Everyone has a different salary, lives in a different part of the country and in short, is different. Building a budget is a unique process for everyone. This doesn’t mean you can’t follow some basic rules, rules that can be applied to any income level. Let’s apply some of these basic rules to a couple with an income of $150,000 who file taxes jointly.
Pay yourself first
This is one of the first rules in building wealth. No matter what, make sure you put money aside for yourself. If you don’t, no one else will. I feel 10% is the minimum people should be saving for retirement. The good news, if you do this with an employer sponsored plan, you can also lower your income taxes. So if you are earning $150,000 a year, you will be saving $15,000. If your employer offers a match, this will be higher, but you should still save 10%.
Usually taxes are withheld directly from your paycheck. In our scenario for a couple who files jointly, the standard deduction is now $24,000. If we take our savings and the standard deduction, our taxable base is now $111,000. (Income – Pre-tax Investing – Standard Deduction = Taxable Income).
Our new tax rules would put your Federal Income Tax at about 15%. Most states will also charge an income tax (3.07% in Pennsylvania) and you may also have to pay a local tax (usually about 1%). While taxes are different for everyone, we will estimate the annual tax liability to be about 20%, or $22,200.
This now leaves our household with $88,800, but we still need a place to live.
When purchasing a home, in order to qualify for a conventional loan, a lender will look at your housing expense ratio (HER). This number should be under 28% of your pre-tax income and will include loan principal and interest, property taxes and insurance. In our case here, the most that should be spent on housing is $42,000, or $3,500 per month. If we assume property taxes and insurance of about $650 per month, this leaves $2,875 left for loan repayment. A 30 year loan at a fixed 5% rate with a monthly payment of $2,875 is about $535,000.
The minimum down payment for a conventional loan is 20%, which would bring our purchase price up to about $668,000 with a down payment of $133,000. Remember, you do not have to spend this much on a house. This number is in your control!
After savings, taxes, and housing, our household is now left with $46,800.
Many people have health insurance taken out of their paychecks and never realize they are paying for it. It is however a very real expense. In addition you may need life insurance and car insurance. Health insurance for a family of 4 will cost about $1000 per month. Additional Life and Auto insurance might run another $400 per month. Add these up and insuring a household will be about $16,800 per year.
This number can be highly variable based on employer benefits, health needs and driving record. This is probably a reasonable number though.
After saving, taxes, housing and insurance, our household is left with $30,000, or $2,500 per month of discretionary income. This will be used to cover food, utilities, gas, clothes, travel, entertainment, gifts and charity. Some people reading this may think, that’s way more money than necessary to live every month. Congratulations, please save and invest the difference!
Perhaps you have car loans, student loans and daycare expenses. If you are reading this and feel overwhelmed because you spend way more than that every month, that’s okay too. First, it may be worth looking at where you’re spending your money every month after savings, taxes, housing and insurance. Can some of these areas be trimmed? The next area I would look at is housing. Spending less on a home may easily free up the shortfall. One area you cannot negotiate is tax rates as they are set by the government. The second area you will not want to negotiate is saving, unless of course you want to eat dog food when you’re 65.
Your personal situation will off course be unique and have its own complexities. While your income will likely be different from this example, the ratios will be the same. Consider working with a CERTIFIED FINANCIAL PLANNERTM professional to be sure you are not sacrificing retirement to live well today.