The 50 30 20 rule divides your after tax income into three basic categories: 50% for needs, 30% for wants and 20% for savings and debt repayment.
Here is how the 50 30 20 rule breaks down:
First, what is after tax income? Income after taxes have been deducted and the cost of payroll deductions for health insurance, 401(k) contributions or other automatic savings have been added back in.
Now that we have that out of the way, here is how the 50 30 20 rule divvies up your income:
50% of income: NEEDS
These are expenses that you simply cannot avoid. Some examples:
- Basic utilities
- Minimum loan payments. Anything beyond the minimum goes into the savings and debt repayment bucket
- Child care or other expenses that need to be covered so you can work
30% of income: WANTS
Wants are the extras that arenâ€™t essential to living and working. Theyâ€™re often for fun and may include:
- Monthly subscriptions.
- Meals out.
20% of income: SAVINGS & DEBT
Savings is the amount you put aside to prepare for the future. Devote 20% of your income to paying down existing debt and creating a comfortable financial cushion to avoid taking on future debt.
How, exactly, to use this part of your budget depends on your situation, but it will likely include:
- Starting and growing an emergency fund
- Saving for retirement through a 401(k) and perhaps an individual retirement account
- Paying off debt, beginning with the toxic, high-interest type
For more budgeting and finance advice, check out our simple methods to help you save money and our advice for how use compound interest to become a millionaire.
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