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Introduction

Formulate a Financial Plan

Know Your Net Worth

Manage & Minimize Debt

Accumulate Assets

Budget to Live Within Your Means

Understand Investing Basics

Plan for Retirement

Insure People & Property

Deal with Financial Advisors

Review Your Employment Contract

Make Plans for Your Estate

Make Good Decisions

Conclusion

A problem many households have is that they’re not sure how much net income or “profit” they generate in a given month or year, which in turn suggests they don’t know whether they’re living within their means. The best way to accurately track your income, expenditures, and net income is by maintaining a household budget.

A budget is a tool for tracking income and expenditures over some specified period of time, for example, over a month or a year. Tracking how much money you receive (income) versus how much you pay (expenditures), allows you to estimate whether you have any money left over (for saving or investing) or whether you need to borrow to make ends meet (use credit cards, get a bank loan, or borrow from family). If you’re constantly borrowing—you’re over-extended! You’ve got to make some changes to ensure you’re living within your means. Usually, this requires cutting down on expenses.        

Figure 7 provides a generic annual budget. For your convenience, samples and templates are available at PillarsOfWealth.com. Feel free to download these and amend them to match your circumstances, including whether you have a family, dependents, own a home, etc.

I strongly urge you to create a household budget. It’s not just about the final product. Much of the benefit comes from going through the process: communicating clearly with your partner or spouse, identifying all income and expenses, discussing the necessity of each item, and cutting back wherever possible.

 

Figure 7: Generic Annual Budget

 

Budget Item

Dollar Amount

INCOME SOURCES

 

  Salary (W-2 Income)

 $      200,000

  Bonus (if applicable)

 $              -  

  Profit sharing revenue/Partnership income

 $              -  

  Moonlighting income

 $              -  

  Child Support/alimony received 

 $              -  

  Gifts/loans from family

 $              -  

  Dividends, interest, capital gains 

 $              -  

  Rental property income 

 $              -  

  Other 

 $              -  

TOTAL INCOME

 $     200,000

 

 

PAYROLL DEDUCTIONS FROM INCOME

 

  All taxes *

 $       45,649

  Social Security and Medicare

 $       11,140

  401(k) or 403(b) contributions

 $       19,000

  Health insurance plan

 $         3,000

  Health FSA

 $         2,000

  Other 

 

TOTAL PAYROLL DEDUCTIONS FROM INCOME

 $       80,789

 

 

INCOME AFTER DEDUCTIONS

 

  = Total Income minus Payroll Deductions

 $      119,211

 

 

EXPENDITURES

 

  Rent/mortgage payments

 $       15,600

  Student debt payments

 $       24,000

  Child support/alimony paid 

 $              -  

  Association or condo fees

 $              -  

  Utilities (gas, electric, water, sewer, trash)

 $         2,550

  Internet/cable/satellite

 $         1,680

  All phones

 $         1,440

  Food  

 $       18,000

  Clothing  

 $         4,000

  Day care costs

 $              -  

  Private school tuition

 $              -  

  Personal care/medical expenses 

 $         3,000

  Car payments

 $         6,000

  Car maintenance (repairs/oil changes)

 $         1,200

  Commuting costs (parking/fuel/tolls)

 $         2,040

  House maintenance

 $         2,000

  Insurance - auto (2 drivers)

 $         1,200

  Insurance - life (term, 2 adults)

 $         1,800

  Insurance - home

 $         1,000

  Insurance - umbrella

 $            300

  Insurance - LT disability (1 plan)

 $         3,600

  Charitable contributions

 $         2,000

  Continuing Medical Education

 $         1,000

  Travel, dining out, entertainment

 $         6,000

  Moving expenses

 $              -  

  Wedding expenses

 $              -  

  Estate planning attorney

 $              -  

  529 for children

 $         5,000

  Costs of starting up a new practice

 $              -  

  Property taxes

 $         4,500

Accountant fees

 $            800

  Other 

 $              -  

TOTAL EXPENDITURES

 $      108,710

 

 

NET INCOME

 

  = Total Income minus Expenditures

 $        10,501

* taxes computed using https://smartasset.com/taxes/income-taxes

 

Income

Make sure you include income from all sources. Although ultimately you will sum up all sources of income to yield a single total income number, it’s useful to distinguish between active, passive, and portfolio income sources.

Active income refers to regular compensation including wages/salary, employment cash bonuses, tips, and commissions. Moonlighting income falls under the category of active income because you are actively performing a medical service during your moonlighting hours.

Passive income is derived from activities in which you are not actively involved. These may include managing a rental property, book royalties, or income from online courses you’ve created outside of your regular job.

Portfolio income comes from investments and includes dividends and interest earned.

Income type distinctions are relevant because different income sources may be subject to different tax treatment. For example, losses in passive income generally can’t be deducted from active or portfolio income.

If you participate in a significant (or material) way in generation of income, it’s more likely to be viewed as active, allowing you to offset losses from that activity against your other active income, and ultimately reducing your tax bill. Rental property income is generally viewed as passive, regardless of whether you participate significantly, unless you are a real estate professional. Material participation is a formal IRS designation of active participation, and is permitted only under strict rules. Figure 7 assumes you only have active wage income.

 

Expenses

As you are undoubtedly aware, households face a multitude of expenses. These include, but are not limited to: housing (rent or mortgage, real estate taxes, property insurance, utilities), children (clothing, school books and/or uniforms, computers, toys, phones, school supplies, tuition, daycare), transportation (car payments, auto insurance, maintenance, gasoline, bus/train tickets), personal grooming, food, entertainment, hobbies, etc.

Some expenses are recurring, that is, they occur again and again. For example, mortgage and car payments recur monthly. Other expenses are non-recurring: they happen once. For example, purchase of a bicycle.

It can be useful to identify those expenses that are discretionary (i.e., optional). These are the first ones you should cut back if you find yourself over-extended. Typical examples are expenses in the entertainment or leisure category, including travel and dining out.     

 

Budget Instructions

The first step is to maintain good records. Your pay stub(s) will list your income and sometimes a few deductibles or expenses. Receipts, bank, and credit card statements will help you identify other expenses.

Develop a habit of saving all transaction records. When asked by a vendor if you need a receipt—always say yes. Then put all the receipts in one place. You or your accountant can sort through them later. If the IRS decides to challenge your accounting choices, it’s crucial to have receipts backing up your tax filings.

You can create a monthly budget, but an annual time frame ensures you capture expenses that occur only once or twice a year. Make sure all the figures are annual equivalents. For example, if you have a monthly car payment, multiply it by 12 for the annual budget.

Enter gross salary under Income, and the various tax, Social Security (OAS), Medicare, and other deductions under the appropriate headings. This information should be shown on your pay stubs.

This approach assumes that the state and federal taxes deducted from your paycheck are the correct amounts you owe in a given year. Your paycheck deductions depend on choices you make on IRS Form W-4, and are impacted by your filing status, marital status, and number of dependents.

When you actually file your taxes, you may end up owing more than the amounts deducted from your paycheck. To ensure your budget accurately reflects all taxes for that budget year, add those additional taxes payable to the respective tax line items in your budget. Similarly, if in a given tax year you receive a tax refund, reduce the tax entries in your budget to reflect the correct annual totals actually paid.

An alternative is to ignore the income tax amounts deducted from your paycheck and instead to use tax tables to estimate your budgeted tax expenses for that year. Tax tables are available at the IRS website or through many other online sources.

Regardless of which approach you use, once your household settles into a pattern it becomes easier to refine the numbers based on prior years’ data.

Next, input and sum all Other Expenses. The difference between Total Income and Total Expenses is known as Net Income. If Net Income is negative, then instead of saving, you are over-extended and must borrow or tap your existing savings to cover your costs.

A budget usually tells you how much you earned and spent over the last year (or month). If you want a future budget forecast, you can use projected or estimated earnings and expense numbers. Such projections help you plan for major (or minor) life changes, such as purchase of a new home with a higher mortgage, costs associated with starting a family, or acceptance of a new job with higher income.

 

Related Links:

 

Cost to Raise a Child

SmartAsset.com income tax calculator

Neuvoo income tax calculator

Taxfoundation.org, an independent nonprofit tax policy group


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