Session 2: Budgeting and taxation

Introduction

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MARTIN LEWIS

Budgeting and taxation, both sound simple. Both are easy to get wrong. Let’s start with budgeting. Obviously, as a working person, you shouldn’t spend more than you, yeah, earn.

But when it comes to doing a budget, many people approach it the wrong way. Two big tips to start. First of all, don’t just look at one month’s finances. That will cause a lot of mistakes.

We don’t spend by the month. Sometimes we spend by the week, sometimes the month, sometimes the year. We might buy a new sofa every five to 10 years, and you have to factor that all in.

So when you’re doing the budget, get at least three months’ worth of bank and credit card statements, and go through them item by item. But don’t forget to factor in Christmas, 600 pounds a year, and your summer holiday, and those big one-offs. Put them all in there to get a true picture.

The next problem when it comes to budgeting is most people try and go big, when you should go small. What do I mean by that? Well, you might have the category motoring. What’s that, 100 pounds? No.

Don’t have a motoring category. You need to have petrol, car insurance, breakdown cover, MOT, replacement tyres, item by item. Do it small. Gives you greater accuracy, and means there’s a less of a chance of missing it.

Then, after all of that, you’re going to add up your expenditure, and hopefully it’ll be less than your income. If it isn’t, well, you’re overspending, and that leads to one of two things. You either build up debt, or you reduce your savings. And in most cases, you don’t want either.

So how do you then control your spending once you’ve got your budget? Now, the technique I use, I call it piggy banking. Some people call it jam jarring. It works like this. The big problem is when you look at your bank statement, it lies.

It doesn’t tell you what’s coming in and out. It’s just a snapshot of today’s money. So we need to make it tell the truth. And the way you do that is by having different categories of known spending.

Bills is an obvious one most people should have. And you’ll know how much to put away for your bills from your budget. But you could have clothes shopping, Christmas, summer holidays. And then each month, when your money comes in, you syphon it away in the right account.

We’ll stick with that 50 pounds a month for Christmas. Then when it comes to Christmas, you know how much you can spend on it without worry. When it comes to your summer holiday, if there’s 300 quid in there, you can spend 300 quid. If you want a 600 pound holiday, you know you can’t afford it. But it also now means your actual bank account, when you look at it, is telling you what you can truly afford to spend.

Now, taxation, it’s really important to understand what money the state is taking off you. Of course, tax is the cost of living in a legitimate, civil society. It’s what we pay for our membership, and the money’s then spread out to everybody, possibly redistributed.

You may be a beneficiary. You may not. But either way, understand how it works. And my emblematic example of that is your tax code. If you’re a working person or on a pension, each year you’ll be sent a tax code, something like 1250L. Now, most people get it, look at it, don’t know what it means, and forget it. But your tax code is what dictates to your employer or your pension company how much tax to take away from you. And do you know whose responsibility it is to get it right? Not the state’s, not your employer’s, yours.

So if your tax code’s wrong and you’ve been overpaying tax for years, meaning you’ve got too little income, you may be able to get it back, but you could have had a cash flow problem. If you’ve been underpaying tax for years, guess what? They’re going to ask you for more money once it’s discovered. You’re going to be upset.

How am I going to find the cash? I thought this was all right. Your tax code is your responsibility. This module is going to explain to you how taxation works. Don’t ignore it. It’s important.

End transcript: Video 1 Introduction to Session 2

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Video _unit3.1.1 Video 1 Introduction to Session 2

This is the second session of a course on money management produced by The Open University in collaboration with MoneySavingExpert.com.

In this session on budgeting and taxation you will learn how the income you receive – your net income – is affected by the deductions of income tax and National Insurance Contributions (NICs) from your gross income.

You’ll then explore the characteristics of your spending before you start building your budget.

Understanding how to manage your budget provides the foundation of good financial management and in this session you will learn how to go about this.

After studying this session, you should be able to:

• understand how income tax and National Insurance impact on earnings
• understand household spending
• compile a budget
• understand the key aspects of budget management.