Learn Budgeting 101 The 50/30/20 Budgeting Rule

50/30/20 Budget

The 50/30/20 rule is one of the most effective budgeting methods to align your expenditure and saving goals. It ensures you do more than just pay your bills on time, but also enables you to determine how much you should spend and on what.

This budget rule is an excellent technique for diversifying your financial profile and fostering financial health. In this post, we’ll take you through everything you need to know about using this budgeting technique.

What is the 50/30/20 Budget Rule?

The 50/30-20 budget rule breaks down your after-tax monthly income into three main categories: needs, wants, savings, and debt.

It stipulates that you should spend 50% of your income on needs, 30% on wants, and 20% on savings and debts.

Graph showing the 50-30-20 budget rule

The 50/30/20 budget planner was introduced in the book by Senator Elizabeth Warren and Amelia Warren Tyagi (her daughter), titled “All Your Worth: The Ultimate Lifetime Money Plan.” It has since become one of the most popular budgeting techniques, thanks to its simplicity, flexibility, and adaptability to different stages of life.

You don’t need any special tools or know-how to make it work for you. This makes it an excellent tool for people who don’t know how to budget.

Unlike other budget methods that rely on the amount of income, the 50/30/20 rule relies on percentages of different spending categories. As a result, you can apply it to different scenarios.

Is the 50/30/20 Rule Necessary?

The 50/30/20 rule is a great budgeting tool for most people.

If you don’t like detailed budget tabulations and complicated spreadsheets, you can use this suitable budgeting strategy.

There are many reasons to use the 50/30/20 budgeting method, including:

● Improving your credit: This rule allows you to allocate money for debt to help you get out of debt and ultimately improve your credit score.
● Achieving your financial goals: Whether you want to pay for a new car, go on a summer vacation, or put a deposit on a house, the 50/30/20 budgeting method makes it easy to save money.
● Improving spending habits: Many people live paycheck to paycheck as they overspend on unnecessary things. This financial tool can help you improve your spending habits because it guides you on where your money should go.
● Holding yourself accountable: This reasonable budget strategy accounts for every dollar, giving you an incentive to stick to the plan.
● Helping prepare for an emergency: Life is full of unforeseen surprises. A 50/30/20 budget allows you to put aside money for these emergencies, which may include becoming sick or injured, being laid off, going through a divorce, etc.
● Control over Your Finances: This budget type is a financial roadmap that will improve your family relationships and give you a sense of direction for the future.

It’s not always easy to stick to a budget, especially if you are new to budgeting. That said, identifying the reasons for saving can motivate you to achieve your financial goals.

Budget Your Money Using the 50/30/20 Rule

If you don’t know how to start your budget, breaking it into the three main categories of the 50/30/20 rule can be really helpful. These can help you balance between goals, obligations, and splurges.

Here is how to organize your finances using the 50/30/20 budget.

Step #1: Calculate Your After-Tax Income

An after-tax income is the net income after all the state, federal, and withholding taxes are deducted from the gross income. It represents the amount of disposable income available to spend.

If you have a steady job, the after-tax income is indicated on the pay stubs. Self-employed individuals can calculate their after-tax income by deducting business expenses and taxes from their gross income.

Step #2: Needs (50% of the Income)

Financial needs are the expenditures essential for you to be able to live and work. These essential expenses include housing, utility bills, transport, clothing, and food. Set aside no more than 50% of the after-tax income for your monthly expenditure.

What if 50% of your income is not enough for all your essential expenses? This is a sign that you are living beyond your means and need to adjust your lifestyle accordingly.

Step #3: Wants (30% of the Income)

Wants are the expenses that help you live more happily and comfortably. These include entertainment, traveling, gym membership, dining out, and designer clothing. Allocate 30% of your income for your wants.

The fewer the expenses in this category, the more you can save for a rainy day.

Step #4: Savings (20% of the income)

The final 20% should go towards paying off debt and securing your financial future through saving. Make sure you have enough emergency savings to last you three months if you lose your job.

Once you’ve cleared your debt and set aside an emergency fund, work on your retirement fund, and achieve any other financial goals you may have.

Step #5: Stick to Your Plan

A budget means nothing if you don’t stick to it – you will not realize its real value. The best way to ensure you abide by the rules is by splitting up the money into the three main categories immediately you get your income.

If your living expenses are high, consider implementing some of our budget tips to save more. You also don’t have to spend all the money you’ve set aside for your “wants.” If you have a balance in this category, move it to savings.

50/30/20 Budget Calculator

To quickly calculate your budget, consider using our 50/30/20 budget calculator, which will show you how much you should be putting aside for your needs, wants, and savings according to your after-tax income.

Calculator 50/30/20 Calculator

Here’s how much you have for:

Example of 50/30/20 Budget Plan

Let’s say you earn $5,000 every month. According to the 50/30/20 budget rule, you can only spend $2,500 on needs per month and no more than $1500 on wants. The remaining $1,000 can be used for savings or to repay debt.

Consider shifting some of the “wants” money to the “needs” column if your monthly rent or mortgage is too high so you can have enough money for other expenses.

Additionally, review your needs to see what you can do to make the budget more manageable. For instance, a credit card with a lower interest rate or cheaper insurance will reduce some recurring expenses.

Graph showing an example of 50-30-20 budget calculator

50/30/20 Budget Spreadsheet

If you would like to create a more in-depth budget, then a 50/30/20 budget spreadsheet should come in handy.

Spreadsheet software like Google Sheets, Apple Numbers, and Microsoft Excel all have ready 50/30/20 budget templates to help make your budgeting fast and easy. Even better, you can download a budgeting excel template and use it right away.

How Do You Include Your RRSP in the 50/30/20 Budget?

RRSP is a retirement savings account for both employees and self-employed individuals. In this plan, income that hasn’t been taxed is placed into the account and allowed to grow free of tax. Ultimately, tax is applied (at the marginal rate) only when it’s time to withdraw.

You can include your RRSP in the savings category of your budget. This, together with other savings, should add up to 20% of your after-tax income. For instance, you can devote half of your monthly savings (10% of your income after tax) to the retirement account, and the rest can go into an emergency savings account or a debt repayment plan.

Employee Savings vs. Self-Employment Savings Using the 50/30/20 Budget Rule

If your employer matches your retirement savings, it makes sense to put a significant amount of your savings into a retirement plan account. Often, you will need to meet the employer’s maximum match threshold. So, instead of prioritizing paying off debt, find a way to pay debts and save simultaneously.

If you are self-employed, ensure you have a significant emergency fund in case of irregular income. This means a significant portion of your monthly income should go into this.

When is the 50/30/20 Budget Rule Not Applicable?

Unfortunately, life is not always straightforward, and there are scenarios where the 50/30/20 budget may not be applicable.

For example, making minimum payments won’t get you out of credit card debt quickly. With credit cards charging as high as 20% interest rates, it makes more sense to prioritize paying off debt over saving.

What’s more, this monthly budget rule doesn’t work for all income levels. Junior employees and college students are almost always forced to spend 80% of their income on needs alone. This means lower savings and money for shopping.

Additionally, many people have to spend 40%-50% of their net income on debt. This makes it challenging to set significant savings aside, even after cutting living expenses to the bare minimum. The same applies to individuals planning to retire early as they are forced to save a more significant percentage of their paycheck.

For high-income earners, the 50/30/20 plan may need some tweaking. For example, if you earn $20,000 in after-tax income, spending $6,000 every month on wants may be a little on the high end.

If the 50/30/20 rule doesn’t work for you, there are a few alternatives you can try, including:

30/10/60 Rule

This is where you spend 30% of the after-tax income on living expenses, 10% on wants, and save 60%.

It is an excellent plan if you want to get out of debt fast while saving for the future. It’s especially viable for individuals with very few expenses.

30/30/30/10 Budget

This technique splits your income into four categories:

  ● 30% for housing expenses
  ● 30% for childcare, groceries, and other household expenses
  ● 30% for debt repayment
  ● 10% on entertainment and other wants

This budgeting method is especially useful for families.

Zero-Sum Budgeting

This budget strategy ensures that you have allocated every dollar of your income to a specific expense, savings account, or debt. This can help deter unnecessary spending because you will know how much you have to spend per item.

Cash Envelope System

This budget plan helps you track the amount of money in every category by tucking away cash in envelopes. Each category of your budget gets an envelope, and you only spend what is in the envelope.

This budgeting strategy doesn’t need any regular updating of records. It helps to keep you on track, holds you accountable, and makes it extremely difficult to overspend.

The cash envelope system is a good alternative for low-income earners who find it difficult to save. That said, this system has a downside: it is not practical for cashless transactions.

Make Your Life Easier with a 50/30/20 Budget

The 50/30/20 budget is an easy way to streamline your finances. There are only three categories to keep track of (i.e., needs, wants, and savings), eliminating the stress of constant calculations.

While this budget rule may not be practical in some situations, you can always make adjustments and create a budget plan that allows you to pay off debt, meet daily obligations, save and invest, and have fun. Besides, successful budgeting is about finding the right balance and discipline.

With a 50/30/20 budget, getting loans in Canada is easy because you know how and when you can repay them without stress.