A budget should evolve as your circumstances change. In this section, we’ll discuss some common life changes and how you might want to adjust your budget as a result.
Getting a Raise
When you get a raise, you should consciously choose how you will spend the extra money. First, keep in mind that if you get a raise of $200 a month, it won’t be nearly that much after taxes. If your marginal tax rate is 25%, an extra $200 a month will leave you with $150 after federal taxes, even less after Social Security and Medicare taxes, and still less if you also pay state or local income taxes.
Just as you’ve done with the rest of your money, decide what the best use of your new income will be. Do you want to save it, and if so, for what purpose? Saving it is a good way to avoid the lifestyle inflation that tends to accompany raises. If you want to spend it, consider how much you’re going to spend, where that money will go and why. Don’t let your extra income disappear without thinking through the best way to use it. (Learn more in When Is the Best Time to Ask for a Raise& and How Getting a Raise Affects Your Taxes.)
Losing Your Job
If you lose your job, you’ll almost certainly need to scale back your spending.
Examine your budget to see where you can cut back. You may be able to cut out a particular category entirely, like going out to eat, and easily save $200 a month (though you’ll have to increase your grocery budget a bit to make up for the lack of restaurant meals). Or you may be better off making smaller cuts in several categories, like decreasing your grocery bill by $20 a month and swapping out cable television for a streaming service. You may not be able to reduce your expenses enough to fit the reduced amount of money you have to spend, but because you’ve been budgeting, you should have at least some money stashed away for emergencies. This is the time to use that money if you need it. (For more, see Losing Your Job: From A to Z.)
What if you’ve been at a company so long that you receive a generous severance package — say, six months’ worth of your salary and health insurance — that enables you to maintain the same quality of living for an extended time? You’d still be wise to cut back as much as possible, for several reasons:
- You don’t know how long it will take you to find another job.
- You don’t know if your new job will pay as much as your old job.
- You don’t know if your new job will offer better or worse benefits than your old job.
- You might have to go back to school to acquire the skills you need to get rehired.
In a best-case scenario, you’ll get a new job quickly and can use your remaining severance pay to bolster your savings.
A smaller severance package or state unemployment insurance can help tide you over, but neither will provide you with the kind of income or financial stability you’re probably used to. In any case, losing your job should mean revising your budget to plan for lower spending.
Experiencing a Financial Emergency
Losing your job certainly counts as a financial emergency, but it’s not the only one you may encounter. Your beloved old Honda might suddenly sputter its last breath — or at least the last breath it’s willing to take unless you want to pay for some costly replacement parts and labor. If you don’t have good public transportation where you live or a friend, relative or coworker who can take you to work, you’ll need to find a new vehicle fast, and probably rent one in the meantime.
Again, your emergency fund is a good place to look for new car money. If you don’t have an emergency fund, you’ll have to find the money elsewhere in your budget. Even if you do have an emergency fund, you’ll need to adjust your budget so you can replenish your fund over the upcoming months after buying your replacement vehicle. Yes, you could get an auto loan, but unless you qualify for an extremely low interest rate — say, 0% to 3% — we would advise against taking on debt to buy an asset that declines in value. If you must get a loan, minimize it by making as large of a down payment as you can afford. (See 5 Apps to Help Build a Financial Safety Net.)
Saving for a Major Purchase
Adjusting your budget so you can afford a major purchase, like a down payment on a house, is similar to adjusting it when you lose your job or have a financial emergency. You’ll need to find significant ways to cut back in one or more spending categories and perhaps a way to increase your income as well.
The difference is that, since you’re cutting back for something you’ve chosen, it won’t be as painful. It’s also often possible to plan for major purchases several months to a year or more in advance, making them easier to fit into your budget without making major lifestyle changes.
Buying a House
If you buy a house, you’ll need to make long-term changes to your budget.
To prepare yourself for the change and make sure you can afford it, adjust your budget several months to a year in advance and pretend as if you already have the new expense. This way, if you find out you can’t meet all your obligations, you won’t incur any real damage and you’ll have time to fix things before the real expense kicks in.
Changing Your Habits
Any time you change your habits, you will see a corresponding change in your finances – sometimes giving you more money, and sometimes less. Deciding to start eating healthier may not equate to healthier finances in the short run, for example. If you’re trading in boxed mac and cheese for fresh fish, fruits and vegetables, your grocery bill is going to increase (though your health expenses will likely go down, at least in the long run). If you’re trading in seven nights a week’s worth of take-out meals for healthy home cooking, quitting smoking or cycling to work instead of driving, you’ll probably save money. In any case, you’ll need to adjust your budget. (See 7 Habits That Can Lead to Future Wealth and 10 Habits of Successful People.)
Becoming Seriously Ill or Disabled
“It won’t happen to me,” once thought everyone who has ever become seriously ill or disabled. But it can happen to you and being diagnosed with a major illness or experiencing a major injury can be one of the worst things that can happen to your finances, especially if it means you can’t work for months, years or even the rest of your life. Few people will come out of such situations unscathed, since their medical expenses are increasing exponentially while their income has plummeted.
That’s why you want to be proactive about taking steps to minimize the damage if something does happen to you or your partner.
- Always carry health insurance and private disability income insurance.
- Take full advantage of the money you might have in a health savings account or flexible spending account.
- Be proactive about reducing your medical bills by questioning the need for every procedure and test and getting things done in network whenever possible.
- Claim Social Security Disability Income if you’re eligible.
(For more ideas, see 10 Ways to Prepare for a Personal Financial Crisis and 20 Ways to Save on Medical Bills.)
Getting Rid of a Major Expense
If you’ve finally finished putting all your children through college and they’ve all moved out and acquired jobs, not only will you no longer have tuition expenses, you’ll be free of paying for someone else’s food, clothing, medical bills and other costs. Paying off your mortgage is another time in your life when your expenses will significantly decrease. What will you do with all this extra money? Your budget’s goals can guide you. Maybe you’d like to work less and enjoy life more, take a major vacation or ramp up your retirement savings.
Having a Child
This is the flip side of the above. The first costs of having a child are all the medical bills associated with pregnancy and delivery. There are also ongoing medical bills for your child’s health. Having a child may mean moving to a larger home or to a neighborhood in a better school district, which can increase your budget substantially. Childcare, possibly private school and, one day, a college education are also major expenses. Then there’s food, diapers, clothing, strollers, car seats, toys, birthday parties, braces, extracurricular activities and so much more. According to a Wall Street Journal calculator, the average cost for a middle-income family to raise a child born in 2013 to age 18 is more than $245,000.
This life change may require you to rethink every aspect of your earning and spending. For example, is there a way one spouse can make more money while the other stays home? Can you move closer to grandparents willing to provide childcare while you work? Do you really need cable TV? Why on earth do you still have a landline phone? Do you need that $70 a month cell phone plan when you could go with a low-cost carrier for $30 per month? Can you become a one-car household for a while? Can family vacations be road trips instead of plane trips?
As you can see, multiple factors can change your financial situation from month to month and year to year. It’s important to be flexible and adjust your budget to reflect these changes so that you’ll be able to continue making the best possible use of your money no matter what’s going on in your life.
As with our earlier sections on how to cut your budget in different categories, major life changes require some careful analysis. Sometimes you will feel rich. Other times, you’ll be glad you spent all that time figuring out how to assemble an emergency fund.