$10 a Day Towards $1,000,000
$10 a Day Towards $1,000,000
It All Adds Up
John and Joe
The following comparison is a simplified example of both the importance of one's salary and money management skills:
John and Joe live in the same apartment building in a big metropolis. Both are single men in their early 20's. They work for the same company that is located 25 miles away on the other side of town. John makes $35,000 a year. Joe makes $23,000. Who is better off? It depends on the way each manages his money.
The working years
Initially, John is better off because he earns 50% more than Joe. He has more options in discretionary spending and an advantage in being able to save money for the future. How much is $12,000 over a year? On an hourly basis of a 40-hour work week, it is $5.76. However, when you see it as a percentage, Joe makes 35% less than John, but John makes 50% more than Joe. By viewing their salary difference this way, we can see why it is difficult for so many people to come out ahead financially.
1. John can "squander" only 35% of his income before his income drops down to Joe's level.
2. Joe must increase his income by 50% to reach John's level.
The first is easy, the second is difficult. If you start off with a $1,000, spending $350 can be easy. But if you start with $650, saving $350 is difficult.
Nevertheless, salary is important because it is your starting point. But once your income is set, it is just as important to control your expenses.
Before we look at each man's discretionary spending, let's look at how much each will have after taxes. This is the first sign that John's financial advantage is less-so than it originally appeared to be.
In 2011, the federal personal exemption is $3,700, and the standard deduction is $5,800 for a single filer. Each man will be able to reduce his income tax basis by $9,500. This reduces John's taxable income by 27%, and Joe's by 41%. In terms of absolute dollars, John will pay about $3,400 in Federal income taxes, and Joe will pay about $1,600 in Federal income taxes.
Score: John ($35,000 - $3,400) = $31,600
Joe ($23,000 - $1,600) = $21,400
Social Security and Medicare taxes
Social Security taxes and Medicare taxes also take a bigger chunk out of John's income than Joe's income. Forty years from now, John will get these deductions back because a retiree's Social Security benefit is based on income earned during the working years. Assuming both men were born in June, 1989, both will retire in July, 2059, and they will earn the same amount of pay as each does now for each year until 2059, John will be receiving (in today's dollars) $397 more a month, or $4,767 a year in Social Security benefits.
However, for the year 2011, the total social security plus Medicare tax for each will be 13.3%, shared with their employer. John's employee share will be $1,978, and Joe's employee share will be $1,300.
Score: John ($31,600 - $1,978) = $29,622
Joe ($21,400 - $1,300) = $20,100
Retirement account contributions
The men's company offers a 401(k) retirement plan to its employees. Their employer matches 50 cents per dollar contributed by the employee. John does not participate in the plan. Joe decided to participate, and concluded that he can contribute 10% of his income, or $2,300 per year. The employer matched Joe's contribution by $1,150. Joe's allowable spending for the year will be reduced by $2,300, but he will have $3,450 in retirement savings, an