Guidelines for Creating a Spending Plan

by Gary Foreman

Realtor Tips for Preparing Home for Sale photo

A big part of successful budgeting is knowing how much you can spend in specific budget categories without causing yourself money problems. Use these guidelines to create a spending plan that works for your finances.

Dear Gary,
I understand that 25% of my monthly income should be for mortgage, taxes and insurance. How much should I plan for the remainder of my budget? There are two of us in our household. Is there a set formula?

Also, if I plan to retire in the next five years, should I carry a mortgage for a tax write-off?
Debbie

There Is No Set Formula for Creating a Spending Plan

Debbie’s first question is a very good one. Knowing how much you can afford to spend in any category is important to a successful financial plan.

There is no set formula for dividing up a budget. That’s because every family is unique. Housing costs vary by region. Family size and age will affect expenses. So, your best plan is to adjust your budget until you find a formula that works for you. And, even then, you’ll need to adjust it occasionally as your circumstances change.

A Budget Shouldn’t Be a Straitjacket

The best use of a budget is as a guideline for your expenses and an early warning sign of trouble ahead. A budget can do a great job of telling you where a problem is and can even help you find a solution.

The trick is to keep the total spending to less than 100% of your after-tax income. You can spend more than you make if you use credit cards to borrow money.

But doing that makes it harder to live within your income the next month. That’s because you’ve accumulated debt that must be paid back with interest.

You deserve a comfortable retirement.

Common Causes of Budget Failure

The two most common causes of budget failure are housing and automobiles. Both problems are hard to correct.

You can’t sell a little bit of your home or car. And it’s very difficult to save enough in other areas to overcome a big-ticket mistake.

Preparing Your Spending Plan

When you prepare your budget or spending plan, you’ll probably have a hard time deciding where to put certain expenses.

For instance, dinner with friends could be considered food. Or it could be entertainment. Where you put it is not critical. But making sure that you don’t overspend on both food and entertainment is important.

OK, so let’s look at one possible budget for Debbie. This one uses after-tax income.

Housing	30%
Auto	15%
Food	17%
Health & Life Insurance	5%
Entertainment	7%
Clothing	4%
Medical	6%
Debt Repayment	5%
Savings/Investment	5%
Miscellaneous	6%

How Does a Spending Plan Work Practically?

For illustration, let’s assume a family income of $60,000 per year after taxes. That may seem like a lot. But you’d be surprised how quickly you can spend $5,000 monthly.

If Debbie spent 30% of her income on housing, she’d have $1,500 per month to work with. That would include her mortgage payment, taxes, insurance, maintenance and repairs. Many are tempted to buy a more expensive home. There are even some professionals who advise clients that they’ll do fine committing 35% to housing. Often, the result is a family struggling with mortgage payments that are too big. And finding an extra 5% in the other categories is often painful.

On the other hand, let’s suppose that Debbie manages to keep her household expenses to 25% of her income. That will allow her an extra 5% to use in other places. That $250 each month could be used to repay debts, save more for retirement, or spend however Debbie wanted.

A Word About Automobiles

Trying to fit two car payments into our sample budget could be difficult. Debbie would have $750 per month to spend. Besides any car payments, she needs to leave some money for insurance, registration, gasoline, tolls, maintenance, or repairs.

Realistically, to keep two cars on the road, she’ll probably spend about $150 to $200 per month above her payments. So Debbie really only has about $550 per month that can go towards car payments.

Related: Could You Give Up Your Car?

A Note About Budgeting for Debt Repayment

Note that the “debt repayment” category does not mean making minimum credit card payments. It means repaying previously accumulated debts.

You should always plan on paying off any new charges completely in the month that they occur. Ideally, Debbie wouldn’t have debts to repay and could allocate 10% for retirement savings.

Should You Carry a Mortgage for the Tax Deduction?

Debbie’s second question is easier. No one should be carrying a mortgage for the tax deduction.

It’s really pretty simple when you cut through the jargon. You borrow money and pay interest on the loan. For every $1 in interest you pay the mortgage company, you’ll deduct $1 from your income at tax time. Depending on your tax rate, you’ll save 15 to 30 cents. Trading 30 cents for a dollar is not a good idea!

Some would argue that the money that you don’t use to pay your mortgage can be invested to earn more than the mortgage costs you. But you’ll need a return that’s guaranteed as to principal and earnings for an apples-to-apples comparison.

And with very rare exceptions, you won’t find it. For instance, if Debbie has a 5% mortgage and is in the 30% tax bracket, the money will cost her 3.5% after taxes. She’d need to find a guaranteed investment that would pay that much after taxes.

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Reviewed January 2024

About the Author

Gary Foreman is the former owner and editor of the After50Finances.com website and newsletter. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com.

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