklin saying of “a penny saved is a penny earned”; that quote is not true either.
Now of course please note we have even simplified that math more than real life. As you would really need to have factored in government benefit payments around FICA (social security, disability, etc.). Also, since the income tax brackets in this country are progressive, the fact is your pay may fall into different tax percentages on a sliding scale. But we do not want to complicate this financial literacy concept too much. We really just wanted to show how the “a dollar earned is a dollar saved” is a false statement. If you want to get down to it, you would really need to earn even more than the $1.34 to save the dollar.
Bring this dollar save is more than a dollar earned concept back to spending. Let’s say you buy $5 Starbucks drinks 3 days of the week, or $15 total per week. This is about $780 per year. Someone may justify it is a small splurge that helps them make it through the week. A couple things.
One is you need to annualize that cost. $15 per week is equal to $780 per year. Two you need to factor in taxes you need to pay and how it impacts your gross income/gross spending. Using the 25% tax bracket example above, you need to earn (gross) roughly $1050 per year to pay for that Starbucks. This is $1050 gross – $262.50 taxes is a net of $787.50. If you decide to cut off that Starbucks and stop buying it each week, that $780 per year saved is really equal to $1050 earned.
Another key to spending is understanding types of products/items/assets as part of basic financial literacy. As there are a few types of assets, and they include “appreciating” ones and “depreciating” items. If you spend your hard earned income on assets that immediately go down in value (e.g. cars, boats, etc.) then a dollar spent is even significantly more than a dollar earned even counting for taxes. But if you spend your money on appreciating assets (such as a house or your own education!), then how you spend your dollars, and the items you buy, make a huge difference too. Learn about the difference of appreciating vs. depreciating assets.
The bottom line on saving and earning dollars
We fully understand some of this can be a little complicated, especially the exact math and formulas. It is fine if you do not fully follow the exact math or numbers around this concept.
But if you only walk away with one thing from this post, just be sure to know that you always need to factor taxes into everything you save or spend. Realize that if you spend a dollar, or save a dollar, you really had to have earned more than that dollar from a job. This means “a dollar saved” is in fact more than a dollar earned. Or to save a penny, you really need to earn more than a penny.
By Jon McNamara