Idea$ 2014 - January: Budgeting

Starting this month, the Ruggnotes will be dedicated to one personal financial planning idea each month.  I am calling this Idea$ 2014, with the intention that the idea each month will help readers address a new part of their financial lives.  To begin, January 2014 is dedicated to Budgeting. Almost any financial goal can be achieved by using a budget. Unfortunately, the word "budget" has a negative connotation in our society today. People do not want to be limited or told what to do, especially on how they spend their money. A common response is "I work hard for my money, and I don't need anyone telling me what I can and can't spend it on!"  However, speaking from personal experience , once you buy into the budgeting process and see how rewarding it is to set and achieve financial goals, you will find that a budget is not nearly as limiting as you think.

If you already have a budget, January is a great time to update it for the new year.  If you don't have a budget, I am offering the following thoughts on how to analyze spending and create a budget.  To help, I could think of no better example to use than what I do in my own house, so these ideas are coming straight from my personal experience.

Big picture

The first step is to look at major expenditures throughout the previous year. These would include anything that are not monthly recurring amounts or are large enough dollar-wise to not absorb in a normal month. Some examples are car insurance, property/real estate taxes, or annual memberships. We own a home and cars, so we also consider any large maintenance expenses, such as new tires or tree trimming. Identifying these large expenses and when they will occur can help you develop your monthly budget and how much money you need to have in savings.

Once you have looked at the big picture, it's time to develop the monthly budget.  Here is a picture of the spreadsheet we use:

What is "the budget"?

Before budgeting for monthly expenses, it is important to determine your actual "budget".  In simple terms, your budget each month equals your net take home pay for one month.  You can spend less than that (which is encouraged), but you can't spend more.

Fixed expenses

The first part of your monthly budget should be the fixed expense section. Fixed expenses include anything that is paid on a regular basis, is not discretionary, and the amount is known or can be reasonably estimated. Some examples are mortgage/rent payment, utilities, daycare, etc. Knowing these amounts is vital because they will help you determine how much actual discretionary income you have, because you have to pay these items no matter what. We actually include our monthly savings amounts as fixed expenses to be consistent with the theory of paying ourselves first.

Semi-fixed expenses

The next part of a monthly budget can be called the semi-fixed expense section. This includes expenses that are kind of discretionary, but not completely optional, like groceries and gas for the cars. We know we will have to buy groceries and gas, but by setting a budget we are less likely to make impulse purchases at the grocery store.

Variable expenses

Variable expenses are just that - variable, optional, discretionary. This includes eating out, entertainment, gifts,and a column with the very descriptive title "Other". We budget these categories by taking our monthly take home pay and subtracting fixed expenses and semi-fixed expenses. Whatever is left over we allocate between these categories. One key to this is that both my wife and I have our own columns. Each month we both know we have $xx to spend on whatever we want. This is the money we use to go out to lunch, pay entry fees to run in races, play golf, get manicures or buy clothes.  Setting a reasonable budget for variable expenses, and sticking to that budget, is the key to making your budget work each month.

Net (over) under

At the end of each month, we look to see if we are over or under. This is to say that if our monthly expenses exceed our monthly take home pay, we are over.  If we are over, we try to figure out why and make it up next month. If we are under, we transfer that extra money to our savings or make an extra payment on the house.

Budgeting does not have to be an arduous, time consuming project. A simple spreadsheet works for us. There are also some great tools on the internet. My favorite is Mint, which I was introduced to by a friend of mine a few years ago. Mint pulls in your transactions over the internet and lets you categorize them, and will also guide you through creating a budget. Mint also has an app for smartphones and tablets, so you can see in real time where you stand.

January is a great time to create or update your budget. Using the tips above, you should be able to identify trouble areas in your spending, and set and achieve reasonable goals.

2013 year end planning

Over the next few weeks, this publication will address several topics related to year end tax planning. With Thanksgiving coming next week, it is time for business and individual taxpayers to get their financial houses in order for the end of the year. Topics to be addressed include the following:

• New tax rates for 2013, including new capital gains rates and the Medicare surtax
• Alternative minimum tax
• Incentive stock options
• Capital gains harvesting
• Retirement contributions and other year end expenditures
• Depreciation allowances for businesses
• Considerations for cash vs. accrual basis taxpayers

If you have other topics you would like see addressed, please comment on this post or contact me below.

[contact-form][contact-field label='Name' type='name' required='1'/][contact-field label='Email' type='email' required='1'/][contact-field label='Comment' type='textarea' required='1'/][/contact-form]

Give yourself a raise

With Halloween having come and gone and stores now ramping up to sell Thanksgiving turkeys and other holiday treats, 2013 is quickly drawing to a close.  This brings colder weather and the inevitable task of raking leaves, but it also presents an opportunity to take a moment and analyze employment benefits, spending for the year, and a budget for 2014. I am joining a group of financial writers to encourage people to increase their savings in 2014 by 1%.  One of the easiest ways to increase savings is through a retirement account, the most common of which I have discussed previously.  The related benefits to increased savings can be demonstrated using the grade school theory of the "5 W's".

WHO needs to increase their savings by 1%?

Anyone that wants to retire or anyone that pays taxes.  Everyone has an idea of what they want to do in retirement.  Whether they want to travel the country in an RV, play golf everyday, or move to Italy, all of those activities require money.  Since it is rare for people to work and earn an income in retirement, those dreams require a nest egg to become a reality.  Employees that participate in a 401(k) plan or similar arrangement can enjoy tax benefits by increasing their retirement contributions.  Contributions are not included in taxable income, so for a taxpayer in the 25% tax bracket, every dollar contributed saves approximately 25 cents in taxes.

WHAT money should be used to increase savings by 1%?

This is the biggest challenge for most people trying to increase savings.  "I want to save more, but I also want to keep my subscription to HBO!"  Instead of looking at the savings goal in total, break it down into monthly or weekly amounts.  A goal to increase savings by $1,000 for a year is only $83/month and $19/week.  That equates to not eating lunch out 2 days a week, one less round of golf a month, or no more lattes on the way to work.  Taxpayers that typically receive a refund on their taxes can also consider adjusting their withholdings in order to keep more of that money during the year.  By decreasing tax withholdings and increasing retirement contributions by an equal amount, the taxpayers net take-home pay does not change.  But, the taxpayer will not receive a large refund on their tax return, and that money will have been saved towards retirement.

WHERE should savings be increased by 1%?

As discussed above, a qualified retirement plan offered through an employer is the easiest place to start.  If that's not available, a Traditional or Roth IRA can accomplish similar objectives.  There are also a variety of options available for the self-employed.  IRA accounts can be opened at almost any brokerage such as Vanguard, Fidelity, or TD Ameritrade.

WHEN should savings be increased by 1%?

As soon as the opportunity presents itself.  Several large employers use November and December as "benefits season", giving their employees the opportunity to adjust their benefits, including retirement plan contributions.  Taxpayers contributing to IRA's can make contributions for 2013 by the date their 2013 tax return is filed or 4/15/14, whichever earlier.

WHY should savings be increased by 1%?

Aside from the reasons already listed above, increased retirement contributions align with the time value of money concept.  In short, the time value of money means $1 today will be worth more in the future.  For example, $1,000 today, growing at an average rate of 5% annually for 40 years will be worth $7,040.  These calculations can be made here.

The savings rate in our country has dropped from 5% last year to 4.6% this year.  From an accounting sense, that indicates that current obligations are being met, but future obligations are likely to not be met.  So, I encourage you to put pencil to paper and see where you can adjust your finances to give yourself a raise in 2014 by increasing your savings by 1%.  If anything I have given you a reason to put off raking those leaves for another day.

This post encouraged by the Financial Duckmail blog - see their site and other works here.

Retirement plans

Saving for retirement should be an important financial goal for everyone, no matter their age or income. Everyone has dreams for retirement, whether it is soaking up the sun on a beach somewhere or traveling the country in an RV, and saving for retirement is the key to making those dreams come true. One struggle that people face, especially younger workers, is that retirement is so far away that it's hard to acknowledge the benefit of saving for retirement now, which is why it helps to view a retirement account as both a savings account and a tax reduction tool. In the world of retirement plans, there are a variety of options available for everyone, whether you are an employer, employee, or self-employed.

401(k) plan

This is probably the most common retirement vehicle out there. The 401(k) plan is typically offered by employers, and allows employees to contribute a portion of their wages to an account. The contributions are "pre-tax" meaning that they go in before payroll and income taxes are calculated. The employee usually can direct the investment of the funds within the account, either by buying individual investments or selecting an allocation between mutual funds / ETFs offered within the plan. Employers also have the option (but not the obligation) to make profit-sharing or matching contributions (i.e. free money). The catch is that employee contributions are limited to $17,500 for 2013, and catch-up contributions of $5,500 for employees 50 years old and over.

Individual retirement account (IRA)

The traditional IRA is a useful product for many reasons, but does not carry the same tax deduction characteristics as other retirement accounts. An IRA can be opened by anyone at a participating institution and contributions can be made at any time during the year up to a maximum of $5,500 or taxable compensation for the year. The catch to an IRA is that distributions are almost always taxable, but contributions are not always tax deductible.  In other words, the contributions have the potential to be taxed twice.  For example, for a married filing joint taxpayer that is covered by a retirement plan at work with AGI in excess of $115,000 gets no deduction.  Limits can be found on the IRS website  here.

Roth IRA

The Roth has grown in popularity in recent years due to its tax deferral attributes. The Roth functions almost entirely the opposite as a traditional IRA in that contributions are made "after-tax" i.e. they are still included in your taxable income, but the distributions in future years are not taxable. This is a great resource for someone with the ability to make contributions and still pay the taxes currently such as a young worker with a higher level of disposable income. There are two catches to a Roth, 1) the contribution limit is the maximum of $5,500 or taxable compensation for one year (2013) and 2) taxpayer's with AGI in excess of $188,000 MFJ / $10,000 MFS / $127,000 S cannot make a contribution to a Roth.

All of the options above are also available to self-employed individuals depending on the income level of the business and whether or not it has employees.

The 401(k) and IRA plans can be useful tools in reducing taxable income.  By making higher contributions to a 401(k) plan, an employee's W-2 taxable income will decrease.  Also, if a taxpayer's income is in a certain range, IRA contributions can also help reduce taxable income.  Contributions to a Roth IRA have a different benefit.  Although current contributions are not deductible, distributions from the plan in the future are not taxable, meaning that a taxpayer can experience years of tax free growth for their retirement.