¿Cómo fue el mes pasado? (How did last month go? *I think*) For me, I gave a pitiful, but seemingly valiant, attempt at Duolingo and got quite a few of the cobwebs off since high school Spanish class. I’ll refrain from agreeing to post my laughable 16% fluency on my LinkedIn profile that the app continues to want me to brag about. But it’s tough to learn a new skill; mostly because of that word; “new”. We don’t enjoy doing things we aren’t good at. So I applaud you for considering areas of possible development and hope you continue in that pursuit.
June’s focus is on “Financial Education”. With the plethora of financial information available online, one might be led to believe that we should know everything we need to know. However, Jeff would attest to the fact that finances are just as (if not more) confusing now as they were 20 (or 40) years ago. We spend at least as much time “educating” now as Jeff did back in 1990 (or 1968!). We find one of the toughest fundamentals for people to grasp that bridges into many topics is distinguishing the difference between “gross” and “net”.
The easiest place to see this play out is when discussing income taxes. We commonly get requests like, “I’d like to withdraw X from my IRA.” And of course, we have to ask a question such as “is that before or after taxes”? To which, we commonly get a “oh, I need X”. So, as an example, if the request is for $10,000, we need to tack on percentages for Federal as well as any State taxes. If that person is in a 25% Federal and 8% California bracket, we could need up to 33% withholding. Although, at first glance, it could seem like we would only need 33% of $10,000 (or $3,333) for taxes, we actually need more than $15,000 “gross” to “NET” $10,000. Although this would make logical sense to pay 1/3 of the withdrawal in taxes if the tax rate is 33% total, we have a tendency to think about how it impacts our actual wallet.
Another great example is discussing tax deductible items or expenses. A retirement plan contribution of $1,000, for example, doesn’t actually mean $1,000 if we continue to use the 33% combined tax bracket. Because, if we keep that $1,000, we are actually going to pay $330 (33% of $1,000) more in taxes. So, contributing that $1,000 actually only has a “net” cost to us of $660, which doesn’t have quite the same “sticker shock”. This same theory actually translates over to business expenses as well. If we can deduct a $1,000 computer, it actually only costs $660 due to income taxes, let alone an additional “self employment” tax if it applies, which would make it even “less costly”!
The last commonly confused differentiation is when discussing personal or business income. It’s fun to say things like “my business income was **insert astonishingly large number**” or “my salary is **insert six figure number**!” And as fun as those imaginary numbers are to say out loud, it can mess with our psyche a bit. We start to feel as if we can live like we are “netting” those astonishingly “gross” numbers. But we have many possible costs; including taxes, premiums, employees, and overhead to subtract to find out what we actually took home. From here, we can actually derive what our personal cash flow could be in order to make prudent choices for the rest of the living expenses.
This month, I’d like to challenge you to really distinguish the differences of income and expenses in terms of gross and net. And to weigh on how much those either current or “desired” retirement plan contributions or deductible expenses actually cost. When we ask income, most clients tell us their net (or the amount that goes into their checking account. Secondly, when was the last time you did a “Net Worth Statement”? If you are a client of ours, we recommend to do this every couple of years, but are there loved ones around you who would benefit from that exercise? Additionally, the Net Worth Statement will carry over beautifully to next month’s theme of “Estate Planning”!
Nothin’ but “net”,
(The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.)
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Trent Huston is a Financial Consultant with securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through AK Financial Group, a registered investment advisor. AK Financial Group and OC Wealth Coach are separate entities from LPL Financial.
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