The old saying of a “a dollar saved is a dollar earned” is not true. The fact is that you need to factor in taxes into everything you do. In other words, you need to earn more than a dollar in order to save a dollar.
The same concept applies to spending as well. For example, if you say spend $5 on a Starbuck latte, you really needed to work enough hours to make more than $5…as you need to factor taxes into this equation as well.
We are always surprised at the lack of financial knowledge. And one of the things we often hear is the saying “A Dollar Saved is a Dollar earned”. That statement is so incorrect and it is very unfortunate. As it is almost a perfect illustration of the lack of financial knowledge.
Example showing 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 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 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.
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 tax brackets in this country are progressive, the fact is your pay different tax percentages on a sliding scale. But we do not want to complicate this 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. 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. 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.
The bottom line on saving and earning dollars
We fully understand some of this can be a little complicated, especially I am not sure if I am doing the best job in explaining it in a post and it is often harder to learn something new from a blog vs. in person or doing an exercise. It is fine if you do not fully follow 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 earn more than that dollar from a job. This means a dollar saved is in fact more than a dollar earned.