Breakdown

Imagine you're at an all-you-can-eat buffet with different price tiers based on the amount of food you actually consume. The more you eat, the higher the tier you move into, but you only pay that higher price for the food you eat in that tier. In the U.S., tax brackets work similarly: your income is divided into chunks, and each chunk is taxed at a different rate. So, if you earn more, only the extra income in the higher bracket gets taxed at the higher rate, not your entire paycheck.

Show me some examples

Say you make $50,000 per year. When you break this down within the tax brackets (2022), it looks like:

• $10,275 taxed at 10%

• $31,500 taxed at 12%

• $8,225 taxed at 22%

Math:

Tier 1 ($0 - $10,275 @ 10%)

• Taxes taken out: $10,275 x .10 = $1,027.50

• Money taken home: $10,275 - $1,027.50 = $9,247.50

Tier 2 ($10,276 - $41,775 @ 12%)

• Taxes taken out: $31,500 x .12 = $3,780

• Money taken home: $31,500 - $3,780 = $27,720

Tier 3 ($41,776 - $50,000 @ 22%)

• Taxes taken out: $8,225 x .22 = $1,809.50

• Money taken home: $8,225 - $1,809.50 = $6,415.50

So, in total:

• Taxes taken out: $1,027.50 + $3,780 + $1,809.50 = $6,617

• Money taken home: $50,000 - $6,617 = $43,383

That, of course, is not the last of what’s going to be taken out of your paycheck - you’ve still got Social Security (6.2% as of 2023), state taxes (if your state has income tax), and any retirement/insurance(s)/etc. that you’ve elected to have withheld on your check.

Both Social Security and state income taxes are taken out at a flat rate, so you can just take that total income of $50,000 and multiply it by those percentages:

Social Security at 6.2%: $50,000 × 0.062 = $3,100

Then a state income tax (example) at 5%: $50,000 × 0.05 = $2,500

So for someone earning $50,000 a year in a state with 5% income tax:

• $50,000 pre-tax income

• - $6,617 in federal taxes

• - $3,100 in Social Security

• - $2,500 in state income tax

Leaving them with a total of $37,783 take home pay before we factor in any health and/or life insurance, putting any money into an employer retirement account, or any other things they’ve elected to withhold from their check.

So, before any of that money lands in your account, you can count on just about 25% of it going to Uncle Sam and his folks - which is why having an employer-sponsored retirement account can be extremely beneficial as most of these use pre-tax dollars. This allows you to effectively reduce the amount of money going to taxes and save some for your future self via your retirement account (though Uncle Sam does eventually get his cut, at that point it will, hopefully, not affect your day-to-day spending quite so much).

Bonus

I've come across several people in my life who say, 'Oh, you better watch that raise though, it will end up with you in a higher tax bracket! It may not be worth it.' .... which is just ... so wrong it hurts. That's like saying you shouldn't eat more cake because you'll need a bigger plate. Yes, you’ll pay a bit more tax on the extra money (and only that extra money!), but you'll still end up with more cake in the end. Err, money.

Thanks for reading!

Jake

jakekickscash

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Mandatory reminder

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