Should you create a budget starting with gross or net income? First of all, let’s take a step back and define each of these terms. Gross income is what your employer says they are paying you. This is either a salary (i.e. $35,000 a year) or an hourly wage (i.e. $16 an hour). Net income is your gross income minus your taxes. An easier definition is to look at how much you actually get paid every paycheck, this is your net income.
Now that you are clear on the difference between the two, which one should you base your budget on? Net, net, net… use your net income! If you were to use your gross income, you would have to “budget” for the amount you are paying in taxes, which doesn’t make any sense. I don’t care (and you shouldn’t either) if your salary is $35,000, $75,000 or $150,000, all I care is how much of that you are actually able to spend which is how much goes into your checking account every paycheck. You want your budgeted expenses to be less than your take-home pay or else you’ll slowly sink further and further into debt.
The next step is to figure out how much you make monthly because you will end up creating a monthly budget by the end of this process. Here are some very simple illustrations to show you how to figure out monthly net income.
Please do this calculation and write it down so that you are able to reference it when we move onto expenses later this week.
Some of you are probably wondering what to do about the other items that come out of your paycheck before you even see it in your account (i.e. 401k contribution, stock purchase plans, health insurance, etc.). I am trying to keep it as simple as possible, so we will just leave those off to the side for now. We can talk about how to work those into the budget when we get to that section. If you build your budget off of the net income that I defined above, you will have an accurate bottom line number to base your expenses off of.
I briefly discussed creating a budget last week in Budgeting 101, but I plan on going through the process in more detail over the next few weeks. You can expect to see all of the items (and more) that I mentioned in that article. It is my goal that in a few weeks you have all of the steps you need to create your own personal budget (hopefully you will do the steps along the way). Please stick with me because you will be rewarded with a working budget that will help you start building wealth!
Do you agree with me using net income? Or do you think you should budget for taxes, 401k, etc.?
-Jake-
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Photo by Alan Cleaver
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Pickle
February 6, 2013 at 10:46 am (UTC -5) Link to this comment
I’d absolutely budget using your net income. This is a true representation of what you have to spend during the month. If you never see your health insurance, 401k contributions, or anything else, then you shouldn’t need to budget for them.
Jacob Erickson
February 6, 2013 at 11:13 am (UTC -5) Link to this comment
Completely agree. It starts to get a bit tricky when you have a goal of putting 15% of your income into a retirement account when you already have automatic deductions from your paycheck going to a 401k. All you really need to do is take out how much you’re contributing that way (i.e. 5%) out of the 15% goal you have, then put the difference (10% in this example) into your monthly budget. Thanks for your input!
DC @ Young Adult Money
February 6, 2013 at 8:00 pm (UTC -5) Link to this comment
I found it very useful to not count my 401k money as part of my budget. The nice thing is you get used to not having that money. Same with my HSA; I contribute the max (as you may know I have had some sinus issues that maxed out my insurance last year and probably will this year) and I don’t even miss it because I’m used to those big deductions.
Jacob Erickson
February 6, 2013 at 9:19 pm (UTC -5) Link to this comment
Yea, I like having all of that stuff taken out before I see any money. Like you said, it makes me get used to a lower amount than I would normally have on my paycheck (and inherently makes me spend less money).
Budgets Made Easy Step 2: Track your spending for one month | Common Cents Wealth
February 8, 2013 at 9:02 am (UTC -5) Link to this comment
[...] « Budgets Made Easy Step 1: What income should you use? [...]
Weekly Recap – February 10th, 2013 » Common Cents Wealth | Common Cents Wealth
February 10, 2013 at 11:00 am (UTC -5) Link to this comment
[...] Cents Wealth: Budgets Made Easy Step 1: What income should you use? and Budgets Made Easy Step 2: Track your spending for one [...]
Budgets Made Easy Step 5: How does all of this come together? | Common Cents Wealth
February 15, 2013 at 7:23 am (UTC -5) Link to this comment
[...] that you’ve figured out your monthly net income, tracked your expenses for one month, and had a brief overview of the types of expenses you’re [...]