Many of us consider our tax bracket as a measure of success and use that number to mentally estimate the amount of taxes that we pay. A much better estimate comes from knowing your effective tax rate, which is rather simple to compute.

Before getting into how to calculate your effective tax rate, let’s review why your rate is not equal to your tax bracket. The simple reason is that the progressive tax rates in the United States apply only the taxable income that falls within each tax bracket. An example using the 2008 tax rates shows how this works. A single filer with $30,000 of taxable income would fall into the 15% bracket. The next lowest bracket, 10%, covers all income up to $8,025. Rather than having to pay 15% on the full $30,000, the taxpayer would pay 10% on the first $8,025 and then 15% on the rest (30,000-8,025=$21,975).

One of the nice features of this system is that you will always take home more pay after getting a raise. If you had to pay the percentage of your tax bracket on all taxable income, then going to a higher tax bracket would dramatically reduce your take-home pay. Earning $8,025 would result in a tax bill of $802.50 (10%), leaving $7,222.50, while earning $8,026 would result in a tax bill of $1,203.90 (15%), leaving only $6,822.10. By charging the bracket rate on only that income which falls into the bracket, this ugly situation is avoided.

Other factors that influence your effective tax rate include state and local taxes as well as any refund received or tax due. To calculate your effective tax rate, add up all of the taxes you’ve paid throughout the year. Be sure to add in any taxes due when you file your taxes for the year or subtract any refund that you receive. Dividing the total tax paid by your taxable income gives you your effective tax rate, which should be lower than your tax bracket.

Your tax bracket number is still important, since it is the percentage of additional income that will be taken out in federal taxes. It should therefore be used when deciding whether or not taking on extra work is worth it. Still, your effective tax rate gives you a better idea of the more pressing question most of us consider: “How much of my income gets taken away through taxes?”

What is your effective tax rate?

So you’re planning a relatively large expense – a bicycle, a plasma TV, or even something larger like a car or a major home improvement. But the problem is that you already have other bills to pay, and there’s never enough money left at the end of the month for that purchase you have your eye on. So what can you do?

First, if you don’t already have a personal expense plan, make one for yourself. Create a monthly budget that shows your income, your expenses and bills, and a realistic amount for necessities like groceries and gas. What’s left over is your discretionary spending.

Second, open up a high-yield savings account. There’s no fee for these accounts at ING, for example, and they offer much higher interest rates than a savings account at your local bank. My ING accounts typically earn 4% interest, though since the start of the financial crisis it’s been more like 2.2%.

Third, and this is crucial, pay yourself first. It’s one of the hallmarks of personal finance wisdom. Essentially, set a part of your discretionary funds aside at the beginning of the month, right after you’ve gotten your paycheck, to save towards your goals. There’s a great post on this method here. By setting that money aside right away, you make your personal savings goals a priority over everything else, you get a psychological advantage of never seeing that money in your checking account, and you get to watch your savings grow steadily with each month. Plus, ING lets you open up multiple sub-accounts, which you can name and automatically divide your savings between them, so that you can open up a different sub-account for each savings goal.

For example: say you have $100 to save each month and you want to save $400 for a new bicycle and $1,200 for a computer. With 3% interest, if you save $30 towards the bicycle and $70 towards the computer, you can afford the bicycle in just over 13 months, and the computer in 17 months. And you’ll have earned an extra $30 in interest in that amount of time.
What strategies for saving towards a big-ticket item have worked for you?

It’s easy to allow yourself to become content with an emergency fund towards the low end of the recommended 3-6 months’ worth of expenses, but in times like these, increasing your fund to the higher end of that range may be more prudent. A number of factors contribute to this rationale.

First, the main reason many of us need to use our emergency fund is the loss of a job. With unemployment on the rise, the likelihood of job loss is greater. What’s more, with so many people out of work it will likely take longer for you to find a suitable replacement job. You may even need to settle for a lower paying job. Both scenarios, a longer period of unemployment and lower future income, would benefit from a better-funded emergency fund.

Second, alternative investments look less attractive at the moment. It’s hard to fund your emergency fund when you could be making massive gains in the stock market or investment real estate. With such alternatives sustaining heavy losses of late, many people are wondering where to park their money. Increasing your emergency fund won’t result in large gains, but it shouldn’t suffer any losses either.

Lastly, the slow economy has increased everyone’s money consciousness. Joining the crowd and trying to save money now, even if you don’t feel that you need to, may be easier than ever. Discounts on products and services, intended to aid ailing consumers, can be used for your benefit as well.

When difficult times hit others but not you, it can seem as though maintaining the status quo will allow your relative good fortune to continue. In reality, this situation is a warning to prepare for the possibility that you too may soon face financial difficulty. Now is an excellent time to increase your emergency fund and a decision that may seem very smart should those funds be needed in the near future.

How long would your emergency fund last?

Along with other tasks that naturally tend to be addressed towards the start of a new year, many people evaluate and rebalance their retirement accounts. The horrible performance of the stock market over the past year makes rebalancing particularly important this year.

The traditional rule of thumb for stock/bond asset allocations within retirement accounts was 100 minus your age for stocks. So a 40-year-old would have 100-40 = 60% in stocks and 40% in bonds or fixed income securities. The desire to retire at the same age (or earlier) despite rising life expectancies has caused the rule of thumb to be adjusted. 120 is now the accepted number to use instead of 100. So a 40-year-old would have 120-40 = 80% in stocks.

That number (which is only a general guideline) is easy to understand in terms of new purchases within retirement accounts, but also comes into play with rebalancing. After a particularly volatile year, good or bad, your existing holdings are probably misaligned. Let’s assume that you started last year at your target of 80% stocks and 20% bonds. If your stock choices performed similar to the Dow Jones Industrial Average (which was down -33.8%) and your bonds held steady, your balance would be about 72.5% stocks and 27.5% bonds. To rebalance, you’d transfer some of your bond holdings into stocks to get back to your desired 80/20 split. A similar approach is necessary in years with very good stock performance except that you’d be transferring from stocks to bonds to achieve your rebalance.

An alternative option is to use a lifecycle (also known as target retirement) fund. These funds determine the optimal stock/bond allocation based on your expected retirement age and invest accordingly. They periodically rebalance to maintain the desired mix. What you gain in convenience you give up in control, but these types of funds are appropriate for certain investors.

However you decide to implement your goals within your retirement accounts, it’s important to remember that the performance of your choices often causes your holdings to shift from the desired mix of stocks and bonds. Reviewing and rebalancing your holdings, as appropriate, will ensure that you stay on track. This task becomes even more important after very good or bad periods of performance, such as the one we’ve recently endured.

Have you rebalanced your retirement accounts as a result of the recent market declines?

We all know that bills should be paid on time. The consequences of a late payment, particularly for credit cards, can be extremely expensive. The amount of time required to ensure that your payment arrives before its due date depends on the method of payment you choose to use.

Gone are the days when writing a check for your bills was the only method of payment available. Now, you can pay online through a variety of methods, as well as over the phone in many cases.

There are three basic types of bank-initiated online payments and two types of online payments initiated by service providers. All have their advantages and disadvantages and take varying amounts of time to arrive.

Bank-Initiated Payments

These types of online payments are configured through your bank account. After the initial effort to setup the bills to be paid, payments can be made very easily.

Electronic One-Time Payment
This method allows you to pay a specific amount for a specific bill. When it’s time to pay your bill, you login and enter the payment details. The funds are withdrawn from your account and arrive within a few days. You need to remember to schedule this payment each month and ensure you do it early enough that the money will arrive in time.

Electronic Automated Payment
For bills that have the same due date and amount each month, you can have your bank automatically transfer the money in time. It will still take a few days for the money to arrive, but you won’t have to remember to initiate the transfer. You can schedule it with plenty of time to spare to ensure that the money arrives promptly.

Manual Payment
Some banks will write checks and mail payments on your behalf. They typically even cover the postage to mail the payment to your service provider. This method takes the longest because of processing time on your bank’s end as well as delivery time, so be sure to schedule such payments well in advance of your bill’s due date. The advantage of this method is that you can pay for things that don’t offer online bill payment. You can even pay a friend or babysitter online through this method.

Service Provider Payments

The alternative to paying through your bank online is going directly to the service provider’s website. The disadvantage is that you won’t be able to pay all of your bills from a central location and will have to maintain many different accounts. The advantage is that payments process very quickly, often the same day.

Electronic One-Time Payment
Using a one-time payment, you can pay for a specific bill as it becomes due. You may be able to pay with a credit card or checking account and can usually pay as late as the due date without incurring a late payment fee.

Electronic Automated Payment
The other service provider payment type is an automatic payment. The service provider will charge your bank account (credit or checking) the full amount due on or before the due date. This is the most convenient method, but removes the step of checking bills for errors before payment is made. For bills that are always the same amount, this method can work well.

Obviously, you can also pay a bill by check yourself. You’ll need to plan ahead for the time the check will spend in the mail to ensure that it arrives in time to avoid a late fee.

With various levels of interaction and convenience, you have many bill payment options available. Depending on which method you choose, you can pay as late as the due date or may need to plan 10 or more days ahead to ensure that your payment arrives promptly. Doing so will guarantee that late fees are one expense that you’ll never have to experience.

Which bill payment methods do you use? How early do you submit payments?