True Story: How One College Student Budgets
The story of how a 20-year-old pays her bills
Lexi is a college student. She's living on her own, outside of her mom's house, for the first time in her life. She's budgeting and learning how to pay her own bills.
She doesn't have any specific marketable skills. She also doesn't have a steady source of income. Her only job is performing at parties. Lexi has a great voice, and she's on-call with a talent agency to sing at birthday parties, bar mitzvahs, and other events.
On the nights that she works, she earns good money; she'll sometimes bring home as much as $500 or $600 in a single evening. But then she'll go for a week or two without any more paying gigs.
College Student Expenses
Lexi needs to pay for:
- Rent on her apartment - $575, includes water and trash service
- Electricity bill - Varies
- Car Payment - $180 per month
- Groceries - Varies
- Gasoline - Varies
- Car insurance - $450 every 6 months
- Income taxes - since she's self-employed
- Discretionary income (going out with friends) - Varies
- Clothing - Varies
- Toiletries (e.g. trips to Target, Walmart) - Varies
- Wireless Internet - $40 per month
- Cellular Phone Plan - $80 per month
What's the Best Way for Her to Budget?
Step One: First, she should add up all of her "fixed" bills. For quarterly or semiannual bills such as car insurance, which arrive every six months, she should divide the total so that she knows what her monthly obligations are. (Her car insurance, for example, is $450 every six months, which equals $75 per month.)
Her "fixed" bills add up to $950 per month, plus one-fourth of her total income, which she needs to set aside for paying self-employment taxes.
Step Two: Next, we need to divide her "variable" bills into two categories: necessities and discretionary.
Her variable bills include electricity, groceries, gas, taxes, toiletries, clothing, and going out with her friends.
The necessities on that list include electricity, groceries, gas, taxes, and some (but not all) toiletries. (Shampoo and toothpaste, for example, are necessities, but hair gel and teeth-whitening strips are discretionary.)
The discretionary items on that list include some toiletries, clothing, and going out with friends.
Step Three: Estimate the cost of her variable necessities. She can do this by looking at the past few months of receipts (and/or credit card statements) to see how much she spent on the combined items on that list.
She Understands Her Situation. Now What?
Throughout the month, as Lexi earns money, she should first set aside 25 percent of each paycheck for taxes.
The other 75 percent she should set aside for her "fixed" bills ($950 per month) and her "variable necessities" (such as her estimated grocery, gas and electricity bills).
Any money she earns after paying all of those bills can go towards "discretionary necessities" such as going out with friends, buying clothes and taking a spring break trip.
Lexi is in a good spot compared to many college students. The Georgia HOPE scholarship - which gives free tuition and books to in-state students who maintain a 3.0 grade-point average or better - is covering all of her school-related costs. Lexi doesn't need to worry about saving money for tuition, nor will she need to take out loans.
(The HOPE scholarship also covers housing costs for full-time students, but Lexi has decided to take a year off from school. As a result, she needs to pay her own rent, utilities and other cost-of-living expenses.)
Since she's under 26, she can stay on her parent's insurance plan, so she doesn't need to worry about buying health insurance. That relieves her from paying a large monthly premium.
In an ideal world, Lexi would also start putting aside some of her earnings in a Roth IRA, which is a retirement savings account that's generally ideal for young people and low income earners. That's because contributions to a Roth IRA, unlike a traditional IRA, are taxed upfront rather than upon withdrawal.
Lexi's earnings at this point in her life keep her in a low tax bracket. By putting money in a Roth IRA, Lexi can take advantage of her current low tax bracket by paying taxes on that money now. She'll never pay a dime on the dividends and capital gains that her money accrues within the IRA, not even when she withdraws it in retirement. The money she can earn from Roth IRA contributions at age 20 will be substantial; that money will have 45 years to compound its gains.