Financial Genome Project – Chapter 3

Chapter 3 – Benjamin Franklin the First Tax Planner

“…but in this world nothing can be said to be certain, except death and taxes.” [1]

 ~Benjamin Franklin (1789)

As we discussed in Chapter 2, you are part of a feedback loop that keeps the genome constantly running. We looked at our first connection between you and your employer, and how your salary is sent to your bank account. We showed that if you’re not cognizant of the process, you may be charged bank fees—robbing you of receiving your full salary. Those bank fees are within your control, but there are other genome connections preventing you from receiving your full salary—and those are not really within your control.

Genome – Fee Connection

We left Chapter 2 with our first connection between your employee and you. The picture above is what we’ll call sequencing—a visual representation of the financial genome. The sequence above shows your salary being distributed from your employer, to your bank account, where you can access the money and where you might be charged bank fees. Now, we’ll look into the distribution of your paycheck further to see how payroll taxes, our next genome connection, represent further reductions to your income. The payroll taxes we’ll cover are the Federal/State Income taxes, the Social Security tax, and the Medicare tax. In the first chapters of the financial genome, we’ll stick with the genome in the United States of America. As the popularity of this project grows, we’ll continue exploring other countries, and eventually map out the whole world.

Imagine you’re interviewing for a job and your future boss shows interest in hiring you and offers a $100K salary. You accept the job offer, but your future boss responds, you’ll have to take an immediate 30-40% pay cut. Would you still be interested in this job? Would you be shocked to know that this happens with every job offer in the US?

Payroll taxes have become somewhat transparent in our modern genome. The taxes are automatically deducted from your paycheck and the remainder is deposited to your bank account electronically. Your paycheck stub should show your gross pay less deductions. Your gross pay is the amount before withholdings (taxes and voluntary withholdings), while your net pay is the amount that is actually deposited into your bank account—also known as take-home pay. I remember the difference by thinking about putting a net into a gross pond and your take-home pay is what’s in your net.

You and your employer both pay taxes for your employment—and if self-employed, you pay both sides. You only see your portion on your paycheck. My personal opinion is that people would be more upset about taxes if they saw the full amount. Depending on your state, you may have to pay a State Income tax which goes directly to your state’s government. You also pay a Federal Income tax which goes to the federal government. You can manage the amount both State and Federal is taken out by adjusting your W-4, Personal Allowance Worksheet. Some companies allow you to make changes online, while others require you to visit your Human Resources department. States taxes vary by state—my home state of California is 6.6%, while New York is 9% (2017 rates).[2] Federal Income taxes vary by whether you’re married or single, and by how many “exemptions” you claim. With my income, claiming single and zero exemptions would give me a 12.8% federal income tax. In reality, I claim married with 5 exemptions for an 8.5% federal income tax. I choose to claim more so I get more in my paycheck monthly and receive less in my tax refund; while making sure I don’t owe anything either.

The federal income payroll taxes you pay monthly are estimations of your annual tax on your income. Like I mentioned above, by adjusting what you claim on your W-4 you can reduce or increase how much you pay per month. Depending on your personal situation, you may receive a tax refund or you may owe. If you get a refund, it means you paid more payroll taxes than you needed to. If you owe, then you didn’t pay enough. This generates a common debate amongst taxpayers—is getting a large tax refund a good thing? Mathematically, the answer is no. Continually striving to minimize the amount of taxes one pays is a pillar of a sound personal finance strategy. By maximizing your monthly income you can reduce debt and increase savings much quicker. That being said, behaviorally, people must look within themselves to see if they’re able to effectively utilize the additional money in your paycheck versus receiving a large tax refund. For some (many in my opinion), a large tax refund forces people to save. Unfortunately and only through anecdotal evidence, I feel most people don’t save the refund and make a large purchase instead. It’s really a personal choice; however, most certified financial planners will focus on you maximizing your monthly paycheck. Additionally and ideologically, some people acknowledge a danger of giving the government their own money during the year and then receiving it back without interest later the next year. In 2017, the IRS is already warning taxpayers that their tax returns may be delayed. The IRS will hold refunds for taxpayers claiming the Earned Income Tax Credit and Additional Child Tax Credit until February 15th, so there is some basis to that ideology.[3]

The taxes that you and your employer pay are the Social Security and the Medicare tax. These are both paid equally (50/50) by you and your employer—or completely if you’re self-employed. The total Social Security tax is 12.4%–with each paying 6.2%. Total Medicare tax is 2.9%–each paying 1.45%. So when you combine all the taxes, you’re looking at roughly 30% or more of your paycheck not going to you. In 2014, the average taxpayer paid 31% of his or her income to taxes.[4] This isn’t a conspiracy, it’s just how we created our financial genome in America. The picture below shows our current sequencing with taxes shown.

Genome – Payroll Taxes Connection

President Franklin Delano Roosevelt signed the Social Security Act in 1935. In 1937, Social Security was taken out in one lump sum and then the monthly payroll tax started in 1940.[5] The Medicare tax started in 1965. The Federal Income Payroll tax is different than the Social Security and Medicare payroll tax. The federal income tax originally started in 1861 to help pay for America’s Civil War, and then was repealed 10 years later. In 1913, with the ratification of the 16th amendment, the federal government gained the power to tax the income of individuals.[6]
Unlike the scenario in the beginning of the chapter, employers don’t discuss your net salary prior to mandated withholdings. When you apply for a job, you’re applying for the post-employer taxes salary; however, the salary advertised is before your own payroll taxes. When applying for jobs, you should automatically deduct 23-30% to figure your pre-insurance salary (we’ll talk about that in the next chapter). So the $100K a year job you’re looking at, may only be $70-$77K a year after payroll taxes.

When companies factor in labor costs, they are calculating your total salary. So that $100K salary that they’re advertising costs your employer an additional $7,650 (6.2% Social Security/1.45% Medicare) plus their portion of health insurance, retirement benefits, and any other employer-provided benefits. This is why companies are so resistant to support a federal minimum wage increase. It’s not simply an increase in wages, but a proportionate increase of employer-paid taxes and benefits. Fair wages isn’t as black and white as you may read on mainstream media—it’s actually very complicated, but that’s out of the scope of this chapter.

So far, we’ve only looked at the connection between your employer giving you a salary and how you don’t receive 100% of your salary due to payroll taxes and potential bank fees—but we’re still not to the point of receiving your salary. On top of Medicare, you must also pay for your own health insurance. In the next chapter we’ll look at health and life insurance before we talk about the connections once you finally receive your salary.

[1] http://oll.libertyfund.org/titles/franklin-the-works-of-benjamin-franklin-vol-xii-letters-and-misc-writings-1788-1790-supplement-indexes (To M. Le Roy, 13 November, 1789)

Picture link: http://www.notable-quotes.com/f/franklin_benjamin.html

[2] https://www.adp.com/tools-and-resources/compliance-connection/state-taxes/2016-fast-wage-and-tax-facts.aspx

[3] https://www.irs.gov/uac/newsroom/irs-and-partners-look-to-start-of-2017-tax-season-encourage-use-of-irsgov-and-efile-warn-of-refund-delays

[4] https://taxfoundation.org/average-us-worker-pays-over-16000-income-and-payroll-taxes

[5] https://www.ssa.gov/history/hfaq.html

[6] http://www.loc.gov/rr/business/hottopic/irs_history.html

Financial Genome Project – Chapter 2

Chapter 2 – Newton’s Third Law

For every action, there is an equal and opposite reaction.[1]

Before we begin our adventure through the genome, we should take a look at the most important piece to the entire complex system—you. You are a laborer and you are fueled by your income. Governments siphon part of your income in taxes for their engines. Then you consume by spending money, fueling businesses’ engines. You can also save part of your income which fuels other businesses through investment. The entire complex system that we’ve built as humans relies on laborers earning an income, getting taxed, and then spending or saving the rest. We keep this entire complex system running.

The engine of the genome starts with you receiving an income from a company or a government (local, state, or federal). The taxes go to a government and a part of that goes to salaries to generate government worker incomes. When you spend your money, it represents sales for a company, part of which goes to employees’ incomes. And something different happens in the genome when you choose to save money. We’ll discuss in a later chapter. Governments can only operate with taxes, and companies can only operate with sales. By working and generating an income, you’re keeping our current genome alive.

After reading that, does it seem so farfetched that in the movie, The Matrix, we are being used as batteries to keep the “machines” alive? We think we have control. We can simply stop working right?  Without government assistance, most couldn’t survive very long without relying on primitive skills. Additionally, once too many people stop working, then government assistance wouldn’t be available either. So without you working, the government, companies, and people surviving on government assistance would be unable to operate. By working and earning an income, you create a feedback loop that enables you to generate an income, while simultaneously supporting the governments and companies within the loop.

Income Feedback Loop

In the Income Feedback Loop above, check out that little blue arrow between Salary and You. Have you ever thought about all the connections that happen before receiving your paycheck? Let’s look at just that arrow in this chapter, before we address all the components of the feedback loop. Gone are the days when you worked and your employer gave you your earnings in cash at the end of the day. Now you must wait for two weeks, to a month, before you receive a paycheck. Also, you no longer receive your paycheck directly from your employer. Your employer probably uses a contracted service for distributing payrolls. Finally, your paycheck no longer comes directly to you—now it goes to your bank.

Your paycheck is purely electronic, and we continually drift away from paper money—known as fiat money, or paper money which has no intrinsic value, but is made legal tender through government decree. [2] Nearly every working person in a developed country receives an electronic paycheck directly deposited into a bank account. Only in undeveloped countries do people typically receive daily earnings or receive income in cash or goods. The whole electronic transfer process is nearly transparent to most of us. We check our bank accounts on “pay day” and if all went well, we have money in our bank accounts. Isn’t that convenient?

But this transparency and convenience comes at a cost and it is hidden in dark places of the genome. In these dark places, people are building businesses designed to make the genome appear transparent. By making it transparent, they have the ability to make microscopic changes that may negatively impact you—without you knowing it. In our busy world, where people typically check their online statements only to find out the balance after pay day, we often miss these miniscule disruptions to our paychecks. Our first dark spot in the genome is the “bank fee”—like small, hidden sand bars in a muddy river slowing speed boats down.

Until about 2008, before financial operations were in the negative spotlight, it cost you money to keep money in a bank account even though it was, and still is, mandated by employers in developed countries for payroll processing. Unfortunately, some banks still have a lot of fees just for having a bank account: checking account fees, minimum balance fees, and no direct deposit fee. Then banks charge when you spend your own money with ATM withdrawal fees and annual credit card fees. The banks are even gracious enough to let you spend more money than you have with overdraft and insufficient funds fees. In 2015, the nation’s 628 biggest banks made $11.16 billion from just overdraft and insufficient funds fees alone, according to the Consumer Financial Protection Bureau.[3] Since banks are “environmentally friendly”, they’ll also charge you a hard copy statement fee forcing you to go online to check your statements. If you want to travel outside of the country to spend your own money, you can expect to see foreign transaction fees. Even if it’s something that you can’t control like someone writing you a bad check, you may receive a returned deposit fee.

Genome – Fee Connection

Some fees have gone away as hard-pressed banks had to reassure people that keeping your money in banks was safe after the 2008 financial “collapse”. If you’re reading this, go through your last three statements and check to see if you are being charged any fees. If you are being charged multiple fees, you need to change your bank. I’ve shined the light on this genome dark spot specifically to help you receive 100% of the paycheck that you’re supposed to be earning. As you can see from the image above, these fees prevent you from earning 100% of your salary. Eliminating fees improves your “fuel efficiency” in your financial engine as we travel through the genome.

Do you ever find it unsettling that your paycheck doesn’t actually come directly to you, but goes to your bank and then you are charged fees for accessing it? Keeping your money is how banks make money. Banks with more than $115.1M in liabilities (i.e., loans to other banks, companies, and individuals) only have to keep 10% of it on hand.[4] Have you ever heard of a “bank run”? This is where many people want to take out their money from their accounts and the bank doesn’t have enough in reserve. Banks saw this happen in 2008 and, more recently, in 2016 when the “Brexit” (Britain’s departure from the European Union) happened. There’s been multiple times where people have tried to get their own money and were denied. Not having access to your own money is part of the modern genome that we must live with, but by eliminating fees, we improve our position in the genome.

My intent is not to demonize banks, but I do want to introduce to you that almost everywhere in the genome, there’s an equal, yet opposing force to everything you do. Sir Isaac Newton’s third law states, “For every action, there is an equal and opposite reaction.” We find this is true in the financial genome. For every dollar you make, there is a part of the genome trying to pull that money away from you. Some of it is voluntary, like with our spending habits; some of it is involuntary, like taxes, and some of it is voluntary only if you know about it—like fees.

This is only the top surface of the connection of your income between your employer and you. The Income Feedback Loop shows the aerial view of what the genome connections look like, but as you’ve just read, there are many connections in between only one aspect of that loop. The Genome Fee Connection exposes one dark connection that you need to be aware of and change if it applies to you. There are more connections between your employer and you, regarding your salary. In the next chapter, we’ll discuss payroll taxes.

[1] http://www.physicsclassroom.com/class/newtlaws/Lesson-4/Newtons-Third-Law

[2] http://www.investorwords.com/1928/fiat_money.html

[3] http://files.consumerfinance.gov/f/201602_cfpb_variation-in-bank-overdraft-revenues-and-contribution.pdf

[4] https://www.federalreserve.gov/monetarypolicy/reservereq.htm

Financial Genome Project – Chapter 1

Chapter 1 – It All Starts With You

“We shouldn’t expect immediate major breakthroughs but there is no doubt we have embarked on one of the most exciting chapters of the book of life,” Professor Allan Bradley, director of the Wellcome Trust Sanger Institute.[1]

     Like the movie, The Matrix, there is a complex system operating around you. Instead of operating off of sleeping humans, like in the movie, the system operates with our finances. It impacts you every day without you knowing it. I’ve called this financial system the Financial Genome; comparing it to the Human Genome Project. Once you know about the financial genome, then you’ll be able to influence it to secure your future, protect your family, and understand the world around you. It is like the galaxy, infinite in all directions with complicated networks of connections. We’re going to start small and then expand farther out making “connections” with various parts.  Every day that passes without you knowing and understanding it, the greater the influence other people have on you and soon you won’t have any more control.

I want you to embark on an exciting adventure as we explore the Financial Genome together—known as the genome from here forward. Exploring the genome can help you with your personal finances; though it’s not a personal finance book. Economic principles will be the highway as we explore the genome, but don’t worry, it’s not an economics book. This isn’t a self-help book either, but one of the key concepts of this book is that time will continue to push and evolve the genome, whether you understand, believe, or participate in it.

This is simply a way of understanding the genome and exploring the exciting connections around us. There are some great parts of the genome where the smallest, marginal, influences can create a positive impact on the whole genome. And unfortunately, there are a lot of dark areas in the genome where bad influences can negatively influence the genome—some overt and some covert. Simply knowing about these great parts and dark areas are can help most of us. In our vastly complex genome, we must start somewhere.

I had a hard time deciding where to start our journey into the genome. My first thought was to start with money—but what is money? The concept of money is extremely complex and we’ll cover our concept of money in another chapter. My second thought was to start with “the why” of exploring the genome. “The why” will be explored through each chapter as we go deeper into the genome. But for now, “the why” is simply to allow you to understand where you fit in the genome and, most importantly, apply force to your surroundings—creating a change in your financial environment.

The most logical point to start to me is to start with you. Not you specifically. You as a human being, which as a species, has accepted and participates as a functioning part of the genome. It’s important not to think of the genome as some linear shape with input and output, or a hole that we can go deeper into until we meet an end. Instead, think of the earth in the entire galaxy. If the galaxy is infinite, then you’d need to start somewhere, and most of us would start on Earth. You are the Earth of the genome.

99.9% of the time, the “person”, or you, our starting point of the genome, is a plugged-in member of our genome. When we discuss money in more detail, you’ll see that the entire genome relies on our belief in the entire construct. The genome slowly evolved into the complex system it is now. Once one of our ancestors traded a product for another product, it created a connection in our genome. Those two humans believed that those two products had an equal value in which a trade was completed. Assuming these two humans didn’t immediate kill each other, and the trade went through without conflict, then the first verbal contract was completed. The majority of our genome is simply a verbal contract, growing larger and larger, and more complex as technology advances.

The modern genome relies in your utmost faith and obedience to the verbal and written contracts you engage in every day. As a human, you absorb an input, typically as an income and you produce an output, typically as you spend, save, and are taxed.

You exert influence on genome connections in three ways. 1) You exert influence based on how much you believe in the system and how obedient you are. 2) Your influence is usually greater as your income increases. In almost all cultures, the rich are able to control more connections and exert influence on genome connections that increase their control.  3) The genome can exert influence on you through your output. Governments can tax you and companies can increase prices. Your ability to manage your consent, input, and output will determine your impact on the genome.

The genome is constantly evolving around you, regardless of how much influence you may have on the genome. No matter how complex it becomes, your understanding of how you influence the genome will help you navigate through it. Despite our knowledge of the system or how powerful some connections become, there are also outside pressures on the genome as well.

There’s an external pressure on the genome, that has nothing to do with your participation, understanding, or obedience. It is time.  Time is the greatest pressure on the genome. It can be a negative or a positive force. The longer you remain ignorant of your presence in the genome, the more negative the force is perceived—like pressure building as you go deeper underwater. For those of us that become aware of the genome early, the positive force is like the wind in your sails pushing your boat effortlessly. Remember, time exerts its pressure on the genome no matter what you do.

The biggest secret of the genome is…the entire system can be altered, changed, and modified if enough connections (people in this case) make it so; however, the system has been carefully crafted to prevent that from happening. There is a surface layer that most of us know about—and accept and are obedient to. An example of a simple connection, in which we’ve accepted and are obedient to, is the 40-hour American work week. Back in the late 1800s, the 40-hour work week was actually an improvement on the average 100-hour work week that some industry workers experienced[2]. The 40-hour work week isn’t common among all countries and neither is the Monday through Friday work week. We’ve accepted the 40-hour work week and the 5:2 work-to-rest ratio. Financially independent people don’t have a 40-hour work week. They may have more or they may be completely free.  There are many more examples deeper into the genome. There are some we can modify ourselves, and some that require an entire culture to change. This is why it’s so important to explore the Financial Genome. Come with me.

[1] http://www.cnn.com/2003/HEALTH/04/14/genome.reut/

[2] http://www.businessinsider.com/history-of-the-40-hour-workweek-2015-10