A budget should be based on a person’s _ income. (Gross, Net, or discretionary)
The Correct Answer and Explanation is :
The correct answer is net income.
Explanation
A budget should be based on net income because it represents the actual amount of money available to spend after mandatory deductions. Gross income refers to the total earnings before taxes and other deductions, while discretionary income is what remains after paying for necessities like housing, food, and utilities. Neither of these provides a realistic foundation for creating a reliable budget.
Why Net Income is Key
Net income accounts for deductions such as:
- Taxes: Federal, state, and sometimes local taxes reduce gross income significantly.
- Social Security and Medicare: These mandatory contributions impact take-home pay.
- Retirement Contributions: If you contribute to a 401(k) or similar plan, this amount is deducted from your gross income.
- Other Deductions: Health insurance premiums and other workplace benefits may also reduce gross income.
By using net income as the foundation for your budget, you avoid overestimating the money you have available. Budgeting based on gross income could result in financial shortfalls because it does not account for obligations that reduce your earnings.
Building a Budget with Net Income
- Calculate Net Income: Determine your take-home pay for each paycheck.
- Track Expenses: Categorize fixed expenses (rent, insurance) and variable expenses (groceries, entertainment).
- Set Savings Goals: Include savings in your budget for emergencies, retirement, or specific goals.
- Allocate Funds: Use the 50/30/20 rule:
- 50% for needs (essentials like rent and utilities).
- 30% for wants (entertainment, hobbies).
- 20% for savings and debt repayment.
Using net income ensures your budget reflects your financial reality, helps prevent overspending, and promotes financial stability.