Stop Forgetting These Essential Items From Your Budget
Do you use a budget for your household expenses every month?
If you do, congratulations! You are on your way to a more financially secure future. If not, check out my beginners guide to budgeting.
There are items in a budget that seems to never be included when you look at normal family budgets: savings and taxes. These are often overlooked because people don’t see them. Taxes come out before you ever get your money and savings is just whatever is left over at the end of the month once everything is spent. Giving these items more priority will lead you down the path towards financial freedom.
These items are essential for wealth building and to have a total view of your finances.
Let’s go through why these items are essential to your budget.
Savings Are #1
Save first, spend second. Your future self will thank you.
The top item in your budget should be the amount that you desire to save each month. This could be $100, $500, $1000, or whatever you feel comfortable with, but it needs to be given the highest priority. Nothing matters more than your personal well-being, so pay yourself first and then move on with your budget.
In a normal budget, savings is the leftover.
Income – Expenses = Savings
However, you should rearrange it like this:
Income – Savings – Expenses = 0
With this rearrangement of the equation, we now see that income is obviously important. You should not spend any money or save any money if you have $0 income. In order for this to hold true, with $0 income, you should have $0 savings and $0 expenses. Obviously, this is not possible. There are recurring expenses for food, shelter, utilities, insurance etc, that you cannot get out of, but when income is $0 you are in the red (negative growth).
Second here is savings. It is your first expense and is broken out of expenses because you are not spending it, but investing it in your future self. Your savings should be prioritized generally like this if possible:
- $1000-$5000 emergency fund
- pre-tax retirement accounts (401k, then Traditional/Roth IRA, then HSA)
- regular brokerage accounts (save here for a house down payment, vacations etc.)
In this order, you are prioritizing your future self and making him the happiest possible.
Prioritize savings first before expenses and you will be happier as savings will become natural. Automate it with direct deposit to your destination accounts and it is completely hands off. This way you don’t even have to think about fulfilling your budget savings allocation as it was completed without you!
Include Taxes In Your Budget
Most people only include their after-tax income in their budget, so they do not even see how much they pay in taxes. I would argue that taxes are definitely something that needs to be included in your budget so that you are aware of how much money is headed off to the government.
There are 2 certainties in life, death and taxes. ~Benjamin Franklin
Our 3rd US president was correct when he stated these certainties. There really is no way to reasonably and legally avoid them forever. Of course, if you are a financial ninja then you can bring your federal income tax down to $0 and pay nothing in tax there, but you will end up paying sales tax, property tax, and miscellaneous others. We should strive to prolong our healthy life and work to minimize our taxes.
Including taxes on your budget means you need to use your before-tax income. Using the before-tax income increases your awareness of the true cost of taxes. It will motivate you to take a closer look at your taxes and see if there is any way for you to minimize them.
I developed a tax liability calculator to help me project future taxes based on expected pre-tax savings, income levels, and tax brackets. It was developed using Form 1040, so it is based purely on the US tax code for individuals or couples.
My personal win with this calculator was to get my tax withholding lowered from $600 per month to $350 per month for federal taxes and my state taxes to be lowered from $250 to $175, for a total decrease of $325 per month. This is all money that was mine anyway, I just get it every month instead of one lump sum at the end of the year as a tax return from Uncle Sam. Throughout the year, I saved $3,900 in taxes!
Having a tax withholding greater than your tax liability is the same as giving a 0% loan to the government for the year! The only people I would give a 0% loan to is close family that I completely trust.
You can put your money to better use paying your future self in savings today than Uncle Sam will.
Side Income Taxes
If you are on the path towards financial freedom with side income, then you will need to pay extra attention to taxes in your budget. Having side income you are required to make quarterly estimated tax payments to the federal government and applicable state governments. If you pay too little, then they will come back at the end of the year and fine you.
You should budget each month a portion of your side income towards the tax liability that you will incur on it. The side income tax is higher than your normal tax rate because you have to pay both the personal and employer portions of social security and Medicare, which are 6.2% and 1.45%, respectively. This sums up for a total tax liability of 15.3% before normal income tax.
Having side income is great to propel you towards financial freedom, but be prepared for the extra tax accompanied with it by including it in your budget.
Conclusion
When creating your budget with these 2 seldom used items in it, the equation becomes:
Income – Taxes – Savings – Expenses = 0
You want to:
- Maximize Income
- Minimize Taxes
- Maximize Savings
- Minimize Expenses
When we follow these simple steps, we are treating our future self with the respect that he deserves. We are prioritizing our future happiness and preparing for a long life of freedom. Prepare your budget with taxes and savings included and you are set up for success.
Note: This article originally appeared at Atypical Life.
Category: Personal Finance
