Debt-Proof Living, Part 5 - Freedom Account

This section will discuss what I believe is one of the reasons so many people have trouble with money and rely on credit cards. This section deals with both the non-monthly and unexpected expenses that occur...and how to deal with them.

Part 5 - Freedom Account

Many people have the problem that their monthly expenses (ie. rent, groceries, utilities, etc) equal (and often exceed) their monthly take-home pay. People often consider these monthly expenses to be their necessary expenses because they repeat every month. However, not every necessary expense repeat every month.

Most people don't allow for the things that happen occassionally or unpredictably. These include items such as car maintenance, clothing, house maintenance, quarterly utilities, birthday and holiday gifts, deductibles, travel, insurance, pets, etc.

So, how does Mary say we should handle these occassional and unpredictable expenses? She created the Freedom Account (FA). The FA is a tool that turns unexpected, irregular, and intermittent expenses into ordinary, predictable, and necessary expenses. If you have heard of the "Christmas Club" that many banks or employers have that allow you to have money deducted from each paycheck and then give it back as Christmas nears to allow you to buy your presents...the FA is very similar. This will take time to set up and really get going, particularly if you are already spending everything you earn on your monthly expenses. But as you find ways to either reduce your current spending or earn more money, you will find that the FA helps you prepare.

How to Set it Up:

1. Figure out what occasional and unpredictable expenses you have. You will probably need to look back through old statements and checkbooks to figure this out. You will need to find all expenses that do not occur every month. These might include bills that come quarterly, every six months, or annually. They might occur so sporadically that you might not know when it will come up again, if ever.
   
2. Next to each expense, list the annual amount spent on it. For some expenses, this will be easy because you'll know exactly how much you spend. But for others, like car maintenance, there wouldn't be a set amount. This is where you have to make an educated guess by looking at how much you've spent previously on car maintenance. You may also need to multiply some expenses to get the annual amount (by 4 if quarterly, 2 if every six months, etc).
   
3. Divide each annual amount by 12. This will give you how much you should save for each expense every month. If you spend $120 a year for your car taxes, you will save $10 a month. This way when it is due, you'll have the $120.
   
4. Open a second checking account or online savings account. Mary recommends this so that you keep it separate from your regular monthly expense money. This will help you from "accidentally" spending it. A checking account will allow you to write checks when you need to pay. A savings account requires more work because you'll need to transfer money back and forth, but you'll earn some interest on it.
   
5. Create a Freedom Account notebook. Mary recommends a 3-ring binder to that you can add and remove pages easily. Each expense that you listed in step 1 will be treated as a subaccount. Each subaccount will have its own page. Each page will be set up with columns labeled: Date, Description, In (Deposit), Out (Expense), and Balance.
   
6. Make a deposit every month. Every month, you deposit into your FA the amount that is equal to the total monthly amount needed you figured out in step 3. If you are paid weekly, every other week, or twice a month, you will probably want to divide up this amount between each paycheck. On each subaccount page, you will add the deposit for the required amount of that subaccount. Then when you need to use it, you will write when you spent it, where you spent it, and how much you spent.

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Some expenses will be completely used up whenever you pay it, such as insurance. However, others like clothing, will probably always have a balance because you probably won't spend it all.

Examples of Irregular Expenses:

• Accountant (for Taxes)
• Taxes (if owe)
• Clothing
• Car Inspection
• Car Insurance
• Car Taxes
• Car Registration
• Car Maintenance
• Home Maintenance
• Lawn Care
• Pest Control/Termites
• Veterinarian
• Garbage
• Water/Sewer
• Magazines
• Entertainment (movies, plays, etc.)
• Gifts (birthday, holiday, wedding, etc.)
• Travel
• New Car
• Prescription
• Insurance Deductibles (medical, car, home)
• Property Taxes (if not escrowed)
• Home Insurance (if not escrowed)
• Renter's Insurance
• Appliance Replacement

Frequently Asked Questions:

1. How do I balance this account? You would add up each subaccount and that should equal the balance on your statement (minus allowances for uncleared checks and deposits not posted).
   
2. What happens if I have an expense that is greater than the current balance? If at the time you start your FA, you know that an expense you pay every six months is due in 3 months, you should save a third of what is due each month so you'd have enough by the time it was due. Then, you would go back to saving the regular amount. However, this might not be possible, or the expense might be larger than you thought. One option is to work a few extra hours to earn some extra money (or sell some stuff). Another option is to use whatever money is already available in that subaccount, supplementing it with money from your regular checking account or put on credit card. Then, you would pay yourself back or pay off the credit card charge the next month with the money you paid into that subaccount the next month. It will take some time to get this account working properly, but eventually you will do it and it will help you out tremendously.
   
3. Should I save in my Contingency Fund or fund my Freedom Account? Ideally you would do both at the same time. Remember, the Contingency Fund is one of the 10's in the 10-10-80 formula, while the Freedom Account would be considered part of the 80 (along with your regular monthly expenses, including your debt repayment). However, if you can't do both, work on your Contingency Fund first. When something unexpected comes up, you'll be able to use this money to pay it rather than using your credit cards. As you find more money by decreasing your spending or increasing your income, you can start working on your Freedom Account too.

Of all the parts, I think this can be the most confusing. There are so many steps and you might not have the extra money right away. Take it slowly. Start with only a few subaccounts, particularly those that are due the soonest. Then, you can add subaccounts and work up to saving the desired amount determined earlier in step 2. It's Your Money has a great write-up about the Freedom Account, so check it out for more information.

And remember, you can always post a comment if you have any questions and I'll respond as quickly as possible.

Debt-Proof Living References:

Part 1 - Tracking Your Spending
Part 2 - 10-10-80
Part 3 - Contingency Fund
Part 4 - Debt Repayment
Part 5 - Freedom Account
Part 6 - Spending Plan
Part 7 - Savings Levels