Maintaining a budget helps you understand how much money you earn versus how much you spend. That way, you can see if and where improvements can be made to your spending and saving habits. But you can be even more precise with your budget and allocate every dollar you earn appropriately. One effective strategy that can help you do this is the 50/30/20 rule.
Key Points You Should Know About The 50/30/20 Budgeting Rule
- The 50/30/20 budgeting rule allocates your net income into three categories: 50% for needs, 30% for wants, and 20% for savings and debt repayment.
- You need you net income to use the 50/30/20 budget. You can get this number by taking your gross income and subtracting your income taxes and deductions.
- The 50/30/20 is one of many budgeting styles, other methods include envelope budgeting, pay-yourself-first budgeting, and zero-based budgeting.
- You can better save money by automating your savings, tracking spending, and using high-interest savings accounts and tax advantage accounts.
What Is The 50/30/20 Budgeting Rule?
The 50/30/20 rule is a popular budgeting strategy that helps consumers manage their money more effectively by dividing their net income into three categories:
Needs: 50%
These are essential expenses that you must pay to live and work. Examples include the following:
- Housing
- Groceries
- Utilities
- Transportation
- Insurance
- Minimum debt repayments
Wants: 30%
These are non-essential expenses, such as the following:
- Dining out
- Entertainment
- Vacations
- Hobbies
- Memberships and subscriptions
Savings And Debt Repayment: 20%
This part of your income goes towards financial security and goals and includes the following:
- Savings
- Emergency account
- Investments
- Extra payments towards paying down debts (over the minimum payments)
Learn more: How To Make A Monthly Budget
50/30/20 Rule In Action
To help you visualize how the 50/30/20 rule works, let’s illustrate using an example:
- Monthly gross income: $5,000
- 50% (needs): $2,500
- 30% (wants): $1,500
- 20% (savings): $1,000
| Needs (50%) | Wants (30%) | Savings (20%) |
| Rent: $1,500 Utilities: $150 Groceries: $400 Transportation: $200 Minimum debt payments: $200 | Dining out: $100 Entertainment: $100 New clothes: $200 Gym membership: $50 Streaming subscriptions: $25 Vacation fund: $150 | Emergency fund: $200 Retirement funds: $400 Debt repayment: $300 |
| Total: $2,450 | Total: $625 | Total: $900 |
Based on the figures in the above chart, the total for each category fits within the applicable budget.
How To Calculate Your After-Tax Income
Calculating your after-tax income gives you a clear understanding of what your actual take-home pay is, which is essential when it comes to budgeting and financial planning.
To determine your after-tax income, follow these simple steps:
Step 1: Determine Your Gross Income
Find out what your total annual income is before taxes and deductions. If you’re paid an annual salary, simply divide your income by 12 months to get your monthly income.
If you’re paid an hourly wage, multiply your rate by the number of hours you work each week, then by 52. This will give you your annual income. To get your monthly gross income, divide your annual income by 12.
| Example: Hourly rate: $25Hours per week: 35 Annual income: $45,500 ($25 x 35 x 52 weeks) Gross monthly income: $3,792 ($45,500 ÷ 12 months) |
Be sure to include any additional sources of income, such as bonuses, commissions, or investments.
Step 2: Identify Your Income Taxes
Your income taxes include federal, and provincial/territorial taxes. Find out what these are, which you can do using any one of the many online income tax calculators online.
Be sure to identify other deductions, such as:
- Canada Pension Plan (CPP) contributions
- Employment Insurance (EI) premiums
- Employer-specific deductions (ie, health benefits, retirement plans, etc)
Step 3: Subtract Your Taxes And Deductions From Your Gross Income
Once you’ve determined your total gross income and the total amount of income taxes you’re required to pay, plug these figures into the following equation:
| Gross Income – Income Taxes/Deductions |
The answer you get will be your take-home pay.
| Example: Gross monthly income: $5,000 Total taxes and deductions: $1,150 Take-home pay: $3,850 ($5,000 – $1,150) |
Where Can You Find Your After-Tax Income?
You can find your net income from the following sources:
Pay Stubs
If you’re an employee, you’ll receive pay stubs from your employer after every pay period. These pay stubs clearly display your net pay, as well as your gross income and all deductions made for income taxes, CPP, EI, and any other applicable withholdings.
T1 General Tax Form
The T1 General form summarizes your income, deductions, and income taxes paid in the applicable tax year. It displays your final after-tax income after all taxes have been applied.
Bank Statements
If you’re paid through direct deposit, your bank statement will display the net amount deposited into your account each pay period.
Other Types Of Budgeting Strategies
As effective as the 50/30/20 rule may be for budgeting, there are other strategies you can employ to get a handle on your finances, such as the following:
Envelope Budgeting
Envelope budgeting involves dividing your income into different “envelopes” (or categories) for different expenses. The goal is to allocate a certain amount of money to each envelope and only spend what’s in it for each category.
Main expense categories include things such as housing, utilities, groceries, transportation, entertainment, savings, and debt repayment. Based on your monthly income, determine how much money to allocate to each category, which should be based on your financial priorities.
Pay-Yourself-First Budgeting
Pay-Yourself-First budgeting involves putting saving and investing before spending money on other things. This ensures that you’re setting aside enough money for your future before tackling other expenses.
To put this strategy in action, you’ll first need to identify your financial goals, such as saving for retirement, creating an emergency fund, or buying a home. Then, decide how much of your income to put towards your savings and investments. Any money left over can then be used to pay for other necessities, like housing, groceries, and utilities.
Zero-Based Budgeting
Zero-Based Budgeting is a strategy that justifies every expense for each new period. Instead of using any previous fund allocations from past budgets to determine your current budget, the zero-based budgeting tactic starts from a zero base.
In other words, the money allocated to different categories or expenses is determined by your current requirements instead of how money has been spent or allocated in the past. This ensures that your money is used more efficiently, encourages savings, and helps you achieve specific financial goals since every dollar is spent with a purpose.
Tips For Saving
If you need some help setting money aside for your future, consider the following tips:
Automate Your Savings
Set up automatic transfers from your bank account to a dedicated savings account. This will ensure that money is always set aside, without risk of forgetting or having to manually put money away. Plus, automating your savings can help ensure that the money is put away before you spend it.
Track Your Spending
Keep a record of your expenses to see where your money goes every month. This is where a detailed budget comes in handy. To simplify this process, consider using a budgeting app, like YNAB or Mydoh, which makes staying on financial track relatively simple.
Save In High-Interest Savings Accounts
Put your money in a high-interest savings account to help your money grow faster. These accounts come with much higher rates on your deposits compared to traditional savings accounts.
Use Registered Savings Accounts
Contribute to retirement accounts, such as an RRSP or TFSA, to take advantage of tax perks while your money grows.
Bottom Line
Putting the 50/30/20 rule into play can help you more effectively manage your finances, keep you out of debt, prioritize spending, and reach your financial goals. Knowing exactly how much you earn relative to what you spend ensures that more money stays in your pocket. Being more focused with your budget by using a strategy like the 50/30/20 rule can help you be more purposeful about where you use your money.
