Some numbers matter more than others. How much you make is important, for example, but your financial health depends far more on how much you keep.
Knowing certain numbers can help you understand how well you’re converting income into wealth, as well as the impact of your spending and tax situation on that process. The following calculations can help you make better decisions.
- Your wealth ratio
A wealth ratio is a measure of how effectively you’ve converted your lifetime income into wealth.
Add up the annual earnings over your entire life, as reported in Social Security statements or old tax returns.
Then calculate your net worth — what you own (the value of your assets) minus what you owe (your debts).
Your net worth divided by your lifetime income, expressed as a percentage, is your wealth ratio. If you’ve earned $500,000 and your net worth is $125,000, your wealth ratio is 25 percent.
There’s no pass/fail here. Knowing your number can motivate you to look for ways to save and invest more so that your ratio grows.
- Your overhead ratio
How much of your after-tax income is eaten up by basic, must-have expenses? If you’re having trouble making ends meet, calculating your overhead ratio can help explain why.
A must-have expense is one that can’t be delayed or skipped without serious consequences. They include shelter costs, transportation, groceries, utilities, insurance, minimum loan payments and child care. In their book “All Your Worth,” bankruptcy expert (and current Massachusetts senator) Elizabeth Warren and her daughter Amelia Warren Tyagi recommend limiting must-haves to 50 percent of after-tax income.
A 50 percent limit isn’t easy to achieve, but it frees up money for “wants” (30 percent) and savings or debt repayment (20 percent).
- Your tax rates
Your tax bracket doesn’t reveal the amount of taxes paid on your total income. Instead, the bracket (also called the marginal tax rate) reflects how much Uncle Sam claimed of the last dollar you earned. If you’re a single filer in the 25 percent federal tax bracket, the first $9,275 of your 2016 taxable income is taxed at the 10 percent rate, the next $28,375 at 15 percent and the amount above $37,650 at 25 percent.
Your tax bracket, like your overhead and wealth ratios, can change over time. Check these numbers regularly to stay on track with your financial life.
YOUR TAX BRACKET
Your tax bracket — which measures how much tax you paid on the last dollar you earned in a year — determines the value of your itemized deductions and tax-advantaged investments. Someone in a low tax bracket, for example, doesn’t get much value from write-offs, such as mortgage interest deductions or investments such as municipal bonds or variable annuities, that can benefit people in higher brackets.