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How to Calculate Your Take-home Pay – Making of a Millionaire

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Money Simplified

And Why Calculating Your Take-home Pay Is the Critical First Step on the Path to Financial Independence

Photo by Kelly Sikkema on Unsplash

The most important variable in personal finance is your savings rate. Your savings rate tells you how much of your take-home pay you are saving and investing each month.

The higher your savings rate, the sooner you will reach Financial Independence, the point where your passive income is enough to cover your living expenses and you are “financially independent” from your paycheck. A

Once you reach Financial Independence limitless options open up for you.

  • You can continue to work your job and build further wealth.
  • You can take more risks in your career.
  • You can work part-time.
  • You can spend more time with your family.
  • Most importantly, you can live your life without ever worrying about how you are going to pay the bills. You no longer need to live in fear or ask yourself “what happens if I lose my job?”

If you know your savings rate, you can actually predict how many years it will take to reach Financial Independence. FIRE blogger, Mr. Money Mustache developed this simple chart that will tell you how many years it will take to reach financial independence given your current savings rate

Source: Mr. Money Moustache

If you have a 10% savings rate you will reach financial independence in 51 years. If you have an 85% savings rate, you will reach financial independence in 4 years.

(Note: The math in this chart assumes you are starting from scratch and you can earn 5% above inflation on your investments.)

The path to Financial Independence starts with your savings rate. It is critical that you accurately calculate your savings rate.

  • Savings rate= Amount of money you invest each month divided by your monthly take-home pay

Therefore, you must know how to properly calculate your monthly take-home pay.

Step 1: Grab your most recent pay stub.

If you are a salaried employee or receive an hourly wage with consistent hours calculating your take-home pay is rather simple. Grab your most recent paystub, it should look something like this.

Your net pay is how much you take home each paycheck after taxes and other deductions come off your gross pay

The above paystub is an example of what a salaried employee making $65,000 per year living the state of Georgia might look like.

Step 2: Identify your net pay per paycheck.

You’ll notice three totals at the bottom of this paystub.

  1. Gross pay which is equal the $65,000 salary divided by 26.
  2. Deductions such as taxes, medical deductions, and employee pension contributions and social security deductions.
  3. Net pay which is equal to gross pay minus deductions.

In this example, the gross pay is $2,500 and $824 of taxes and deductions are taken off that paystub and the employee receives a net pay of $1,676 each paycheck as highlighted in the yellow box.

Step 3: Turn your net pay per check into monthly take-home pay.

  • Most salaried employees get paid every two weeks.
  • That means you receive 26 paychecks per year.
  • Therefore your monthly take-home pay= (net pay per check X 26) divided by 12
  • Using the above paystub as an example, monthly take-home pay= ($1,676 X 26) divided by 12 which is equal to $3,631.
  • The monthly take-home pay for this hypothetical person making a $65,000 per year is $3,631.

Now that this person knows their monthly take-home pay, they can calculate their savings rate. If this person was putting away $1,000 per month towards retirement, their savings rate would be equal to 27.5% ($1,000/$3,631).

A 27.5% savings rate would put this person on a 30-year timeframe to reach Financial Independence. Knowing this number is powerful. If they are unhappy with a 30-year timeframe they can begin making informed decisions to cut certain expenses or increasing their income to reach Financial Independence faster.

The journey to living a life of freedom starts with knowing how to calculate your monthly take-home pay.

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