50/30/20 Rule: Detailed Guide For Employees and Freelancers

The 50/30/20 rule is a budgeting method of splitting income into three categories: needs, wants, and savings. It’s supposed to provide a broad framework and a general starting point when managing personal finances, which you can then customize to suit your personal needs.

In this article, you’ll learn whether the 50/30/20 rule is for gross or net income, and how youcan apply it in practice. We’ll also provide specialized tips to freelancers and independent contractors on how to budget using the rule. Lastly, we’ll give you the biggest benefits and drawbacks of managing your finances by using this method.

Key Takeaways

• The 50/30/20 rule refers to splitting your after-tax income into three parts: 50% for needs, 30% for wants, and 20% for savings.
• “Needs” represents the essential living expenses, like rent and groceries; “wants” are discretionary spending, like shopping and hobbies; “savings” is the part of income set aside for emergency funds, retirement contributions, and more.
• Some of the biggest benefits of the rule are that it’s easy to use, encourages savings, and can be adjusted to meet different circumstances.
• Some of the cons of the 50/30/20 rule are that it’s not suitable for all income levels or those with complex financial situations, and that it may result in overspending on “wants.”

What Is the 50/30/20 Rule?

The 50/30/20 rule is a strategy for managing personal finances; the name describes a ratio based on which individuals are meant to split their after-tax income.

Popularized by U.S. Senator Elizabeth Warren in her book All Your Worth: The Ultimate Lifetime Money Plan, the 50/30/20 rule template is designed to help people achieve three vital aspects:

1. Cover their essential living expenses.
2. Enjoy the lifestyle that they want.
3. Build a secure future through savings without overcomplicating finances.

This rule is meant to be a broad framework and a solid starting point that can be adjusted for each individual based on their circumstances.

Here is a breakdown of each component that the 50/30/20 rule encompasses:

• 50% for needs. These are the essential living expenses. Half of your income (after paying all taxes) should be allocated to cover your daily life and well-being. This includes paying for your rent, mortgage, utilities, transportation to and from work, groceries, and minimum debt payments.

• 30% for wants. This category encompasses discretionary spending. Everything that isn’t necessary for your day-to-day life, but can improve it, goes into this category. For instance, dining out is typically more expensive than grocery shopping, so it goes in this category. This also includes hobbies, traveling, entertainment, and more.

• 20% for savings. The remaining 20% should be set aside for your long-term financial goals. There are various ways to save money, including creating an emergency fund, contributing to a retirement account, investing in stocks, bonds, real estate, and commodities, and even paying off debt beyond the minimum payments.

Here is a simple graph that visually explains the 50/30/20 budget rule and lists the most common expenses for each category:

How to Apply the 50/30/20 Rule to Your Income

Now that you understand the basics behind the 50/30/20 rule, let’s find out how you can put that knowledge into practice by applying it to your income.

#1. Understand Your Income

The first step in correctly implementing the 50/30/20 rule in your budgeting endeavors involves determining your after-tax income. This is not to be confused with gross income, which will be reduced once you take out all the deductions and pay taxes.

If you’re an employee, you can find this amount (also referred to as “net income” or “take-home pay”) on your pay stubs. It represents your gross pay minus deductions for taxes, Social Security, and Medicare.

Freelancers and independent contractors can calculate their after-tax income by subtracting estimated taxes and business expenses from their gross income.

#2. Track Your Expenses

Once you have a solid understanding of your income, you need to see where your money is going. You should conduct an internal audit to figure out how much you are spending on which aspects of your life, before you can make meaningful and data-driven adjustments.

To ensure accuracy, you can spend a month or two meticulously tracking your expenses, covering everything from a morning coffee to rent. Record every expense to ensure accuracy. You can use a simple notepad, a spreadsheet, or even professional budgeting apps and software.

#3. Identify the Most Important Expenses

After taking control of your earnings and spending, you should identify and categorize your expenses.

The first thing you should do is identify the most important expenses and put them into the “needs” category. These are essential costs that you likely can’t reduce without significant lifestyle changes.

It’s important to be honest with yourself during this process. You should rigorously evaluate each expense and not fall into the trap of categorizing something as a need if it is likely a want.

#4. Analyze and Adjust

The next step involves comparing your current earnings and expenses against the 50/30/20 rule. You are looking for areas where your current lifestyle and financial situation don’t align with the rule.

For example, if your “wants” section is considerably more than 30% of your after-tax income, you may want to look for ways to cut back. The same goes for your “need” section, but keep in mind that reducing them often requires considerable changes.

Lastly, you can implement these adjustments to create a new 50/30/20 rule spreadsheet and see whether you can follow through with it in the upcoming months.

#5. Automate Your Savings

The easiest way to ensure that you always allocate 20% of your after-tax income to your savings is to automate the process. The importance of savings for long-term financial planning and well-being cannot be understated, so it’s important to stay consistent, as long as you have the means for it.

The “pay yourself first” approach transforms your savings expenses into non-negotiable expenses. This will help you avoid accidentally overspending on your “wants” and missing putting funds into the “savings” portion.

Tips for Freelancers and Independent Contractors

The general idea behind the 50/30/20 rule applies to freelancers and independent contractors, the same way it does for traditional employees. However, these professionals usually need to make certain adjustments to account for irregular income and additional financial responsibilities associated with their line of work.

Here are some tips that can help you implement the 50/30/20 rule more efficiently:

• Set aside money for taxes. Freelancers and independent contractors don’t have employers to automatically withhold taxes from their pay. Instead, they are responsible for self-employment taxes in full, and typically need to make quarterly estimated payments. As such, it’s recommended to set aside 25–50% of gross income for taxes.

• Base your budget on the lowest-earning month. The income of many self-employed professionals can fluctuate quite a bit from month to month. That’s why it’s recommended to look at a longer period (e.g., a year) and budget based on the lowest month. This ensures you can cover the essential expenses during slow periods.

• Build an emergency fund quickly. Emergency funds are critical in unpredictable lines of work, like freelancing. Quickly building up 3–6 months’ worth of living expenses (e.g., by initially overwriting the savings rule and allocating more than 20% of your income to an emergency fund) allows you to budget more freely after that.

• Separate business and personal finances. You should have a separate bank account for personal and business needs. This makes it easier to track your expenses and evaluate your business’s financial health.

Finally, the 50/30/20 rule isn’t set in stone; even more so for self-employed professionals. If you find that another ratio better suits your needs and circumstances, you can adjust the percentages either temporarily (e.g., for leaner months) or permanently.

Example of 50/30/20 Rule

Let’s take a look at the example of the 50/30/20 rule, as seeing it in practice is one of the best ways to truly understand it.

Meet a fictional employee, John Doe, who has $4,000 after-tax income per month. If they were to apply the 50/30/20 rule, they would divide his income into the following portions:

• 50% for Needs: $2,000
• 30% for Wants: $1,200
• 20% for Savings: $800

Following that, here is how John could organize his spending each month:

With a plan clearly laid out, John will know exactly how much money to set aside for each item. It will make it easier to stay within the budget and ensure long-term financial health.

Benefits of the 50/30/20 Rule

The 50/30/20 rule offers many benefits, especially to those who are new to budgeting. Here are the most notable ones:

• It is easy to use. You don’t need to be a financial expert or know everything about the psychology of money to use this rule. The simplicity makes it so that you can apply the rule in your budgeting efforts immediately and see the results right away. Plus, it’s easy to stay consistent as you don’t need to track countless metrics.

• Promotes healthy financial habits. By using the 50/30/20 rule, you’re encouraged to approach your finances with balance and restraint. Moreover, you’re covering not just your immediate needs, but you’re also planning for the future while simultaneously allowing for discretionary spending.

• Encourages savings. By setting aside a specific amount for savings each month, you’ll start working toward long-term financial goals, such as retirement, home ownership, or financial independence.

• Offers flexibility. The percentages outlined by the rule are subject to change and can be modified to suit different needs. If you want to be more aggressive with savings, you can cut back on your “wants.” On the other hand, if you live in a low-cost area, your “needs” percentages may be lower.

Potential Drawbacks of the 50/30/20 Rule

While the 50/30/20 rule offers many advantages, it’s not without drawbacks. Here are the biggest ones:

• May not be realistic for all income levels. Individuals who live in high-cost areas often have to set aside a substantial portion of their income to rent, utilities, transport, and similar expenses. This can be significantly more than 50% of after-tax income, rendering the rule almost useless.

• Can result in overspending on “wants.” Some people may see the 30% part of the “wants” portion as a target, rather than a limit. As a result, they might often hit it long before the month ends, and then continue to spend. This overspending can eat into the “savings” portion of the budget.

• Might not apply to complex situations. While the 50/30/20 rule is flexible and adjustable, it may not be suitable for individuals with complex financial situations. This includes people with multiple streams of income and passive income, significant debt, or specific investment goals.

Take Control of Your Finances with Paystub.org

Paystub.org offers several robust and intuitive generators you can use to manage your finances and improve record-keeping. These online software tools are tailor-made for individuals, independent contractors, and small business owners alike.

Here are the tools that we offer:

• Pay stub generator. Create detailed pay stubs for your employees or for yourself, to track your earnings and better calculate your spending.
• Form W-2 generator. Generate year-end documentation for tax filing purposes.
• Form 1099 generator. Record payments made to independent contractors and take control of your business expenses.
• Invoice generator. Bill your clients professionally to improve your cash flow, stabilize your income, and make budgeting easier.

Final Thoughts

The 50/30/20 rule is a simple but powerful budgeting framework that can help you take control of your finances and optimize your spending. The rule is easy to implement, and, in addition to providing an immediate improvement to your situation, it will also help you build healthy long-term habits. Finally, its versatility makes it applicable to both employees and freelancers.

However, this rule is not without flaws and drawbacks. It falls short for individuals with low income, those who live in high-cost areas, or have significant debt to repay. Moreover, in complex situations with multiple streams of income and specific investment goals, it’s often better to go with a more tailored budgeting solution.

50/30/20 Rule FAQ

#1. Is the 50/30/20 rule realistic?

Whether the 50/30/20 rule is realistic depends on individual circumstances. While it’s meant to be a broadly achievable financial framework fit for the general public, the rule may require some adjustments, especially for those who live in high-cost areas or have low incomes.

#2. Can I apply 50/30/20 if I have irregular income?

You can apply the 50/30/20 rule if you have irregular income, but you will likely have to make some adjustments. In general, it’s recommended to look at your income from the past several months or more and base your budget around your lowest earnings.

#3. Does the rule work for freelancers or small business owners?

Yes, the rule works for freelancers and small business owners. However, they need to account for self-employment taxes and business expenses when calculating after-tax income. It’s also essential to separate personal from business finances.

#4. Can I adjust the percentages based on my financial goals?

Yes, you can adjust the percentages based on your financial goals. For example, you can increase the amount you allocate to your savings by reducing the “wants” part of your income. Also, if you live in a low-cost area, your “needs” section may require less than 50% of after-tax income.

#5. When might the 50/30/20 rule not be the best saving strategy to use?

The 50/30/20 rule might not be the best saving strategy to use if you live in a high-cost area, have a low income, or have high debt. In these cases, you may need to adjust the ratio or evaluate it every month.