Debt is a part of life, and it’s no surprise that millions of people are in debt at various stages of their lives. A report published by Pew Charitable Trusts found that 8 in 10 Americans have some form of debt. However, having debt and being crippled by debt are two very different scenarios.
If you feel as though your debt payments consume most of your finances and you’re ready to begin paying off your debt, there’s no better time than now to start. There are many different ways to get out of debt.
But, if you want to pay off your debt while also saving money, you’ll want to know all about the 50/20/30 rule. Here’s what you need to know about this method of managing debt.
What Is the 50/20/30 Rule?
The 50/20/30 rule is a term coined by U.S. Senator from Massachusetts, Elizabeth Warren. In its simplest form, the rule sets percentages on how much of your income should go towards certain types of purchases.
The budgeting rule says that 50% of your income should go towards needs, to include housing, groceries, car payment, utilities, and health insurance. Then, 20% of your income should go into savings. Only 30% of your income should go towards wants, such as eating out, shopping, and other hobbies.
How to Use the 50/20/30 Rule
There are many steps you’ll need to take before you can use the 50/20/30 rule. Before using any method of saving money, you should first create a budget so that you can properly track your monthly income and expenses.
Calculate After-Tax Income
The first step is to calculate your after-tax income. This is the money that you have left over after taxes have been taken out. We all pay a variety of taxes such as local tax, state tax, Social Security, and Medicare.
Most paystubs that are given to full-time employees provide an after-tax figure. Be sure to add back in any deductions, such as retirement contributions and health care costs.
For self-employed workers, you can determine your after-tax income by subtracting your business expenses from your gross income. You’ll also need to include the self-employment tax.
Determine Your Needs (50%)
The next step is to figure out how much of your money goes towards paying for you “needs” each month. In this instance, needs include expenses such as:
– Housing cost
– Car payment
– Car insurance
– Health insurance
The biggest hurdle here is differentiating between your needs and wants. For the 50/20/30 rule, needs are expenses that you could forgo that would only cause a minor inconvenience. Items such as new clothes or cable aren’t seen as needs. Expenses that would severely impact your quality of life should be noted as needs.
Savings, Retirement, & Debt Repayment (20%)
The second step of the 50/20/30 budgeting rule is to spend 20% of your income on savings and debt repayments. The money you pay towards student loans, credit cards, and your emergency fund all fall under the last chunk of money.
You should be spending no less than 20% of your income saving money, adding to your emergency fund, repaying debts, and paying into retirement accounts. In the scenario that you carry a balance on your credit card, the minimum balance falls under the “need” category while any extra payment falls into the 20% category.
Determine Your Wants (30%)
Limiting your wants to only 30 percent of your income is no easy feat. If you’re like most people, nice new clothes, fancy vacations, trips to the salon, and top-notch dinners are your forte. But, wants very rarely include such extravagant purchases. Instead, wants should be basic life niceties, such as wi-fi, cable, cosmetic car repairs, and your cell phone.
Most people spend a lot of money on their wants but there are ways to reduce the costs. You can save money on your wants by:
– Using coupons
– Shopping for discounts
– Price comparing
– Bundling services
When determining your wants, it’s most important to draw the line between things that are nice to have and things that we want just because they’re nice.
Benefits of the 50/20/30 Rule
Using the 50/20/30 rule allows you to better manage and budget your money. By categorizing your expenses and setting thresholds for each category, you can more wisely spend your after-tax income. The rule also gives you freedom and flexibility with your spending behaviors.
No matter how you choose to budget your money and prioritize your expenses, what’s most important is that you find a plan that works for you.
The 50/20/30 rule is one of many money managing methods that aims to help people better understand how much money they may, and how much of that money is going towards certain expenses. By following this methodology, you can greatly improve your financial security and freedom, while also paying down debt.