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Planning

Creating a budget can be a challenge. How exactly do we go about categorizing our spending? Here we show you how to create the perfect spending plan using just 5 high level budget categories.

Hierarchy of Needs

When I started my first real budget as an adult, the concept was not difficult. I knew I had to track my spending.

Tracking my spending would keep me from spending too much. And that would help me control and fix my financial situation. I was trying to reverse the trend of increasing my debt every month. So I came up with a simple spending plan that suited my needs.

Experimenting with My Budget

At the time, I used a free version of MoneyDance, a budgeting software. I also experimented with GnuCash. I categorized my expenses into at least twenty categories. But I quickly found that complicated budgets don’t work that well. Instead, what worked best for me was a simple plan that broke spending down into a few core components.

I started working towards J.D. Roth’s Balanced Money Formula. He suggests approaching your very basic budgeting categories this way:

  • 50% of after-tax income goes towards needs
  • 30% of after-tax income goes towards wants
  • 20% of after-tax income goes to saving

These ratios were my goal. But, for one thing, I wasn’t quite there yet. And for another, this isn’t a complete solution. It laid the groundwork. But I needed to examine my spending with a little more detail. So I started asking myself a few questions.

Asking the Right Questions

The questions I asked, and answered for myself, included:

  • What’s a need, and what’s a want? For an entrepreneur whose business relies on internet access, good internet access is a need. But what about those who only use the internet for personal entertainment and browsing?
  • Does a cell phone count as a want or a need? What about a Smartphone versus a basic phone?
  • Where does charitable giving fit in?
  • How about food? Eating is, of course, necessary for survival. But what about dining out?

This is just how I started dividing out my spending among J.D.’s broad categories of spending and saving. These questions are complicated and can be difficult to answer. Plus, in order to answer some of them, you need to know what you’re already spending in these categories. We’ll get to that later.

Maslow’s Hierarchy of Needs

So instead of just using those broad categories, I referred to Maslow’s Hierarchy of Needs.

Maslow's Hierarchy of Needs

 

This image is one you often see in a Psychology 101 class in college. The basic theory is that in order to fulfill higher-level needs, you must first fulfill lower-level needs. In other words, it’s really hard to feel safe and secure if you don’t have adequate food. And it’s hard to create relationships when you’re struggling to meet your basic physiological needs.

It’s pretty easy to use this hierarchy to prioritize your finances. In fact, using the Hierarchy of Needs is a great way to decide how to spend your money when there’s not enough to meet all of your expenses. Think about it this way:

  • First, consider basic physiological needs. This includes adequate food, running water, heating in the winter, housing, and basic clothing. Given how much we rely on electricity, you can probably put paying the electric bill here, too. The most important spending is on these items.
  • Next, spend on things that are essential for your safety and security. This includes health insurance, especially if you’re one medical emergency away from bankruptcy. Affordable term life insurance can give you peace of mind for your family’s future, too.
  • After this, spending, you’ll start moving from wants into needs. Some items, like the internet access we talked about above, are a gray area. You may have certain “wants-like” expenditures that enable you to continue earning money so that you can pay for your needs. For instance, this could include daycare for your children or transportation costs.

You might put your spending in slightly different categories, but here’s a basic breakdown of what this might look like:

Level 1: Physiological Needs

  • Housing: rent or mortgage payments
  • Basic sustenance: groceries, cooking, and water
  • Clothing: non-designer brand essential wear

Level 2: Safety Needs

  • Power (electricity, gas)
  • Basic telephone service
  • Insurance: health, home, and life
  • Vehicle or other transportation
  • House repairs and maintenance
  • Expenses related to operating your business

Level 3: Love and Belonging

  • Gift-giving
  • Charitable contributions
  • Entertainment
  • Spending time with friends and family

Level 4: Esteem

  • Work-appropriate clothing
  • Education and professional development
  • Dining out
  • Fitness beyond basic health needs

Level 5: Self Actualization

  • Hobbies
  • Internet, if not needed for generating income
  • Television
  • Vacations, non-essential travel
  • Luxuries

Creating Your Budget Based on the Hierarchy

So what do you actually do with this information? Here are some steps to take when creating a needs-based budget, especially if you can’t pay all your expenses every month:

  1. First, budget for your most basic physical needs. If you can pay for nothing else, pay for these.
  2. Next, budget for the safety and security related needs.
  3. After this, you can start budgeting for the next two levels lumped together. For instance, some months, you might need to budget for a wardrobe upgrade or a new suit. To do that, you might need to cut back on dining out with your family. That’s technically mixing up the hierarchy, but it still makes sense.
  4. When you have extra money, use it on the self-actualization categories.

As you get better at budgeting, you may not need to be so strict with your categories anymore. But when you’re starting out, it helps to divide things down to their basic components. This is a great way to get going!

For a great budgeting tool, check out Personal Capital Financial Dashboard. It’s totally free, and you can track all your spending, credit cards, bank accounts, and even investments.

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It’s a fact: multigenerational households are becoming more common in the United States. In the ’50s, it wasn’t unusual for older adults to live with their grown children and possibly grandchildren. That living arrangement trended downward for several decades, but saw a big upswing between 2000 and 2014. In fact, in 2014, 19% of Americans — 60.6 million people — lived in households that included at least two generations of adults.

The economy explains some of these trends. When retirement funds crashed during the Great Recession, older adults may have suddenly found themselves unable to financially make it on their own. Now, couple that with rising housing costs and a shaky job market. The result is that many middle-aged children caring for elderly parents can’t afford to put mom and dad up in a care facility.

You can’t trace the entirety of this trend to the economy, though. Actually, some of it is due to increasing diversity in America. The Pew research shows that more families with Asian, African American, and Hispanic backgrounds are likely to live in a multigenerational household. This is likely due, at least in part, to upbringing and the cultural expectation that adult children are to support their elderly parents.

Regardless of culture or background, many adults expect to have at least some role in caring for their parents when they’re no longer able to do so themselves. But what this looks like — and the financial and emotional toll it takes — can vary from family to family. If you think you might be in this situation in the coming years, start taking the following steps now:

1. Consult your spouse and siblings

The first step in deciding how to help your aging parents financially isn’t necessarily to talk to your parents. Sure, the conversation might come up. But before you commit to anything or set expectations, consult with your spouse and any siblings who are in the picture.

It’s essential to be on the same page about elderly care with your spouse. Financially and practically supporting one (or more) spouse’s parents can put some serious strain on your marriage. So, talk to your spouse about what you would like to do for your parents. Then, reach an agreement on what you, as a couple, are willing and able to do — financially, but also practically and emotionally. Also, decide ahead of time what boundaries you need to put in place, in order to preserve healthy relationships all around.

You’ll definitely want to pull in your siblings for this. See how much they’re willing and able to contribute to your parents’ care, financially. But again, also consider the practical aspects of caring for them. Who is most able to take on emotional support roles? Who is best at dealing with practical details? Does one of the siblings prefer to have mom or dad live with their family, or do you need to work together to support your parents in a care facility or retirement community?

Having these conversations before approaching your parent(s) can help everyone stay on the same page.

2. Talk with your parents

Next, you’ll want to have a frank conversation with your parents. You don’t have to start by laying out the nitty-gritty details of their budget. Instead, try talking more generally about your parents’ goals and needs as they approach old age. Do they want to live on their own as long as possible? Have they considered a retirement or assisted living facility, depending on their physical and medical needs? Do they expect to be healthy well into old age, based on their ancestry? Or are health problems already cropping up and complicating matters?

Read More: How to Afford Healthcare in Retirement

During this conversation, you might bring up some of the options you’ve already thought out. Whether that’s helping your parents settle into a nearby assisted living facility or adding an in-law suite to your home, present these options as just that… options. Unless your parents are at the point where they are no longer capable of making sound decisions, you should try, wherever possible, to defer to their judgement and preferences.

3. Understand the financial situation

Once you’ve gotten a feel as a whole family — spouse, siblings, and parents — for everyone’s needs, preferences, and boundaries, it may be time to have a more frank conversation about money. By this time, you should already know what you are willing and able to contribute to your parents’ care and well-being. Hopefully, you also have an idea of what, if anything, your siblings can contribute.

Now, it’s time to figure out where your parents are financially. You might even want to consider pulling in a financial planner who can look holistically at your parents’ investments, retirement accounts, and other assets. This can help you get a more objective view of the best way to allocate resources.

Related: Moving Assets Into a Revocable Living Trust

Digging into the financial details may be awkward. But it’s essential in this decision-making process, as the available resources — including government-funded benefits, Social Security, and assets — will tell you what options are available to your family now and in the future.

4. Consider long-term care insurance

If there are potential health issues in the picture — or if mom and dad don’t have enough money to handle potential assisted care — consider long-term care insurance. This is an insurance product specifically for paying for long-term healthcare, often including assisted living and in-home care that isn’t covered by insurance or Medicare. Depending on your parents’ current health status, premiums may be relatively affordable. And you could consider paying for premiums yourself — or with the help of siblings — to reduce the risk of having to pay out loads of money for long-term care in the future.

5. Put a plan in place (and have a backup)

Once your family has worked through all of these issues — probably over the course of several month or even years — it’s time to put a formal plan into place. This might include steps like adding an in-law suite to your own home, or converting some space you already have in order to move your parents into your home. Or it might require you to visit local assisted living and retirement communities, to be ready to move mom or dad there when the time comes.

Whatever you plan, though, make sure you have a backup. This is especially true if your goal is to move your parents into your own home. Often times, this is an excellent fit and winds up benefiting everyone. But if medical or mental health needs become more complex, this arrangement may not work out as well as you’d hoped. Always hope for the best, but plan for the worst. In this case, you may need to plan for an alternative living situation, or figure out how you could afford in-home care to help lighten the load.

6. Make it all legal

After the plan is made, it’s a good idea to ensure that a responsible sibling has medical power of attorney and financial power of attorney for your parents. While you’re helping your parents get these documents drawn up, it’s a good idea to have them go over their will with an attorney, as well.

Planning Your Estate? You Need These 3 Documents NOW

In the end, it’s up to your parents, as long as they are of sound mind, to decide who has power of attorney and how to spell out their own will. And they may prefer to work these documents out directly with an attorney. If that’s the case, simply make sure you know who has power of attorney and where copies of their documents are stored, in case you should ever need them.

7. Start helping out early

As memories start to fade or medical needs get complicated, older adults occasionally have trouble managing their finances. If you notice this happening to your parents, you may want to start helping out with their finances sooner rather than later. Sometimes this is as simple as helping them write a budget and set up automatic bill payments so things don’t get missed. Or it may be more complicated, like managing investment accounts to make the most of the savings.

Related: 7 Free Tools to Help Aging Parents With Their Money

Caring for elderly parents can be stressful — both emotionally and financially. Taking the time now to plan ahead for this eventuality will help take some of the stress out of the situation for everyone.

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It’s a good thing I’ve been saving a good portion of my income for the past year. Even with making estimated tax payments — the last of which was due on January 16 — I still have a significant tax bill this year, thanks to increased income.

Many taxpayers dread filing their taxes, even if they receive a refund from the IRS. It’s often a time-consuming process that can be fairly stressful. Plus, pressing Submit on your electronic return (or licking the stamp of your paper return) can bring out fears and anxiety over the possibility of an audit, no matter how diligent you were about your records.

Some people, like me, have a stronger reason for the lack of anticipation: we will end up owing money. And for those who haven’t saved enough money throughout the year, this is a dreaded situation.

TAX BILL

What If You Can’t Afford Your Tax Bill?

First of all, you don’t want to owe the IRS money. This type of debt is one of the hardest types to erase. There is no statute of limitations on IRS debt, either, so it won’t just go away on its own if ignored long enough. Even if you declare bankruptcy, it’s very difficult to get rid of tax debt.

Related: How to Adjust Your Witholdings for a $0 Return

Sometimes taxpayers receive a notification saying they owe money, but it might not be accurate. The IRS is a system subject to human error, just like any other agency. You can dispute the amount you owe if it doesn’t match your records and you have a reason to believe your calculation is correct.

Need More Time to File? How to Get an Extension on Your Taxes

The government is sensitive to the issue of whether you can afford to pay, so they’re willing to work with you a little bit. The best option is to avoid using a credit card to pay your debt, which would ordinarily be many consumers’ first choice. When you file your taxes, don’t pay online at that time if you can’t afford it in cash. Instead, wait until after you submit your form and it’s accepted by the IRS. Then, visit the IRS website to file an Online Payment Agreement.

If you take long enough, the IRS will send you a tax due notification, but there’s no need to wait for that to arrive. If you have your adjusted gross income (AGI) from your tax return, the amount you owe, and, of course, your Social Security number, you can get started. The form will first ask you how much you can pay and when you can pay it. Then, it will come up with a payment plan that works for you.

The payment plan will allow you to spread your tax bill out over a longer period of time. This improves the chances that paying your bill won’t cause you a financial hardship, and the IRS still manages to collect the monies due —  a win-win in their book. There is a fee for creating a payment plan, ranging from $43 to to $225.

If your financial hardship is only temporary, the IRS may delay collection, though interest and late fees will still be added to your bill. The IRS could also file a federal tax lien, even if they delay collection. This means your property could become property of the government in order to satisfy your debt.

The last line of negotiation with the IRS is an Offer in Compromise. There are only a few situations in which the IRS will accept a lower tax payment than what they believe is due. If the IRS believes you’ll never be able to satisfy your tax liability, but you agree to the amount you owe, an Offer in Compromise might satisfy the IRS.

If there is legitimate doubt about the tax bill — this will usually happen only in complicated situations — the IRS might consider an Offer in Compromise. Also, if you could afford your tax bill, but paying it would create a significant economic hardship, the IRS might consider an Offer in Compromise for you, as well. This is only in exceptional circumstances.

Because the IRS does charge you interest and penalties when you don’t pay in full or on time, the best solution is to pay the bill in full as soon as possible to reduce these extra costs, even if you agree to payment plans. I prefer the above options over other payment types (such as a high interest credit card) when cash isn’t available at the time the bill is due. However, the IRS offers these additional suggestions:

I’m not a big fan of any of these, but it is important to take care of your IRS debt above many other financial priorities.

Have you ended up with a big tax bill you couldn’t immediately pay? What was your plan of action?

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Whether you’re taking care of multiple children, a disabled spouse, or elderly parents, you’ve likely experienced the high cost of dependent care firsthand. With expenses from babysitters to after school programs, it can be difficult to stay ahead of all your other financial obligations while spending on dependent care.

To help make dependent care more affordable, President Donald Trump has included a new provision in his child care plan: the Dependent Care Savings Account. It’s a tax-favored account that anyone with dependents can contribute to in order to save for eligible expenses. Read further to learn exactly what it is, how it works, and who will benefit from it.

What Is The New Dependent Care Savings Account?

Trump’s child care proposal includes creating a Dependent Care Savings Account (DCSA). Parents can contribute up to $2,000 per year to this tax-favored account. Contributions are tax deductible and grow tax-free. Much like a Health Savings Account (HSA), money in a DCSA doesn’t expire. Unused contributions can even be used for a child’s college education expenses once he/she reaches 18.

How Does The Dependent Care Savings Account Work?

DCSAs will be available to everyone regardless of employment status. They won’t be tied to employer accounts.

As previously stated, the maximum annual contribution for DCSAs will be $2,000. Unlike employer-sponsored Dependent Flexible Spending Accounts, unused money in a DCSA will be allowed to carry over year after year. In this way, substantial amounts of money can be accumulated for future dependent care expenses.

Examples of eligible dependent care expenses include:

  • Children
    • After school programs
    • Babysitters
  • Disabled  Spouse
    • In-home care
  • Elderly Parents
    • Adult day care
    • Assisted living

The exact details on how claims will be processed and reimbursed have not been released yet. We suspect it’ll operate similar to an HSA, but on a federal level.

Who Does The Dependent Care Savings Account Benefit?

Anyone who spends money on dependent care can take advantage of the DCSA and reap the tax benefits.

It should be noted that dependents include disabled spouses and elderly parents, not just children. This broadens the applicability of the money put into the account and makes it all the more easy to use it for eligible expenses.

Low-income parents will receive an additional benefit when using DCSAs. The government will match half of the first $1,000 contributed each year. That’s $500 in additional benefits each year.

Trump hasn’t laid out the specific details on how he plans to fund the government match for contributions made by low-income parents. That, however, would come at a large cost. Over 40% of American households have children. If every low-income parent contributed to DCSAs up to the government match, he would need to find a viable way to fund all of those accounts.

His general answer to the funding question is that it’ll be “offset by additional growth.”

Final Thoughts

It’s important to note that in order for DCSAs to have a large scale impact in reducing the cost of dependent care for American families, parents will need to take advantage of the account and contribute to it. Given that participation in FSAs and HSAs has been increasing, the outlook seems promising.

The $500 government match for low-income parents is a lofty provision but may be underutilized in reality. Low-income families may have a hard time coming up with the disposable income to contribute to a DCSA in the first place.

President-elect Trump’s child care plan, specifically the creation of the Dependent Care Savings Account, depends largely on utilization rates. We have our eyes peeled to see how this change affects finances for the U.S., especially families with children or elderly parents.

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How Is Your Budget Doing These Days?

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This is a guest article by Phil Cioppa of Arbol Financial Strategies, LLC. Phil has over 10 years of financial service experience and specializes in asset management strategies, insurance planning and taxation issues. A budget is an important part of any financial plan, and right now is the best time to take another look at […]

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