How to Save Money with a Cash Envelope System
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Knowing the difference might even help you save on your tax bill...
If you’re like most people, you’re probably most familiar with “income” as your paycheck. Maybe you even have a small investment portfolio or rental property that generates some extra cash.
But the truth is that there are many categories and sources of income, and a few ways to look at the same income.
We've got Cleo's resident financial advisor, Anna, to answer some of your most-searched questions around income.
Anna Yen, CFA, is a financial wellness expert with 2 decades of experience in financial markets. This includes on the trading floors of JPMorgan and as a Director at UBS. She specializes in personal finance, derivatives, and alternative investments including crypto.
Here's what you need to know about your income.
Economists and accountants define and measure income in different ways based on its source and purpose. But while the experts have their fancy jargon and analysis, the average person is probably more focused on personal and business income.
As an individual or household, income is any money that you receive from:
Your income can be categorized as earned or unearned. Knowing the difference might even help you save on your tax bill.
Earned income comes from business or work-related activities. Sources of earned income include:
Generally, you have to pay income taxes and US federal payroll tax (FICA, which funds Social Security and Medicare) on earned income. You need earned income to contribute to most individual retirement accounts (IRAs) and qualify for some tax benefits. And when you retire, your earned income determines the value of your Social Security benefits.
Unearned income is any money you don’t earn through active participation in a job or business, like:
With the exception of alimony, you can’t use unearned income to contribute to a retirement account.
Another way to examine your income is by gross or net earnings. The difference between gross vs. net income can impact your spending decisions.
Your gross income is the total value of your income before anything has been taken out. It includes earned and unearned income from wages and salary, self-employed earnings, investments, retirement, rentals, etc.
Your gross income is the number that lenders and landlords will consider when qualifying you for:
And come tax time, the IRS will use your gross income to calculate your tax bill.
Net income is the actual amount of income you take home, typically after you pay:
In other words, it’s the amount that actually hits your bank account on payday. Your employer will deduct the relevant amounts and pay you your net earnings. (Or if you’re self-employed, net income is the amount left after paying taxes and business expenses.)
Your net income is important because it’s the money you can actually use to budget and pay your bills. And though lenders might consider gross income for handing out loans, you may prefer to use your take-home instead. Doing so can ensure you have a solid financial cushion to save or afford the finer things in life.
Your annual income is all of the income you earn in one year, including both earned and unearned income like:
You can measure your annual income in gross (pre-tax and deductions) or net (post-tax and deductions) terms. This way, you can evaluate both your total income as well as how much actually hits your financial accounts.
Another helpful number to know is your total monthly income. Depending on how you get paid, calculating monthly income can take a little more math.
If your only income is your salary, calculating your monthly income is easy: Just divide your annual salary by 12 months. For instance, if you earn $48,000 per year, divide that by 12 to get $4,000 in monthly income.
If you’re paid hourly, the complexity of the calculation depends on how regular your hours are and whether you get paid overtime.
If you work regular hours without overtime, you can add up all the hours worked in the month and multiply it by your hourly rate.
So if you worked 160 hours this month and got paid $20 per hour, this is the calculation for your monthly income:
Monthly Income: 160 * 20 = $3,200
If you also worked 10 hours of overtime on top of that and got paid $25 an hour, then you would add overtime pay on top of that.
Overtime Income = 10 * 25 = $250
Your total monthly income would be:
Regular Income + Overtime Income ($3,200+$250) = $3,450
If you have other sources of income like alimony or government benefits, then calculating your monthly income gets a little trickier.
If you have a monthly salary figure and also add up all the other sources of income on a monthly basis, then you can determine a total monthly income.
Otherwise, you can work backward from a total annual income amount and divide it by 12 months to get a monthly average.
One of the easiest ways to examine your monthly income from multiple sources is by tracking that cash flow in a spreadsheet or finance app.
Before today, you probably thought about your income in terms of your paycheck alone. But now you know that there’s a whole, wide world of income out there, just waiting to be earned (or unearned…) and taxed.
Most jobs are listed using the gross income number, which is the total income before paying taxes and deductions. Understanding your take-home pay is the first step to figuring out how much you can spend on essentials and everything else.
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Big love. Cleo 💙
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