A General Guide to Saving Using the 50/30/20 Rule
I received an Instagram message recently that read, “How much should I be saving every month?”
I had a couple of follow up questions liiiiiike...What’s your income? How old are you? Are you saving for something specific? Do you have a 401(k)? Are you maxing it out? Do you have any high interest debt? What are your monthly expenses? Are you a multimillionaire?!
Do you see where I’m going with this? There’s no one size fits all answer to that question, because everyone’s financial situation is entirely unique; however, there is a general rule that can help get you started called the 50/30/20 rule.
Before we go any further, I want to call a bit more attention to the word “general.” If you’re starting from ground zero, implementing this rule will provide you with very clear direction. On the flip side, if you’re on the road to financial independence and are planning to retire within the next decade, you (a) probably aren’t reading this article and (b) would probably assign MUCH different percentages to the categories we’re about to discuss. The beauty of this rule is that the “bones” of it can work for anyone.
Let’s dive in, shall we?
What is the 50/30/20 Rule?
This rule takes a lot of the guesswork out of appropriately handling your hard earned cash by providing you with specific percentages of your take home pay that should be spent or saved on certain categories. While this is widely known as a budgeting rule, I think it’s the most clear cut answer to the “how much should I save” question. (Fun fact: The rule was first introduced in 2005 in a book titled, “All Your Worth: The Ultimate Lifetime Money Plan,” written by Senator Elizabeth Warren and her daughter.)
It advises you to allocate your after-tax income to 3 different categories: 50% for needs, 30% for wants and 20% for saving or paying off debt.
50% Needs - think “food, shelter, water” — Examples include:
Monthly grocery bill
Rent or mortgage payment and accompanying utilities (gas, electricity, water)
Cell phone bill
Internet
Insurance
Personal care items
Car payment
Your needs should include expenses that are non-negotiable and contribute to your staying alive, taking care of dependents, or working.
30% Wants - think “nice to haves” — Examples include:
Retail therapy
Travel
Gym memberships
“Fun” Subscriptions
Food delivery
Your wants aren’t necessary to keep you alive, but they do contribute to some additional level of happiness. These are important and should be included in your budget, but they shouldn’t make up a majority of your monthly expenses.
20% Saving or Paying Off Debt — Examples include:
Paying off student loans
Paying off your car note
Contributions to individual retirement or brokerage accounts
Building an emergency fund
Saving for a large purchase or trip
Your savings should be used to pay down outstanding debt or fund your future.
Let’s explore what this looks like with a real salary and how you can make this rule more customizable for your income level and specific savings goals. We’ll start with the basics!
Income vs. After Tax(+) Income
It’s really tempting to see your annual salary, do some quick mental math (if you aren’t me, lol), and start to estimate how much money you’ll have to play with every month. Don’t do that to yourself — you’ll thank me later.
Why? Let’s see! Assume your annual salary is $60,000 and you’re paid every 2 weeks. If you were to do the little aforementioned mental math exercise, it would reveal that you could expect ~$5,000 to hit your account each month. WOOHOO - dinner’s on you tonight!
But there’s something you should know… you only get to touch about half of that cash.
Why? Because there’s a big difference between your stated annual salary and the annual salary that actually hits your bank account. That’s why I was sure to underline “after-tax” in the first section. After-tax income is the amount of money that hits your checking account after taxes (federal, state, and withholding) are set aside for Uncle Sam.
If you receive health insurance through your employer and/or take advantage of employer tax-advantaged savings plans (like a 401(k) or HSA), you’re going to have even less money at your disposal each month. Let’s call what’s left over, after all things are considered, your “after tax(+)” amount.
The after tax(+) amount equals:
Your gross monthly salary (aka, the amount that you calculated with quick mental math without taking out taxes or anything)…
after your tax withholdings are removed
after your 401(k) has been funded
after your HSA or FSA has been properly padded
after you’ve paid health insurance premiums
after any other automatic contributions related to your employer are successfully transferred
#Adulthood amirite? Let’s look at some numbers to bring this thing to life.
Sticking with the same example, assume your annual salary is $60,000 and you’re paid every 2 weeks.
You plan to max out your employer 401(k) plan — $20,500 for 2022
You’re on the high deductible health insurance plan — $110 per month
You add $200 per month to your Health Savings Account (HSA)
Your tax withholdings are set at 0 (withholding the maximum)
If you’re having flashbacks to the word problems that started out like “If Train A is going 50 mph, and Train B is going 70 mph” stick with me! Let’s take all of that nonsense and make sense of it by turning it into a “monthly income” number so that we can easily apply the 50/30/20 rule:
Gross Monthly Income: $5,000
Less: Monthly 401(k) contributions: ($1,708)
Less: Insurance costs ($110)
Less: Monthly HSA contribution: ($200)
Less: Monthly Estimated Tax Withholdings: ($688)*
Monthly After Tax(+) Income: $2,294
*This is a rather complicated number to estimate, so I encourage you to check your pay stubs each pay period to understand how much is withheld from your paycheck based on your own elections.
Here’s what the 50/30/20 split would look like using the $2,294 after-tax(+) income amount:
50% (Needs) - $1,147
30% (Wants) - $688.20
20% (Savings) - $458.80
If you’re looking at these numbers thinking “umm…my rent is higher than the calculated 50%” or “I’m trying to save at least $600 a month, not just $458,” have no fear! You don’t have to blindly follow these percentage guidelines if they don’t work for your particular financial situation.
Customization Station
Super Savers
When I first learned about this rule, I stared at the savings percentage for a long time thinking to myself, “this is wonky.” Why are the general guidelines telling us to put “frivolous spending” above saving?
Well, the reality is, this rule helps you sneakily save way more than you think. Because you allocate after-tax(+) income to the 3 categories, you end up saving more than just 20% each month (if you take advantage of those employer provided retirement and health savings plans we just talked about.) In this example, you’d be saving more like 47% of your total income if you add your 401(k) and HSA contributions to the $458 savings amount.
If 47% still isn’t enough for you — maybe you’re aggressively saving for a house, wedding, or some ballin’ vacation — go ahead witcha bad self! Try adjusting your split to 50/10/40 or 40/10/50. If your necessary monthly spending is lower than the calculated 50% and you’re happy to decrease your fun spending now to reach a bigger goal down the road - why not?
Practical People
On the flip side, you may be more concerned about the number allocated to your “needs.” If your necessary monthly expenses exceed the calculated 50%, you may have to pull money from your “wants” category in order to make ends meet. If that’s the case - track your modifications for a few months until you notice a trend. Once you identify how much you’re consistently stealing from other categories, adjust the split! Maybe try out a 60/20/20 or a 70/10/20 split.
Ready to Start Saving?
There are clearly so many different ways you can slice this, but don’t get overwhelmed by all of your options and forget to actually start. If you’re brand new to this - apply the basic 50/30/20 rule and then make modifications after a few months. If you’ve already built good saving habits or have a specific savings goal on the horizon, try out different variations of this rule to expedite your savings with an aggressive approach (40/10/50) or smooth your savings with a moderate approach (50/20/30). Saving anything is better than saving nothing - everyone has to start somewhere.