Budgeting: Accounting for Payroll Deduction expenses

[MooseOutFront]

It just hit me that I've never really accounted for expenses that get deducted from our paycheck.

I'm trying to add these numbers into my expenses to get a better total but my brain isn't functioning correctly.

Medical insurance for example.  Total payroll deductions are $2,869.74.  Since this is pre FICA (7.65%) and pre federal tax (15%), the $2,869.74 only actually costs me $2,219.74 ($2869.74*(1-0.15-0.0765).

So when I record my expenses for the year for medical insurance, it makes sense to me to use the tax adjusted number. Same with FSA Dependent care.  $4992 is deducted from my income, but my out of pocket expense for this is only $3861 because that's the amount that would have been paid to me had I not had an FSA, the difference going to taxes.

Another reason why I care to come up with a good system for this is that I try to calculate my % savings based on after tax income.  If I do the following, it should get to zero, but it won't unless I use the whole expense for medical insurance and FSA or pull it from the top of gross income.

Gross Income
-taxes
-expenses
-investments & savings
= zero

Except it doesn't because I didn't record the pre-tax expense for medical insurance.  You know what I mean?  Sorry for this low quality post.  I'm not saying what I'm trying to think very well.

ETA:
Edited with some improvements; still a bad job of message boarding for the day.

[Cheddar Stacker]

I'm not saying what I'm trying to think very well.

Agreed. I want to help, but this all went into my brain as "surrender yellow quick pickle lift topwise." I'm going to re-read and see if it makes more sense, but I think you may need a re-write when you are less scrambled.

[MooseOutFront]

Ha!  Just as I suspected.  OK, simple question, how do you account for your cost of medical insurance, assuming it gets deducted from your paycheck pre-tax?  Do you use the gross number taken out of your pay or do you tax adjust it? If that doesn't apply due to company fully providing, then same question applies to your FSA medical contributions.

[marblejane]

I usually just ignore the cost of my medical insurance, but that is because it is peanuts- I'm paying about $40 per month against a gross income of $10k per month. It sounds like you have very high medical costs, though.

Regarding the FSA, you have two options. The first option is to treat the FSA contributions as a budget transfer to a balance sheet asset. In this scenario, your FSA is a type of savings account that you are making automatic contributions to each month. FSA reimbursable medical expenses are just recorded as regular expenses at the time that they are incurred. Any FSA balance that expires unused would be recorded as an expense at the time of expiration.

The second option is to treat the FSA contributions as an expense. In this scenario, your FSA contributions each month are recorded as a medical expense, and reimbursable medical expenses are ignored in your expense accounting. This isn't as good from an accounting perspective, but it works since FSA balances expire at the end of every year.

Regarding medical insurance, I'm not sure that I understand the purpose of tracking this as an expense.

[Cheddar Stacker]

Ok, so I've re-grouped, re-read the initial explanation, and read your edits. I think I know what you're trying to do, but I'm unsure why you are choosing to do this. But whatever, here's what I have for you.

This is what you have been doing presumably:

 100,000     Gross    
 (2,870)    Medical    
(4,992)    FSA    
 92,138     Taxable    
 (7,049)    FICA Tax    7.65%
(13,821)    Federal Tax    15.00%
(20,869)    Total Tax    
 79,131     After Tax Income    
 
71,269     Net Paycheck    
 (35,000)    Expenses    
 (36,269)    Investments/Savings    45.83%
 -       

I think what you're going for is this, which is a slightly higher savings % in my example:

 100,000     Gross    
 (2,220)    Medical    
 (3,861)    FSA    
      
 (7,049)    FICA Tax    
 (13,821)    Federal Tax    
 (1,781)    Deemed Taxes on Deductions    
 (22,651)    Total Tax    
 77,349     After Tax Income    
 (41,081)    Expenses    
 (36,268)    Investments/Savings    46.89%
 -       

In the second version I used your "deemed taxes" from your calculation and added them to taxes. Then I added your net medical costs on top of the guestimated expenses of $35K. Result is a 1% increase in your savings rate.

Is that what you're looking for?

[beltim]

Medical insurance for example.  Total payroll deductions are $2,869.74.  Since this is pre FICA (7.65%) and pre federal tax (15%), the $2,869.74 only actually costs me $2,219.74 ($2869.74*(1-0.15-0.0765).

So when I record my expenses for the year for medical insurance, it makes sense to me to use the tax adjusted number. Same with FSA Dependent care.  $4992 is deducted from my income, but my out of pocket expense for this is only $3861 because that's the amount that would have been paid to me had I not had an FSA, the difference going to taxes.

This seems odd to me.  I think I understand what you're trying to do, but it creates odd distortions.  Your insurance, for example - cost you $2869.74, not $2219.74.  You didn't pay the income tax.  You didn't pay FICA, and you won't get the higher Social Security benefit from the larger salary.  What's your goal here?

[Franklin]

I'm not sure I see the point.  By lowering your taxable income you are saving money on taxes.  But it didn't change your medical expenses.  So adjust your tax expense, not your medical expense.

[MooseOutFront]

marblejane I've always used your second FSA accounting example and ignored the reimbursable medical expenses when they come in, but I've never counted the FSA contribution as an expense either.  Same with medical insurance, just never counted it as an expense.  I'm now wanting to just to get the most accurate picture possible.

CS, I appreciate you taking the time to help.  The way you listed the numbers shows me the error in my logic.

beltim and Franklin, yall are right.  I was trying to double give myself credit for those tax savings.  In reality I need to be listing the full cost of these pretax expenses and the savings on taxes is already accounted for by not having paid those taxes.

Thanks for bearing with me on this.

[MooseOutFront]

On a related note, how do you fine folks account for mortgage principal reductions?  Currently I have the full mortgage payment as part of my expenses, and then include the principal reduction as part of my savings.  Seems almost as if I should only include the interest payments on the expense side of things.

[dandarc]

On a related note, how do you fine folks account for mortgage principal reductions?  Currently I have the full mortgage payment as part of my expenses, and then include the principal reduction as part of my savings.  Seems almost as if I should only include the interest payments on the expense side of things.

I'm not as concerned with what my savings rate is exactly as I am with how much longer I have to keep at the grind.  To that end, and knowing my wife and I will not consider ourselves FI without paying off the mortgage, my 'time to retirement' sheet bases my target number off of current expenses less mortgage P/I.  It figures savings by subtracting total expenses (including full mortage payment) from income.  Ex:

Our current annual outlay is $60,400.
Of that, $8500 is mortgage P/I for minimum payments, so if the house were paid off our expenses would be $51,900.
Our income estimate is 146,000 / year.

Put it all together, slice and dice and I get the following:
We'd be FI today if we had $1,297,500 (25 X $51,900) invested
We only actually have $177,800
We are saving at an $85,600 / year rate (146,000 - 60,400)
Assuming 5% real returns, we are looking at 9.53 years to get from here to there (under ten years - hurrah!)

Any way, not the most precise way to do this possible, but good enough for us, and much more encouraging than assuming we'll be paying that mortgage forever on the end result.  We're predicting the future here, so there will be some error.

I also have a 'playground' version where I can try various things - when I put in spending cuts that we've agreed to but won't go into effect for the next few months, I get only 8.33 years!  I also compute the two extreme ends on the savings rate formula - mortgage P&I is 100% expense vs. mortgage P&I is 100% savings - from that I can tell our savings rate is somewhere between 58 & 65% currently, and heading to somewhere between 62 and 68%, if we don't cut the budget further than we already have planned.

[MooseOutFront]

Nice.  Sounds like you do the same type of playing around with this stuff as I do.  I have been on a kick this week to get real precise with what is happening in 2014 down to the dollar.  What got me to re-doing my stuff is that my actual savings, now that I can see pretty much what that number will be at year-end, wasn't footing exactly with what I had for gross income - expenses. 

The most important number is expenses since that projects into the future, but while I'm cleaning up the books I wanted to get the income and savings numbers dialed in to.  Like, for example not counting my payroll deductions as expenses was screwing me up.

[dandarc]

On a related note, how do you fine folks account for mortgage principal reductions?  Currently I have the full mortgage payment as part of my expenses, and then include the principal reduction as part of my savings.  Seems almost as if I should only include the interest payments on the expense side of things.

And I agree that if you want to count the principal as savings, then only the interest should count as expense. 

In my mind the basic equation is: total income = spending + savings.  I compute income as after tax income + pre-tax savings (401K, traditional IRA, etc.) 

If you count the mortgage principal as both spending and savings, you're double-counting it.  As to whether that part is spending or savings, you can tell from my post above that I think that the entire regular mortgage payment is spending, but also acknowledge that it will stop someday.  My thought process may not be consistent though, as my formula counts anything extra that we send in on top of the minimum payment as savings.

[Franklin]

On a related note, how do you fine folks account for mortgage principal reductions?  Currently I have the full mortgage payment as part of my expenses, and then include the principal reduction as part of my savings.  Seems almost as if I should only include the interest payments on the expense side of things.

When I had a mortgage, I would do a split categorization on each mortgage payment - 1. a transfer from my checking account to my mortgage account (thereby decreasing my principal)  2. a payment of an interest expense 3. a transfer from my checking account to my escrow account.    Then at the end of the year I would true up my escrow account by recording tax and insurance expenses as they became available.

I've explained it much harder than it is when using Quicken. 

[dandarc]

Nice.  Sounds like you do the same type of playing around with this stuff as I do.  I have been on a kick this week to get real precise with what is happening in 2014 down to the dollar.  What got me to re-doing my stuff is that my actual savings, now that I can see pretty much what that number will be at year-end, wasn't footing exactly with what I had for gross income - expenses. 

The most important number is expenses since that projects into the future, but while I'm cleaning up the books I wanted to get the income and savings numbers dialed in to.  Like, for example not counting my payroll deductions as expenses was screwing me up.

Yeah - I've thought about getting more precise, but here's my reasoning as to why I'm not worrying about what we're paying today on some of those paycheck deductions.  Basically, what they cost today does not correlate in any meaningful way to what they will cost us once retired.  Your FSA might not fit that bill, because presumably you are actually spending that money, but I'll use health insurance as an example.

Right now, we are paying 180 / month for health insurance.  Seems like a good deal.  My wife is currently in consideration for a promotion that will change her employment class to one where we would only pay 30 / month for exactly the same insurance.  I've gotten some quotes on Obamacare, because I like to think a decade in advance apparently - if we were to retire today, we could get the cheapest insurance unsubsidized for about $440 / month (that very first year of retirement might be rough).  However, if we were retired the whole year and managed our income right, we could get much better insurance for $5 / month or less after the subsidy.  I really have no idea what that aspect of our retirement budget will look like -and I suspect the health insurance market itself will look a lot different in 10 years (seriously - we would have over a million dollar net worth, and yet we can get essentially free health insurance?  I bet that changes someday.).

On top of that, we have expenses that will go away once FI - life and disability insurance will no longer be needed, for example, so even if our health insurance is not a nominal amount, we have some things that will off-set it already built in.  Once we get much closer, we'll probably focus on getting a more precise feel for post-retirement spending.  As you can tell, I suspect that it won't be that different from pre-retirement spending, if we do a good job of managing the situation.

[dandarc]

But yeah, getting your books to balance is a totally different goal than what I'm referring to - apparently I feel a need to defend myself for not accounting down to the penny for every aspect of our lives.  Self-awareness face-punch for me.

[Cheddar Stacker]

I don't really calculate savings rate. I "budgeted" for around a 50-60% savings rate in December/January. I think we're close to 50%, but there are many things up in the air. As dandarc said I'm more concerned with creating enough passive income to support the retirement expenses. I track Net Worth regularly, and I track expenses, and I want my savings rate to be as high as possible, but I don't fuss over the details. But to answer your question Moose:

Principal = Savings
Interest = Expense
PMI = Expense
Escrow = Transfer/Expense. You can make an argument for either. I used to count it as expense since it ends up there anyway. I just cancelled my escrow a couple months back, so now I have a lower payment and the tax & insurance payments will obviously just be an expense.

If you use mint split the mortgage payment into expenses and principal. Then tag the principal as debt reduction. Then hide that tag when analyzing expenses/net income.