Nick Frostbutter

First 3 Steps to Financial Freedom

Nick FrostbutterNick Frostbutter
Jan 13, 2020

Get a head start on your financial goals with these first 3 steps to financial freedom. Simple steps to figure out what you earn, keep, and spend.

take the steps to gain financial freedom

Without a doubt, the biggest and most important 3 steps to financial freedom is knowing what you earn, what you take home, and what you spend. The before and after tax numbers are so very important to know, and even more so, how much you spend each and every month.

Once you have built a strong financial foundation with these first 3 steps to financial freedom, you will set yourself up for the future.

Step 1: Know What You Earn, the "pre-tax" earning

Everyone makes money. Everyone makes different money. Some people make more. Others make less. Some make even less. According to CNBC, the average income of for 2018 is $61,372. But this number is "pre-tax". With the current tax brackets for these "average" Americans, they would be paying around $4,000 - $6,000 in federal taxes, not to mention their local state and municipality. Each year. That's a lot of money going to taxes.

Do you know how much you make a year?

do you really???

If you got passed on the street could you answer accurately? I am willing to bet that the average person cannot accurately answer this question. I know I couldn't until very recently.

This "pre-tax" annual earnings is know as Gross Income. That's the total. amount of money a person makes each year. So let's say you are a hourly wage earner. If you get paid $10 per hour of work and work the standard 40 hour work week, you earn $400 a week and therefore $1,600 a week, and finally $19,200 a year. That would be your "pre-tax" Gross Income.

If you are a salaried worker, determining the correct Gross Income you make can be a little more complicated. Often times, you can just use the salary wage that was negotiated into your contract with your employer. But this may be less accurate than you might think. On the bright side, knowing your Gross Income is not all that helpful or useful in life. What really matters is the after tax income and knowing how to legally lower your taxes.

Step 2: Know What You Keep, your after tax earnings

How much do you spend on taxes each year? Can you answer that either? I couldn't either! The U.S. tax bracket code can be very confusing and be cause of that, most people don't know how much money they actually pay for in taxes each year. Especially when everything seems to have a different tax rate and it changes just about every year. For now, I will just focus on Income Tax.

Simply put *Income Tax *is just the tax you pay on your income. According to U.S. tax law and rates, every person will fall into a certain "Tax Bracket". These brackets are largely based on the actual amount of income that you make each year (aka Gross Income). There are certain ways to lower your taxable income, including investing in your 401(k), IRA, or other tax deferred retirement account, but I won't get into those in this article.

For the year of 2019 (when I am writing this article) the current U.S. tax brackets are:

**Rate ** **Individual (or Married, filing separate) ** **Married, filing jointly **
10%< $9,700< $19,400
12%$9,701 - $39,475$19,401 - $78,950
22%$39,476 - $84,200$78,951 - $168,400
24%$84,201 - $160,725$168,401 - $321,450
32%$160,726 - $204,100$321,451 - $408,200
35%$204,101 - $510,300$408,201 - $612,350
37%> $510,301> $612,351

But knowing what "bracket" or percentage you will fall under does not quite give you the entire picture of how much you pay. These brackets are actually on a rising scale themselves. Meaning, you income will be taxed at the lowest rate, until you reach the cap of that range. Then the remaining income will be taxed at the next highest rate, until you reach the cap on that range. And so on and so forth.

Example #1: Filing as "Individual" with $50k salary

So let's say I earned a Gross Income of $50,000 in 2019 and filed with an "Individual" status.

  • I would pay 10% tax on my first $9,700 of income.
  • Then 12% tax on the next $29,775 of income (now totaling $39,475 of income).
  • Then a 22% tax on the next $10,525 of income (totaling the entire $50k of income I earned in the year of 2019)

So with this income, I would pay $6,858.50 in federal taxes in the year of 2019.

Example #2: "Married, filing jointly" with $50k salary

Now consider the same scenario, but now let's say I filled "married, filing jointly" with the same $50k income for 2019. And lets assume my wife does not earn an income for the year. I would pay about $5,612 in federal taxes. That is around $1,250 less a year I would have to pay in taxes. It might now seem like much, but there are certain tax benefits to being married. (Which is why some people say they get married for money or the tax reason only)

Confusing right?!?! Well, it is actually benefiting everyone being setup in this strange way. The reason is because it actually saves people money on taxes by averaging down the taxes. Going with the example above, my $50k income. If I had to pay the tax rate for the final bracket my income falls into (22%), then I would pay $11,000 in federal taxes in this same year (vice the $6,858.50). So because of this average down method of taxing, everyone actually pays less in taxes, no matter how confusing it may be.

Something to keep in mind that every single year, the IRS updates the tax brackets for the entire country to follow. If you are looking for more recent brackets or even the old ones, you can find them on the IRS website on the News Release page. They normally get released around November.

Step 3: Know What You Spend, Start a budget and track your spending

Most people do not do the best job with tracking their spending. Most people even spend more than what they make, slowly but surely building the amount of consumer debt. Falling further and further into a sinking hole. The key to not spending more than you earn is simply tracking your spending.

The simple routine of tracking your spending, every single little transaction, can help you save so much money. And notice that I said routine. It has to be a routine. It is a constant action that needs to be done. Now, you don't have to use pen and paper and go though your bank statement each week or month (unless that is your style, in which case then go right ahead). There are dozens of smart phone apps out there that you can use.

Track Your Spending with Apps

Recently I have been using TrueBill on Android, because I like the interface. But I know a lot of people like to use Mint from Intuit, but you can use which ever method works for you. The important thing is that you track your spending.

When you first setup these apps, you will be able to link your bank accounts using the Plaid platform. They support thousands of different financial institutions and will likely have yours. After linking your bank accounts, you will be able to see all of your transactions and incomes. The apps will then categorize each as best they can auto detect. I have noticed that it is not the most accurate at categorizing for some transactions. For others, I prefer they be put into different categories. Luckily when I change the category they are in, the apps can learn those preferences. Saving them for later to make life easier by correctly auto categorizing.

The important part about tracking your spending, especially getting it correctly categorized, is being able to simply tell where all of your money is going. I think you will be surprised to see. You can get a really good kick in the but when you see what you spend on eating out or random shopping expenses. When I started tracking my spending a few months ago, I learned where most of my money was going. I knew it was from dining out, but never realized how much it truly was.

Know Your Numbers!

Taking these first 3 steps to financial freedom and knowing these basic numbers will set you apart from most people. IT will set you on the right path towards financial freedom.

Once you know how much money you actually make (after tax) and how much you actually spend (no more guessing), you can really start to cut down on the major costs and start building a great savings rate. Slowly getting close to your own financial goals. Good luck!