"Pretax income vs. post-tax income (take-home pay) is one area that is so commonly overlooked by so many people when they start taking a closer look at their personal finances."
When people talk about income and salary and they tell you how much money they make from their jobs - $50,000, $75,000, $100,000 - those nice numbers are usually pretax numbers i.e. it is their income before any taxes get taken out. The thing is, when people get paid their salaries they get paid post-tax. This means they get paid after taxes have been deducted from their income, also known as take-home pay.
How much do you really earn?
From a mindset perspective, however, although people get paid post-tax, many people still think about their overall salary in terms of their pretax amounts. This causes some people to assume they make more than they really do and in turn may cause them to spend more than they can really afford. Are you confused? I'll give you an example:
Meet Lisa. Lisa makes $50,000 a year pre-tax but her biweekly post-tax salary after 25% taxes (assuming 25% is her tax bracket plus other deductions) is $1,562.50. This means post-tax Lisa really only makes $37,500 a year but because she's never really sat down to calculate her overall post tax salary, even though she gets $1562.50 on a biweekly basis, Lisa still tells herself that she make's $50,000 a year.
From a mindset perspective, $50,000 is a lot more than $37,500 and so Lisa buys things that cost way more than she can really afford because in her mind she will somehow be able to pay for it later - afterall she makes $50,000 a year. The most dangerous part of all this - creditors will qualify you for loans and mortgages based on your pre tax income - now that is scary!
Does this make sense yet? If you ever feel like you make all this money a year but yet you never seem to have enough money based on what you think you earn, take a step back and think about your yearly income from a post tax perspective and create your budget accordingly.
Don't plan for $50,000 when you really only make $37,500 after considering taxes. Don't get caught up in massive loans that banks will qualify you for based on your pretax income. Do you own due diligence and understand what you can really afford.