Annual Expenses: When Dividing By 12 Doesn’t Work
My wife and I both have term life insurance policies. My annual life insurance premium is due in November. Her premium is due in December. In a perfect world, I’d divide my annual premium by 12, place that amount in my checking account each month, and then pay the bill in full when due. But, what do you do when you have an “annual” expense, but you don’t have 12 months between the due date and today?
Option 1: Calculate the number of months between today and the day the annual bill will be due. Divide the premium by the number of months. Let’s use my life insurance premium as an example. The bill will arrive at my door at the end of November. So, counting November, there are about 6 months between now and then. Simply divide the annual premium, say $300, by 6 months, and deposit $50 per month in your checking account. When the bill arrives, make the payment.
Option 2: Simply budget for the expense in the month that it occurs. Let’s take a look at my wife’s premium, at $250. So, in the month of December, I’ll create a budget category labeled Life Insurance. I’ll simply budget $250 in December for Life Insurance. If you use this method, you must be prepared to cut expenses in another budget category, Entertainment, perhaps.
Option 3: Create a budget category labeled Annual Expenses. This works really well if you have several, similar annual expenses. You might have an automobile insurance premium due in January, a life insurance premium in April, a renters’ insurance premium due in September, and automobile taxes due in December. Estimate the total amount of all of these annual expenses, divide that amount by 12. All of your annual expenses become one big budget category. In some cases, you might be paying a different annual expense each month. So, instead of breaking down each expense into it’s individual category, one category will suffice.
Option 4: Don’t budget for annual expenses. Instead, set aside as much as you can in savings, every month, and then make annual payments as they come due. This is similar to Option 3, but allows for the fact that your annual expenses may change, you may incur new annual expenses, or you simply don’t like to deal with the “math” involved.
Option 5: Ask the companies with which you do business to bill you on a monthly basis, instead of an annual basis. For instance, I have the option of paying my automobile insurance monthly, annually, semi-annually, etc. (Bonus fact: MANY companies will give you a discount if you pay your bill on an annual basis. Do the math! Determine if the discount is worth it. Or would you be better off leaving your money in the bank, accruing interest?)
There are some annual expenses which vary, year after year. Examples include property taxes and health care expenses (out-of-pocket). Let’s assume that the maximum out-of-pocket expense associated with your health care plan is $2000. You have a choice to make. Do you divide $2000 by 12, and deposit that amount into your checking account each month, “just in case”? Or, do you hope that your family has an extra-healthy year and not worry about it? Here’s what I do. I acknowledge the fact that I could have to fork out the maximum amount. But, I also know that we’ve never come close to paying out that much in one year. So, I split the difference. I budget a specific amount for Medical, each month, and then I prepare to “dip” into my Emergency Fund, should expenses be higher that I anticipated.
One more thing. If you use a savings account to “stash away” money for annual expenses, be aware that MANY savings accounts have limits on the number of withdrawals you are allowed to make in a month (or quarter). For this reason, I prefer a money market account or interest-bearing checking account.