1. Advanced Budget-Cutting Strategies: Introduction
  2. Budget Tips: Plan for What You Really Make
  3. Budgeting Tips for Essential Fixed Spending
  4. Budgeting for Essential Variable Expenses
  5. Budgeting for Nice-to-Have Expenses
  6. A Budget That Changes as You Do

To plan for the short and long term, you’ll need a basic understanding of your finances. In this section, we’ll give you the kick-start you need to take the budgeting process to the next level and make it truly targeted to your needs and goals.

Know Your After-Tax Monthly Income

You know your wage or salary, but do you know off the top of your head how much you take home after taxes and benefits (payroll deductions for health insurance, retirement contributions and the like) or how this number is calculated? It’s important to know, because these items significantly reduce your paycheck and affect how much money you have to work with each month.

The easiest and more accurate way to find this number is to look at your last pay stub, but if you don’t have one handy, you can calculate your take-home pay using an online paycheck calculator. Or, if you want to understand the formula that the Internal Revenue Service (IRS) uses, check out the federal tax rate schedules.

A comprehensive understanding of taxes isn’t necessary to keep a good budget, but if you’re curious, here’s how income tax works:

Let’s suppose you’re filing as a single person and your salary is $60,000 a year. You’ll use the following tax table to calculate your income tax.

Single Income Tax Brackets and Rates, 2017

Rate

Taxable Income

Tax Owed

10%

$0 to $9,325

10% of Taxable Income

15%

$9,325 to $37,950

$932.50 plus 15% of the excess over $9325

25%

$37,950 to $91,900

$5,226.25 plus 25% of the excess over $37,950

28%

$91,900 to $191,650

$18,713.75 plus 28% of the excess over $91,900

33%

$191,650 to $416,700

$46,643.75 plus 33% of the excess over $191,650

35%

$416,700 to $418,400

$120,910.25 plus 35% of the excess over $416,700

39.60%

$418,400+

$121,505.25 plus 39.6% of the excess over $418,400

Source: Tax Foundation

According to the IRS 2017 federal tax rate schedules, with a $60,000 taxable income, your marginal tax rate is 25%. In this scenario, your first $9,325 is taxed at 10%, the next $28,625 is taxed at 15% and the remaining $22,050 is taxed at 25%. Your entire income is not taxed at 25%, as many people mistakenly believe. The federal tax you owe is $5,226.25 plus 25% of $22,050 ($5,512.50), or $10,738,75.

The new tax bill will likely change the numbers for you, but the principle of working what you'll owe in taxes into your budget remains the same.

On top of these federal taxes, you’ll also pay Social Security at a rate of 6.2% ($3,720) and Medicare at a rate of 1.45% ($870), along with any state or local taxes. (If you're self-employed, double these numbers, though some may come back as a tax deduction.)

Your annual $60,000 taxable income is therefore reduced by $10,738.75 in federal income tax plus $3,720 in Social Security tax and $870 in Medicare taxes, for a total tax liability of $15,328.75. That leaves you with an annual, after-tax income of $44,671.25, or $3,722.60 per month. (Learn more in Tax Withholding: Good For Government, Bad For Taxpayers.)

Note that to have a taxable income of $60,000, you’ll need to have a salary higher than that. Single tax filers for 2017 get a personal exemption of $4,050 and a standard deduction of $6,350.

If your employer deducts health insurance premiums or 401(k) contributions from your paycheck, your take-home pay will differ; those two expenses are taken out of your pre-tax income and reduce your income tax liability.

Make Sure Your Necessities Fall Within After-Tax Income

Once you know how much money you bring home each month, start by listing all of your necessary expenses, like rent and utilities, and making sure their total cost is less than your take-home pay. If it isn’t, can you cut back somehow? Housing expenses take up the largest chunk of most people’s budgets, so that’s the best place to think about reducing your expenses if you’re having trouble making ends meet.

Adding a roommate or moving out of your own place to live with your parents or rent a room from someone else aren’t ideal, but the benefit of improving your finances may be worth the trade-off. A different, less-expensive living situation might even have unexpected benefits like a new friendship or the ability to save even more by sharing groceries, utility bills and household chores.

If you absolutely can’t reduce the cost of your necessities, it’s time to figure out how to earn more, which may involve both a short-term strategy such as starting a side hustle or getting a second job and a long-term strategy like furthering your education or starting a business. (To learn more, read 3 Freelance Gigs to Help You Earn More.)

Taking this step can be difficult psychologically and practically if you’ve been feeling stuck, if you’re already exhausted from work and personal responsibilities, if you don’t have the money to pay for school or if you have a disability that adds extra challenges to your life. In these situations, finding a new source of emotional support or life support like a mentor, coach or social group of people who share your circumstances and a desire to improve them might be the real first step you need to take to improve your finances. Also consider short-term strategies to increase your income, such getting a temporary or seasonal job or selling possessions you no longer use. (For ideas, see Increase Your Disposable Income and Start a Side Gig for Extra Cash and Fulfillment.)

Next, start counting savings as a necessity. This mindset will make you more likely to save because you’ll think of saving as a necessary “expense” rather than an optional thing you do if you have money left over at the end of the month. As the saying goes, “pay yourself first.” Saving regularly will allow you to accumulate emergency savings, which helps keep you from going into debt when an unexpected expense comes up. It will also allow you to save for retirement and other major life goals. Even if you don’t have much to save right now, opening a savings account or designating a jar in your house to put a few dollars into each month can get you going in the right direction. (Learn more in Why You Absolutely Need an Emergency Fund.)

Leave Room for Occasional Expenses

Necessary expenses like car insurance and visits to the doctor may not be monthly charges for you, but rather expenses you pay only once or twice a year. Nonetheless, you have to pay them, and you know they’re coming, so don’t forget to factor them into your necessities. One way to do this is to make a list of all your expenses that only occur a few times a year, add up their total cost, divide by 12, and add the result to your required monthly savings. This will ensure that you have enough cash on hand to pay these bills when they are due.

Discretionary expenses like gym memberships, vacations and gifts are not required and they may not occur every month or be the same amount each month. If you want to be able to afford them, you should also make a list of all optional expenses that only occur a few times a year, add up their total cost, divide that sum by 12 and add the result to your monthly savings. This way, you won’t be tempted to go into debt, nor will you have to deny yourself  these items – unless you see that you can’t afford them, in which case you’ll have to decide what you’re willing to cut out.

Calculate Long-Term Costs for Necessities and Nice-to-Haves

Here’s where you can play a mental game with yourself to look for more ways to save money. To figure out whether your spending in a certain category is really worth it to you, think of it in terms of a yearly rather than monthly cost. Maybe $1,700 a month for rent seems like an acceptable price, but how about $20,400 a year? And that’s after tax; if your marginal tax rate is 25%, you have to earn $27,200 before tax to afford that apartment. Similarly, $300 a month for lunch with coworkers might sound reasonable, but is that how you want to spend $3,600 a year, especially if you’re coming up short in other budget categories that are more important to you and you’re struggling to save enough for retirement? If an expense is worth it to you and you can afford it, that’s fine. It’s your money and you can spend it however you like. But sometimes looking at the big picture gives you a different perspective.

With the next chapter, we’ll start three sections of detailed budget-cutting tips for essential expenses (regular and occasional), plus how to afford some of those nice-to-haves.


Budgeting Tips for Essential Fixed Spending
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