Social Security Tax Increasing...Will that affect my budget?

A crucial part of budgeting is also watching the taxes that are taken out of your pay check.  One such tax is the social security tax.  Based on federal law, it is mandated that each employee pay a social security tax even though some of us may not see those funds.  Anyway, the rate at which each employee is taxed is 4.2%.  The rate of 4.2% is a lesser amount than what we have paid in prior years.  I can't remember the year in which President Bush enacted his tax cuts but this is a reduced amount and is part of his work, which is nice.  As of March 1, 2012, I believe, we are supposed to see this rate increase back up to its original rate of 6.2%.

As you budget keep this in mind because this rate will go up 2 percentage points and is taxed against your gross pay.  So let's illustrate this increase.

Yearly Gross Pay Amount	$50,000
Current Social Security Rate	4.2%
Current Amount You Pay In Social Security Tax Per Year	$2,100
Social Security Rate Beginning March 1, 2012	6.2%
Amount You Will Now Pay A Year in Social Security Tax	$3,100
Amount of Income You Will Lose Per Year With This Increase	$1,000
Monthly Amount You Will Lose	$83.33

This is real money that you will no longer be able to spend on yourself.  Please incorporate this into your budget so you are relying on funds that aren't there.  I don't know about you but I could certainly use and extra $83.33/month. 

These funds are certainly needed by all so let's just cross our fingers and hope that the master minds in Washington will understand that we can no longer sacrifice our hard earned dollars for crazy spending bills.  Remember, there is still hope that they could extend this tax break through the end of the year.  If that is the case, then we can put this added worry on hold until 2013...more to come on this topic.

During the State of the Union address President Obama mentioned the fact that the government needs to pass the payroll tax/social security tax cut now and it extend for the rest of the year.  Let's cross our fingers and hope that happens.

Beware of Budget Complacency

The process of beginning to budget is a big change because it isn’t a habit and it takes time.  Nowadays, I believe that we as Americans want everything quick and in front of us in the least amount of time.  That is a major reason why I think that budgeting is a process that begins as a New Year’s resolution or when times are tough and we are in need of financial help.  Now that you have begun the budgeting process, don’t let up.  The steps that I have outlined really help you become involved in how you are spending your money.  When I talked about tracking your expenses, I talked about going through each of your receipts and tracking the costs based on the expense categories that you have set up.  I highlight this because it helps you really understand where your money is going.  It is time consuming, no argument there.  If this is the approach you are taking, stick with it.  It is said that if you can do something for 21 straight days then it becomes a habit.  Make it happen!

If you are electing to budget with budgeting software such as Microsoft Money, Quicken, You Need a Budget, or some other software, then stick with it.  You may not be as involved in how all your money is spent but at least you will know where your money is going.  Don’t become complacent even if the process is easy.  Most of your information can be downloaded from your online bank account or your credit cards but don’t let that be a reason to not regularly visit your budget.

Remember, Remember if you aren’t aware of how you are spending your money, you could be in for a rude awakening one day…potentially that rainy day when a little extra cash would come in handy!

Analyzing Your Budget

I believe this to be a very important part of the process.  The analysis part of the process is where you can determine whether you are spending your money on your wants or your needs.  This would be a good time to get your list of needs and wants and evaluate your spending habits.  There are a couple ways you can do this.  I will offer a couple of suggestions.

1.  Graph your total monthly costs - This will give you an idea as to how well you are budgeting through out the year based on your spending needs/habits.  For example, you may find that you are spending a lot of money in November and December for Christmas or you may notice more costs in June or July because of summer vacations.  This is good information as this will help you plan your spending and help you be creative in budgeting in the other months so you have enough money to cover theses "wants" or "fun" expenses.

2.  Graph your spending by category - I like this graph because it tells you how much in which areas you are spending your money.  On this graph, you want to probably graph this by total dollars and by percentages of your total expenses.  The percentages usually shine a different light on the process and help you better understand what is going on with your finances.

3.  Amount you are paying yourself - Keep an eye on how much you are paying yourself.  This area is really why we work so hard and to retire and retire hopefully early...right?  Make sure you aren't dipping into this fun to pay other people.  There has to be some relief for all your hard work.  Don't let that hard work go towards paying someone else.  Ensure you have enough to always pay yourself!

4.  How much is your Mortgage/Rent payment eating into your budget? - This is a cost that I will discuss more later but you want to make sure you have control over your mortgage/rent payment.  Make sure you aren't spending more than 28% of your gross income.  This isn't something that you can change monthly so when you do lock down your payment amount, make sure you are paying less than 28% of your gross income.  I guess you could change this after your payments are locked in by bringing in more money.  If bringing in more money doesn't work out then in order to stay within your means I would suggest being creative with your budget.  By creative I mean go through each of your categories and determine where you are spending money that may seem frivolous or you feel you are just spending too much.  For example, if you are spending $400/month on entertainment then maybe you need to figure out a way to spend less in that category.  Or if you are going out to eat so much that you could really be saving more if you went to the grocery store more often and cook more meals at home.

There are ratios that you can use to analyze your finances as well.  Let's dive in:
1.  Housing Ratio - This ratio is very nice because it give you a high level look at how well your house payment is controlling your budget.  This formula can be used for both homeowners and those renting.  If you are a home owner, incorporate your entire mortgage payment (principle, interest, mortgage insurance (if applicable) & property taxes).  If you are renting, then only use the amount you are paying for rent.  Let's say you are a homeowner and pay $1,000 a month for your mortgage.  Included in that $1,000 is your principle, interest, mortgage insurance & property taxes.  You have an annual salary of $60,000 so your gross monthly salary would be $5,000.  The output of the ratio looks something like this:
                             Monthly Mortgage Payment
Housing Ratio =  Gross Monthly Salary

                            $1,000
Housing Ratio = $5,000 = 20%

Based on this ratio, you would be in pretty good shape.  Remember, you want to keep this percent south of the 28%.

2.  Savings Ratio - This ratio is one that I think gets overlooked by most people.  It is ratio that I believe many people think will work out on itself.  This is the percentage of money you have left over at the end of the month that you can use on yourself.  This is the money that will go towards a nice vacation, retirement, a new car, a new home, money to put away for that rainy day, a nice night on the town, etc.  I have read books and heard financial advisors specify that this percentage should be 10% or higher if possible.  Remember, Remember that you are working to pay yourself not to pay your debtors and everyone else.  The ratio is pretty easy to calculate:

                          Net Income (amt. @ end of mth)
Saving Ratio =  Net Pay (amt. you take home after taxes, insurance, etc.)

Let's run a scenario.  You bring home $4,000 after taxes, insurance, etc.  You have net income of $450 at the end of the month.

                           $450
Savings Ratio = $4,000 = 11.25%

This is where you want to be at and then some.  Keep an eye on this ratio and figure out how you can optimize it.

Use this ratio to help manage your expenses and when putting together your budget.  As you become familiar with this ratio you can be creative with your budget.  With this ratio you can:
     A.  Run What-If Scenarios - put in different amounts for your income or other expense categories to get an idea of how much you would need to make to save at least 10% at the end of each month
     B.  Salary Negotiation - I will get into salary talk later but as you put in different salary amounts, you can get a taste for how much you need to earn to save that magical 10% or more on a monthly basis.
     C.  Debt Reduction - If you are carrying any type of debt: student loans, credit cards, car, home, frivious purchases, anything, run a scenario to see how much you would be making if you didn't have to pay off your debtors.  In this scenario, I am suggesting you pay off your debts as fast as you can so you can have a strong credit score, pay as little interest as possible, and enjoy a "raise" as you will now have liberated yourself from financial bondage.  Now once that debt is paid off, don't get back into debt.  Be Wise and Spend Wisely!

The above scenarios work and they will give wonderful perspective into how much you can enjoy life while only working hard at work and eliminating the stress of paying off debt or spending your money unwisely.

3.  Debt-to-Income Ratio - Many of you many be familiar with this ratio, especially if you own a home.  This is a ratio that lenders use to determine whether or not you qualify for a mortgage.  This ratio takes all your monthly debt payments and determines how much of your income is going towards paying down your debt.  This is one percentage you want to be low.  This will take your monthly credit card payments, student loan payments, car payments, mortgage/rent payments, etc.  Let's run a scenario.  You have a $100 student loan payment, $350 car payment, $1,000 mortgage payment, and a $600 credit card payment.  Your total monthly debt payments are $2,050.  You bring home $5,000 a month.  What is your debt-to-income ratio:

                               Total Mthly Debt Pmt's
Debt-to-Income =  Monthly Gross Pay (Amt. before taxes, insurance, etc.)

                                $2,050
Debt-to-Income =     $5,000 = 41.00%

It is said that with a debt-to-income of over 55%, you shouldn't qualify for a mortgage.  Keep an eye on this as well.  Don't drown yourself in debt.  It is good to have some breathing room.

Cheers to budgeting and owning your finances!

Tracking your actual costs

With your first pass of your budget in place, now lets start tracking your actual income and expenses.  There is no right way to do this.  Try to find a way that is easy for you.  Some people like to be very detailed oriented and others maybe not so much.  I believe that no matter how you track your income and expenses, make sure you are consistent.  If you are very detailed and separate out your groceries, household items, fuel, etc. then make sure you do that every month.  If you are consistent, then you will get a very good picture as to how much your are spending and in which categories.

If you are someone who likes to be detailed but just don't have the time, there are ways to achieve this.  There is software available to help make this easy.  The popular types of software include QuickBooks, Quicken, and Microsoft Money.  For example, if you have a version of the software that I mentioned and have a major credit card, it is very likely that you could download your statements into the software.  These types of software also have the capapbility of downloading your bank statement from your bank account.  There may be a fee for this functionality but it is very convenient.  This is an easy way to understand your spending habits and allows you analyze your cash outflows.

Using this software is very nice, however, if you don't heavily use a credit card or are working to limit your credit card usage, here are a couple more suggestions:

1.  Envelope Method - Take a series of envelopes and label them with your major expenses such as groceries, fuel, eating out, entertainment, household expenditures, etc.  At the beginning of each month, with cash from your bank account and put in the budgeted amounts into each envelope.  This is how much money you have for the month and once the money is gone, you can't spend any more cash.
2.  Bank Reconciliation Method - Reconcile your bank account with your monthly habits.  On a monthly basis, reconcile your check book to your bank statement.  This will give you a running total as to how much money you have in your checking account.  Make sure you also track your expenses based on your budget so you don't over spend.
3.  Excel Method - If you like working in excel, this could be a very convenient method.  I have created an excel budgeting template that you are welcomed to use.  You can customize it however you would like.  With the template that I have created, simply input your budget and track your expenses.  There are formulas in place to track how well your actuals compare to your monthly budgeted amounts and how well you are trending for the year.  This is will tell you exactly how much you have leftover on a monthly basis.