Personal Finance Essentials and Tax Basics
Essential Personal Finance Definitions
Core Financial Terms
- Needs – Something you cannot survive without.
- Fixed Expense – Money spent on something that remains about the same amount each month.
- Wants – Something that you desire.
- Variable Expense – An expense that fluctuates from month to month.
- Short Term – A period of up to six months.
- Risk – Taking a chance on losing all or part of something.
- Debit Card – A card that looks like a credit card, but the money is deducted directly from a checking account when a purchase is made.
- Credit Card – Allows a cardholder to use funds from a company up to a certain limit with specific rules for repayment.
- Bank Reconciliation – A process that explains the difference between what the account holder’s records show and what the bank statement shows.
- SMART Goals – A popular acronym used to describe the specific, measurable, achievable, relevant, and time-bound goal-setting process.
- IRS – The Internal Revenue Service, the U.S. federal government agency that collects taxes and enforces tax law.
- PYF (Pay Yourself First) – The concept of paying into your savings first and then living on the remainder of your take-home pay.
- C.D. (Certificate of Deposit) – A low-risk and low-return investment that usually pays a higher interest rate than a traditional savings account.
- Form W-2 – A form that reports an employee’s annual wages and the amount of taxes withheld from his or her paycheck.
- Form W-4 – A form specifying the number of allowances in an employee’s withholding allowance certificate.
- 1040-EZ – A simplified form used to submit your income tax return.
- Form I-9 – A tax form used to verify the identity and employment authorization of individuals hired for employment in the United States.
- Gross Income – The total amount of money you earn before any payroll deductions.
- Net Pay – The amount of money that remains after deductions, also known as take-home pay.
- 401(k) – An employer-sponsored retirement plan.
- Compound Interest – Interest earned on the principal and on the accumulated interest earned over time.
- Rule of 72 – A simplified formula to determine the number of years required to double your money at a given interest rate.
- Pay Stub – An attachment to your paycheck that shows the amount earned and details payroll deductions.
- Assets – Items or property that one owns.
- APR (Annual Percentage Rate) – The interest rate on borrowed funds expressed as a percentage for the entire year.
- SEC (Securities and Exchange Commission) – The agency that mandates registering new issues and establishes federal disclosure requirements, often called the “police” of the stock market exchanges.
- Budget – A detailed estimate of income and expenses for a specific period of time.
- Identity Theft – When private information, such as your name or Social Security number, is used without permission to commit fraud.
- Decision-Making Process – The act of choosing between two or more options or courses of action.
- Diversify – Spreading investments across various assets to reduce risk.
Financial Literacy Facts: True or False
- The decision-making process starts with gathering information. — False
- Procrastination is an example of an economic influence on decision-making. — False
- Higher interest rates result in higher costs of borrowing money. — True
- Rising prices causing lower buying power is referred to as an inflation risk. — True
- Interest earned on savings may be referred to as the “time value of money.” — True
- The budgeting process starts with monitoring current spending. — True
- Most short-term goals are based on activities over the next two or three years. — False
- A common long-term goal may involve saving for college for parents of a newborn child. — True
- Rent is considered a fixed expense. — True
- Flexible expenses stay about the same each month. — False
- Once you fill out a Form W-4, it can never be changed. — False
- You should always review your pay stubs for accuracy. — True
- It is unprofessional to do online research to learn more about the person you are having an informational interview with. — False
- Your net pay is always greater than your gross pay. — False
- Net pay is a person’s take-home pay. — True
- One advantage of paying your bills using the online bill pay feature with your checking account is that the company you are paying receives the money on the same day. — False
- A variable expense remains about the same amount each month. — False
- The sooner you begin saving, the more time your money has to grow. — True
- Banks are required by law to cover any customer transactions even if that customer does not have enough money in their account. — False
- The majority of Americans have an emergency fund and sufficient amounts of money saved for retirement. — False
- A person should consider using excess cash to pay down debt. — True
- Simple interest earns more money than compound interest. — False
- A certificate of deposit is a high-risk/high-return investment. — False
- If you have an auto insurance policy and don’t get into a car accident or file any claims for a year, you get your premiums back from the insurance company. — False
- Setting clearly defined goals can give you a vision for your future. — True
- “I will improve my biology grade” is an example of a specific goal. — False
- Planning for retirement is an example of a short-term goal. — False
- If you don’t achieve your goals on the first try, you should give up immediately. — False
- If you graduate on time with good grades and earn a diploma, the federal government will pay most of your loans for you. — False
Key Concepts in Budgeting and Taxes
Budgeting and Financial Goals
The final phase of the budgeting process is to review financial progress.
An example of a long-term goal would be saving for retirement.
A clearly written financial goal would be to establish an emergency fund of $4,000 in 18 months.
An example of a fixed expense is auto insurance.
Entertainment is commonly considered a flexible expense.
The final step of the decision-making process is evaluating the results.
Economic and Tax Principles
Changes in the buying power of the dollar are measured by the Consumer Price Index (CPI).
Consumer spending is likely to rise when interest rates are low.
Investments that may be difficult to convert to cash quickly have a high liquidity risk.
What a person gives up when making a decision is commonly called an opportunity cost.
The three largest categories of federal government spending are Defense, Social Security, and Medicare/Medicaid.
The term “withholding” means how much is being taken out of your paycheck in taxes.
You start paying taxes when you earn more than the minimum income requirement.
Assuming your only income comes from your salary, you must file your tax return by April 15th of the following year, or request an extension by that date.
The form that determines how much money is withheld from your paycheck for federal and state income taxes is the Form W-4.
The paycheck withholding that puts money into a retirement investment fund that you will manage is a 401(k) contribution.
A savings account is best described as an account that pays you interest on money you have put away for later to help your money grow.
Sara’s approximate net pay is $500.
Mortgages and Tax Filing Details
The statement that is true about fixed and adjustable-rate mortgages is: “Adjustable-rate mortgages have a fixed interest rate for a short period, but then the interest rate fluctuates, which can lead to higher or lower interest rates for the homeowner.”
The description that best defines a dependent for tax purposes is A, B, and D only.
The option that is not a way to make a payment to the IRS if you owe $427 is: “Tell the IRS to take out more taxes next year to pay back the $427.”
The step Lucy is responsible for as an employee is completing a Form W-4.
The statement about the Form W-2 that is not true is: “The W-2 includes information about the interest you earned from your investments.”
The option that is not a way to file your taxes is using your stockbroker.
The tax form received in January that reports earnings and taxes withheld from each employer is the Form W-2.
The person who does not have to file a tax return is Max, whose total income was less than the standard deduction for that year.
A benefit of putting your tax refund and part of your paycheck into a Roth IRA is that you are getting a head start on retirement and will benefit from a long period of compounding.
If Marquis does not file taxes in April, nothing will happen immediately, but he will miss out on his potential refund.
The deduction that represents an employee’s contribution to an employer-sponsored retirement plan is 401(k) deductions.
Understanding Savings, Taxes, and Investing
Saving vs. Investing
The difference between saving and investing is that saving is putting money into a safe place, like a savings account, for short-term needs or emergencies, where it earns little interest and has low risk. Investing is using money to buy assets like stocks or bonds with the goal of growing your money over time, though it comes with higher risk.
Tax Deadlines and Withholding
The deadline to file your tax return is usually April 15th of the following year, unless it falls on a weekend or holiday, in which case it is moved to the next business day.
The number of withholdings you claim on your Form W-4 affects how much tax is taken out of your paycheck. If you claim more withholdings, less tax is taken out and you get a larger paycheck but may owe money later. If you claim fewer withholdings, more tax is taken out and you get a smaller paycheck but may receive a refund when you file taxes.
The Power of Compound Interest
It is important to start saving early because your money has more time to grow through compound interest. The earlier you start, the more interest you can earn on both your original savings and the interest it has already earned, which can significantly increase your total savings over time.