Summary: How to split expenses 101
Money is a stressful topic. A survey of married couples conducted by the Bank of Montreal in 2014 found that fighting over money would be their top reason for divorce, followed by infidelity1. Those at both ends (and in the middle) of the income spectrum fight about money, so it isn’t just about not having enough. Conflict also arises when partners have different outlooks on household finances that lead to disagreements on how funds should be spent or saved and on how expenses should be split.
As with anything, if you fail to plan, you plan to fail. It is therefore important to establish ground rules of how finances will be jointly managed.
How do we best split expenses if there is a big discrepancy in earnings?
Canada employs a graduated tax system, meaning that as your income grows, so does the percentage of your income that you pay in tax. The motivation behind this kind of tax system is the belief that those earning higher incomes can afford to dedicate a greater percentage of their incomes to taxes versus those that are lower on the income scale and likely have to devote proportionately more of their income to necessities (food, shelter, etc.). Given that more of the financial burden is shifted to higher income earners, our taxation system is described as progressive (alternatively, a system where lower income earners bear more of the burden is regressive).
Why did I spend all this time explaining our tax system? Because I feel that this methodology is also applicable for division of household expenses. Rather than splitting expenses evenly, or even proportionately to incomes, I believe a more effective mechanism is splitting costs progressively.
Say one partner has a take-home income of $80,000 and the other partner takes-home $40,000. Household expenses in this scenario are $60,000. Splitting expenses evenly would have each partner contributing $30,000, leaving the higher earner with $50,000 left over and the lower earner with $10,000. Proportionate splitting would indicate that the higher earning partner should pay for 2/3 of household expenses, or $40,000. The lower earning partner would contribute the remaining $20,000. However, even with proportionate division of expenses, this puts drastically different strain on the partners’ respective finances. The higher earning partner has discretionary funds of $40,000 after household expenses are met, whereas the lower earning partner only has $20,000. Significant disparity in funds will have major differences on how partners will be able to save, budget for more expensive purchases, or spend on leisure. This can quickly develop into a source of tension in a relationship.
When a significant earnings discrepancy is present in a relationship, it may make sense for the higher earning partner to contribute more to household expenses than their proportionate income would dictate. Of course, this methodology only applies if finances are not being combined.
What if one partner has debt?
For those with money to save and invest, compound interest works in your favour. For those with debt, it works against you. Interest accrues on top of debt balances, and additional interest is subsequently charged on the initial interest. It’s why some people spend years making minimum payments on student loans and never put a dent in the loan balance.
Unlike other expenses, debt compounds over time. A small expense becomes bigger and bigger. Repaying debt, especially when it carries a high interest rate, needs to be prioritized. Based on degree of financial integration between partners, I feel that there are three approaches to tackling debt balances:
- Debt repayment can be included as a household expense and divided according to the progressive expense sharing strategy discussed earlier. If you feel that your finances are fully integrated, and the “what’s mine is ours” mentality extends to debt, then this would be the most straightforward way to handle debt repayment.
- If the debt balance is not being included in household expenses, then the non-debtor partner can bear a larger proportion of the household expenses, thus freeing up more funds for the other partner to repay debt.
- At the lowest level of integration, the partner with debt exclusively manages repayment and their existing debt balances are not accounted for in the proportion of other household expenses that they pay for. In this instance, the partner without debt can opt to cover more of the discretionary expenses like restaurant meals and entertainment to ease the financial burden of debt repayment.
What if partners have different outlooks on money?
In relationships, the scrimp-and-save mindset often comes into conflict with the current consumption mindset. I’m biased, but I feel that the latter mentality is the result of cognitive dissonance that will eventually become apparent in painful ways. When I do well on an exam, I thank my past self for the time I put in studying. When I wake up with a hangover, I chastise myself for drinking too much the night before. On much longer timelines, those that retire comfortably thank their younger selves for good saving and investing habits. Poor financial habits today maximize gratification in the moment at the expense of long-term well-being. Your future you is still you; your future self will either suffer the consequences or reap the rewards of present-day actions.
By shifting your partner’s outlook on money, you are helping their future self. This starts with small steps like confirming household income and fixed expenses in order to establish a budget. From there, ground rules should be established, such as the need to agree upon big-ticket purchases in advance, and the importance of not using debt to pay for discretionary spending. Not everyone will have a passion for personal finance, but everyone should learn the basics of sound financial decision making.
One of the reasons that money is often a cause of stress in relationships is because couples lack a plan for their finances. When ground rules are set to split expenses and good budgeting is established, then finances can be used as a tool to bring partners closer together rather than pushing them apart.
Opinions are those of the author and may not reflect those of BMO Private Investment Counsel Inc., and are not intended to provide investment, tax, accounting or legal advice. The information and opinions contained herein have been compiled from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness and neither the author nor BMO Private Investment Counsel Inc. shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance. BMO Private Investment Counsel Inc. is a wholly-owned subsidiary of Bank of Montreal.