If you’re trying to become a better money manager, some people find it really helpful to have a clear strategy that ensures they are putting enough of their money in all of the right places. The 50/30/20 budgeting plan is a framework that outlines what percentage of your income to allocate for the three major line items.
The gist is 50% for the essentials, 30% for extras, and 20% for debt and savings.
There’s a lot more to the 50/30/20 budgeting plan than just that simple explanation, so read on if you want to learn:
- Where the 50/30/20 budgeting plan came from
- Why it can work
- How to start using a 50/30/20 budget
- How to realistically categorize wants and needs
- When the 50/30/20 plan doesn’t work
What is the 50/30/20 budget
Elizabeth Warren… yes, that Elizabeth Warren, U.S. Senator from Massachusetts… is also a Harvard University bankruptcy expert who presented the idea of the 50/30/20 budgeting plan in her 2005 book All Your Worth: The Ultimate Lifetime Money Plan.
The goal of the plan is to give people a simple outline of how to balance their wants, needs, debt, and savings. The 50/30/20 plan starts by figuring your after-tax income, and then breaking down your financial allocation like this:
- 50% for your needs
- 30% for your wants
- 20% for debt and savings
Here’s the thing, that breakdown might look a little bit off to you if you have a high debt burden, like six-figure student loans, or are trying to retire early. The 50/30/20 budgeting plan isn’t the golden rule for everyone, and you can adjust the percentages as you go.
Why budgeting with the 50/30/20 plan can work
The 50/30/20 plan is pretty simple in theory, but putting it into practice might take some creative financial planning on your part because categorizing your wants and needs can get tricky.
Not only that, this strategy focuses on the cost of living (necessary expenses) that is probably a little lower than what the average family spends each month. In fact, the average American family, taking home a pretax income of ~$75,000 per year, spends 90% of their income on their wants and needs combined (this figure includes debt). But, there are a few problems with this:
- 10% left for savings probably won’t be enough for retirement
- Interest accrued on debt isn’t included in the 90%, so interest eats into your 10% for savings
- This is based on pretax numbers – not the money you’re really taking home
This is why the 50/30/20 plan can work for some people. You start planning from your actual take-home pay and then whittle your needs and expenses down to 80% or less so that you’re saving at a more effective rate. Now, 20% for debt and savings might not seem like enough to focus on both at once, but ideally you are paying off your debt so you can eventually have the entire 20% for savings.
How to build your own 50/30/20 budget
As with any new budget, prep by gathering all of your statements, recent paychecks, accounts, receipts, open your budget apps, etc. Seriously, you can’t just guess at your budget.
Step 1: Calculate your after-tax income
This is legitimately going to be the easiest step because if you receive a paycheck, all you need to do is look at the final number. Your employer’s payroll software does all the work and gives you a number after state, local, income tax, Medicare, and Social Security are deducted from your gross pay.
However, if you have any deductions for things like a health savings account or 401(k) contributions, you will need to add those figures back in – you will pull those amounts back out in one of the next steps.
For self-employed people, determining your after-tax income can be a little more difficult because your income probably varies month to month. One idea is to use the amount you estimate for your quarterly taxes divided by three to give you a baseline for each month. Flexibility, though, is going to be a necessity.
M$M tip: Read more about self-employment taxes at How to Handle Taxes for Your Side Hustle.
Step 2: Reduce your needs to 50% of your income
Let’s first talk about what your needs are. This might be hard for some of us because sometimes it really does feel like you need to meet your friends for a drink.
But, needs are essentials, like:
- Groceries (basics, not fancy cheese or a nice steak)
- Housing costs (mortgage, rent, insurance, repairs, property taxes, etc.)
- Utilities (water, electric, gas, sewer, trash, internet, etc.)
- Healthcare (including necessary prescriptions and/or treatments)
- Auto costs (insurance, property taxes, maintenance, licensing fees, payments)
- Minimum debt payments (student loans, credit cards, personal loans, etc.)
Your needs are basically anything that would dramatically affect your life if you were to go without. We’re not living in the woods here, so your needs are going to be more complex than a hut, water, and foraging for food.
If you’re questioning whether or not something is a need, ask yourself what your life would be like without it.
For example: What would happen if I didn’t have car insurance? If you live anywhere besides Virginia or New Hampshire, you could get in serious legal trouble without it. This is a need.
Another example: What would happen if I didn’t make the minimum payment on my student loans? You will get a ding on your credit score and will accrue more interest. If you go too long without a payment, you can default on your loans. This is a need, but any amount you overpay is calculated into the 20% for savings and debt.
In the 50/30/20 budgeting plan, if your needs go over 50% of your after-tax income, you will have to make some adjustments, like:
- Getting rid of your car payment
- Finding ways to save at the grocery store
- Looking into alternatives to traditional health insurance
- Shopping around for car insurance, homeowner’s insurance, internet and cell service plans, etc.
- Possibly downsizing your house to something more affordable
Step 3: Minimize your wants to 30%
Depending on your current lifestyle, this one might be HARD, like massively difficult. It’s just way too easy to get accustomed to some luxuries now and then, and anything beyond the basics is a luxury. The other difficult part is that when you’re already cutting back on your needs, you might be using wants as a way to reward yourself – which is cool, just don’t overdo it.
Wants can be things like:
- Unlimited data plan for your phone
- Clothes that go beyond just the basics
- Gym memberships
- Dinners out
- Cable or streaming services
Depending on how much you need to squeeze out, you could even consider things like cooling your house all summer with the AC blasting as a want when a solid fan is all you really need… BTW, I live in Texas, I get needing AC.
The point is, a lot of the things we spend our money on fall into this category. And with the goal of the 50/30/20 plan being financial harmony, you’ll probably need to make some sacrifices and reorder your priorities.
Step 4: Put 20% of your income towards debt and savings
The last part of the 50/30/20 budgeting plan includes funds for:
- Any extra payments or money for your debt (including student loans, credit cards, mortgage, etc.)
- What you put towards your emergency fund
- 401(k) contributions
- Contributions to a health savings account
- Any other retirement contributions
What this plan doesn’t explain is how to even start dividing that 20% between debt and savings – this is up to you. If I know my readers well, most of you would rather focus on destroying your debt first because it will save you money on interest, then freeing up more for long-term savings in the future. But, that’s not the only option for this 20% because a lot will depend on the type of debt you have, your savings goals, etc.
If you’re at least putting 20% of your income towards some combination of debt and savings, you’re probably on a better track than the average American.
When the 50/30/20 plan doesn’t work
Not everyone is going to find that the 50/30/20 budget is going to work for them, so let’s look at a couple of situations when you might need a different strategy.
If you have a large debt burden
While 20% can help you chip away at your student loans or pay off small amounts of credit card debt, if you have a high debt burden, allocating more than 20% is going to be necessary to take care of that debt quickly and effectively.
Let’s look at an example, and pretend you have:
- An after-tax income of $70,000
- $80,000 in student loan debt (6% average rate)
- $15,000 on credit cards (17% average rate)
20% of your income is $1,167 every month for debt. Subtract $890 each month for your student loan payment, and let’s say your minimum credit card payments add up to $400 each month.
Problem 1: You’re now working at a deficit of $123 each month.
Problem 2: Those minimum payments are going to cost you a massive amount of money in the long-term. I’m talking interest charges of $6,500 for your credit cards and $26,000 on your student loans.
You would be spending an additional $32,500 to adhere to a budget. The 50/30/20 budgeting plan is just bad math here, and let’s not even get into the fact that this doesn’t account for any type of retirement savings – problem number three.
If you are working towards financial independence
Plans like FIRE (Financial Independence Retired Early) require that you save at a much higher rate than just 20%. We’re talking savings rates of 50%-65% depending on when you want to retire and what you’re earning.
Saving at that rate is only possible for most people if they drastically cut their spending and increase their income. It also helps if you have a job that pays well over what the median millennial household brings in each year, which is currently at $69,000.
Even if the “retired early” part isn’t in your plan, financial independence alone is a goal for many, with many different meanings too, like debt free, able to vacation whenever you want, only work if you want to, etc. Whatever it means to you, it could be hard to get there quickly with the 50/30/20 budgeting plan.
My final take on the 50/30/20 budgeting plan
Despite those last couple of points, this budget can and does work for a lot of people. I’d say it’s a good maintenance budget once you’ve paid down a lot, if not all, of your debt.
If you’re able to reduce the amount you spend on your wants and/or needs, you can put more than the prescribed amount towards savings. That’s always going to be a good idea.
And, to really make your budget work, I’d recommend using a personal finance app like Personal Capital to help you track your spending and save for retirement – this is what my wife and I use! It’s free to use, and Personal Capital has the most robust retirement planning software I’ve seen. Learn more about the app at Personal Capital Review 2019: Free Investment and Net Worth Tracking.