Funding The Future
The last year has been Jonathan Steen’s version of the perfect storm. His wife stopped working and gave birth to twins, and he went from being a salaried associate to a self-employed of counsel member of his law firm.
Although Steen is excited about the changes, they have wrought budgetary havoc. His new employment status gave him a better but more fluctuating income. Some months he has more than ample cash to cover his expenses, while at other times he draws on a line of credit to get by.
“I may not always have enough coming in to pay fixed expenses,” says Steen. “But, fortunately, there are periods of peaks that allow me to catch up. Still, it’s very stressful in between.”
Life Audit financial expert Thomas Haunty says Steen’s situation is not that unusual. As lawyers leave behind jobs as salaried associates to become partners or of counsel, they find themselves with significantly better earning potential but also with uncertain monthly cash flow. The only way Steen can navigate a future of unpredictable income is by budgeting. But Haunty is not talking about cutting back. Rather, he wants Steen to get a firm grasp of his finances so he can bankroll his family’s future.
Haunty has created a budgetary framework. The process requires that Steen earmark funds for all of his expenses, investments and savings, which will be deposited over time in and out of a variety of bank accounts. Bills are still paid from a checking account that is funded from income and savings accounts, depending on the expense.
To begin with, Steen and his wife need to pull out a pad of paper and start crunching some numbers.
Tackling their annual income is the first goal. They need to estimate their annual income realistically so they have a number on which to base the budget. Haunty suggests that they estimate it somewhere in between worst- and best-case scenarios and at a level where the family can live comfortably.
The figure also is important so that Steen can better estimate his income tax liability. Like many others, Steen withholds too much each paycheck and then gets a hefty tax refund. Haunty would prefer to see Steen keep the extra cash on hand each month instead of turning to a line of credit to make up for shortfalls. Periodic checks of his income should be made to ensure his tax withholding continues to be on track. If not, he should make any necessary adjustments.
Next, Steen needs to calculate all of his expenses and establish a way to pay for them. Doing so may seem like a monumental task, but Haunty says it is more a matter of advance planning.
Steen knows all of his fixed monthly expenses, such as mortgage and car payments. He has been doubling or tripling some of these payments. Haunty wants him to stop and factor into the budget only the required amount. Overpaying is helping foster budgetary chaos.
GET A GRIP ON VARIABLES
Steen needs to plan better for variable expenses like the costs of insurance, holiday gifts and vacations. These bills arrive one to four times per year and are big enough to blow the budget for the month. Many people pull out a credit card to pay for such items, allowing themselves to overspend.
But those irregular variable expenses can easily become fixed through financial modeling. Haunty tells Steen to identify all the categories of irregular variable expenses he encounters and then to put a spending cap on them. With numbers attached to those expenses, they should be funded with a separate savings account called a “savings to spend” account.
“If you are setting aside 100 bucks per kid for Christmas, take out $8.33 per kid each month and put it in the ‘savings to spend’ account,” says Haunty.
Another separate savings account can be established to fund other anticipated (and unanticipated) large purchases like a minivan or children’s furniture. The key, Haunty emphasizes, is always to be planning ahead, anticipating and not just reacting after the expense arises.
Most important for Steen is the need for a third savings account, which Haunty calls a “working capital” account, to bridge the gap during short cash-flow months. Steen needs to build this account so that it contains as much as three to six months of shortfall cash. This way he will have money to cover low-income months and won’t need to take on additional credit card debt or a home-equity loan.
Haunty urges Steen to take advantage of electronic banking to facilitate funding of these accounts and to make saving money a regular habit. Most banks offer Internet-based transactions so that customers can automatically transfer a set amount of funds each month between accounts at the same bank, making it easier to budget and save money.
While budgeting requires much planning and discipline, Haunty tells Steen to remember to include some fun in the process. Budgets should include money for entertainment, trips and the occasional indulgence.
“To be a budget system that really helps,” Haunty says, “it should not feel like a burden but instead should allow you some rewards so you can embrace it.”
Thomas A. Haunty
Thomas A. Haunty, CFP, REBC, is a senior associate with the North Star Resource Group in Madison, Wis. He has provided financial assistance to lawyers and their clients since 1982.
Jonathan O. Steen
Position: Of counsel, Armstrong Allen in Jackson, Tenn. Age: 38 Goal: Budgeting on a fluctuating income
Life Audit Hot Tip: Stop Overwithholding
How many exemptions should be taken from your paycheck? Most people think it’s one per dependent family member, but that’s not true, says Life Audit financial expert Thomas Haunty. Instead, complete an annual income tax projection and determine what you owe per paycheck. Then ask a member of your human resources department or a tax expert to determine the number of exemptions that should be taken out of your paycheck to equal your per-paycheck tax liability. Chances are you’ll find that you’ve been overwithholding and you can use that extra cash flow to balance your budget.
• Write it down
• Estimate a reasonable income
• Figure out proper income tax withholding
• Calculate all expenses
• Automate savings and checking transfers
• Allocate funds for expenses
• Let it float in your head
• Base it on worst- or best-case scenarios
• Overwithhold; it’s better to have the cash sooner than to have to borrow it
• Overpay fixed expenses; it reduces available cash flow
• Rely on manual transfers between bank accounts; it’s too burdensome
• Depend on credit cards; they make it too easy to go over budget