Many people realize that living beyond their means doesn’t work. If your job were taken away, you would be in bad financial shape. It is important to save some of your money in an emergency fund. After the economy took a downturn in 2008, credit card companies cut spending limits and raised interest rates. It also is more difficult now to get a loan, unless you have superior credit. One way to figure out how much income should go to living expenses is the 50/30/20 plan.
In computing your 50/30/20 plan, use the figure for your after-tax income. After-tax income is your gross income minus income tax, Social Security tax, Medicare tax, and -- if applicable -- state income tax, city or other local tax. Add back in 401k contributions, health insurance premiums and union dues. Fifty percent of your after-tax income should go to what Liz Pulliam Weston of MSN Money calls “must-haves.”
Must-Haves and the Rest
Must-haves are expenses that you must pay monthly. Typically, these are rent or mortgage, food, utilities, transportation expense, child care, insurance and loan payments. You must pay these expenses each month or suffer penalties. Your must-have expenses can change. For example, once you have paid off credit card debt or a loan, you have cut your must-have expense.
Thirty percent of your after-tax income can go to “wants.” Wants are items that you want but are not essential living expenses, such as eating out, buying new clothes, taking vacations and pay television.
The final 20 percent of your after-tax income should go to debt repayment and savings. Any debt repayments beyond the minimum required, and any money you save, go in this category.
When you crunch the numbers, you might find that your must-haves are significantly more than 50 percent of your after-tax income. This does not mean you should scrap the plan; it means that you have a goal to work toward. Analyze each must-have expense to determine whether you can trim it.
If your car payments are a large part of this equation, you could sell your car and get a less expensive model, or you could switch to public transportation or carpooling. If you buy ready-to-eat food, try cooking from scratch to save money. You can cut your utility bill by not running the air conditioner on high all day, and by turning down the heat and wearing a sweater. Determine whether you could cancel any insurance policies or raise your deductibles.
About Housing Costs
Because housing is usually a person’s largest monthly expense, you should pay particular attention to how much of your income goes to that. Many people strive to buy or rent the most expensive place they can afford. They then set the rest of their budget accordingly. If you do that, you might not be putting enough money into savings. You would essentially be using your retirement money to live in a more expensive dwelling, according to Walter Updegrave in CNN Money.