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Taxes and savings are considered a leakage factor- explained!

Everyone who makes a salary pays taxes on that income. In the US, those taxes are typically as much as 30%. 

Savings accounts also often incur fees which can range from 1% to 5%. When you include those leaks, your take-home pay may be less than you think.

Gather information on the different types of tax savings and make a plan for how you can best use them in order to decrease your tax burden. 

You should also evaluate the state of your current savings account and make a decision about whether or not it’s worth sticking with this account over others where the leakages would be lower.  which best describes why taxes and savings are considered leakage factors?

Income (taxes and savings) and expenses (expenses and leakages) are both taken from before-tax income. 

To see the effects of those leakages, divide your paycheck by how many hours you actually worked. 

If you don’t work as many hours as you think, then the numbers should be skewed. When you divide your paycheck by working hours, include all allowances such as vacation days and sick time.

The way in which taxes are withheld for any particular person depends on income level, marital status and other factors that determine what is to be withheld from each paycheck.

Factors explaining why taxes and savings are considered leakage :

1. Tax Rate

Taxes are paid on income at a progressive rate. The tax rate will vary depending on your income level. 

As you get closer to the top tax bracket, you will pay more in taxes than you would have otherwise.

 Because of the lower tax rates for higher-income individuals, it is always better, in terms of loss of take home pay, to save for retirement at the end of the year rather than during.

2. Income Tax

When your paycheck is calculated, taxes are deducted before other deductions are taken out at source that are used to calculate take-home pay. 

These deductions include: Social Security and Medicare taxes, Federal Employees Retirement System (FERS), and employer contributions to other retirement plans. 

There are many other deductions that can be taken out and this will vary depending on the tax bracket you fall under.

3. Expenses

If you don’t have enough money to cover your expenses, then money will be taken from your check before it has been taxed. 

For example, if you do not have enough savings to cover your expenses between the income you make and the expenses you normally pay (for example, groceries, entertainment, etc.) then money will be taken out of each paycheck before it is taxed.

4. Savings Rate

The amount it takes to cover the leakages is called the savings rate, and it can vary depending on your income level and whether or not you have a retirement plan to contribute to. 

Most people do not contribute enough money to their retirement plans in order to cover tax leakage. If you make $100,000 a year and you contribute $2,000 per year (your contribution will typically be between 5% and 15% of your take-home pay)

Then you will need at least an extra $200 per month in order to cover the tax leakage from that particular paycheck. 

However, when I calculated my tax savings rate in my last blog post, I was only contributing 1%. It is better to contribute more than that and save for retirement than to put all of your savings into a savings account and therefore receive far less than you would have otherwise.

5. Lifestyles

There are many differences between the lifestyles of people who earn $50,000 per year and those who earn $100,000 per year.

 Those who earn $100,000 will typically spend more on vacations, entertainment and other non-essentials such as food versus people who earn $50,000 per year. 

If you live a lavish lifestyle but do not have enough money saved up to cover the tax leakage; then there may be times when you need to borrow money from a friend or family member.

6. Education

There are many college graduates who are not earning enough money to cover the tax leakage in their paycheck. 

Although paying off student loans is important, it is also important to make sure that you have enough money saved up for retirement.

 If you do not save enough for retirement, then you will be dependent upon the government more than you would have otherwise been. 

Your standard of living may also depend on your government benefits if your paycheck is not high enough to cover your expenses even after paying off student loans.

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