50/15/5: Saving and Spending Rule of Thumb

Budget. Does anyone like that word? How about this instead—the 50/15/5 rule? It’s our simple rule of thumb for saving and spending: allocating no more than 50% of take-home pay to essential expenses, 15% of pretax income to retirement savings, and 5% of take-home pay to short-term savings. (Your situation may be different, but you can use our rule of thumb as a starting point.)

Why 50/15/5? We analyzed hundreds of scenarios in order to create a saving and spending guideline that can help people save enough to retire. Our research found that by sticking to this guideline, there is a good chance of maintaining financial stability now and keeping your current lifestyle in retirement. To see where you stand on our 50/15/5 rule, use our Savings and spending check-up.

Lesson 1: Essential expenses: 50%

Some expenses simply aren’t optional—you need to eat and you need a place to live. Consider allocating no more than 50% of take-home pay to “must-have” expenses, such as:

• Housing—mortgage, rent, property tax, utilities (electricity, etc.), homeowner’s/renter’s insurance, and condo/home association fees
• Food—groceries only; do not include takeout or restaurant meals, unless you really consider them essential, i.e., you never cook and always eat out
• Health care—health insurance premiums (unless they are made via payroll deduction) and out-of-pocket expenses (e.g., prescriptions, co-payments)
• Transportation—car loan/lease, gas, car insurance, parking, tolls, maintenance, and commuter fares
• Child care—day care, tuition, and fees
• Debt payments and other obligations—credit card payments, student loan payments, child support, alimony, and life insurance

Keeping it below 50%: Just because some expenses are essential doesn’t mean they’re not flexible. Small changes can add up, such as turning the heat down a few degrees in the winter (and up in the summer), buying—and stocking up on—groceries when they are on sale, and bringing lunch to work. Also consider driving a more affordable car, carpooling, or taking public transportation. Consider a high-deductible health plan (HDHP), with a health savings account (HSA) to reduce health care costs and taxable income. If you need to significantly reduce your living expenses, consider a less expensive home or apartment. There are many other ways you can save. Take a look at which essential expenses are most important, and which ones you may be able to cut back on.

Lesson 2: Retirement savings: 15%

It’s important to save for your future—no matter how young or old you are. Why? Pension plans are rare. Social Security probably won’t provide all the money a person needs to live the life he or she wants in retirement. In fact, we estimate that about 45% of retirement income will need to come from savings. That’s why we suggest people consider saving 15% of pretax household income for retirement. That includes their contributions and any matching or profit sharing contributions from an employer. Starting early, saving consistently, and investing wisely is important, as is saving in tax-advantaged retirement savings accounts such as a 401(k)s, 403(b)s, or IRAs.

How to get to 15%. If contributing that amount right now is not possible, an employer may have a program that automatically increases contributions annually until a goal is met. Another strategy is to contribute at least enough to meet an employer match, and then allocate all or part of a pay raise or bonus to savings.

Lesson 3: Short-term savings: 5%

Everyone needs an emergency fund. An emergency, like an illness or job loss, is bad enough, but not being prepared financially can only make things worse. A good rule of thumb is to have three to six months of essential expenses readily available. Think of emergency fund contributions as a regular bill every month, until there is enough built up.

Once a sufficient emergency fund is in place, it’s a good idea to turn to saving for short-term expenses that pop up unexpectedly. Who hasn’t been invited to a wedding—or several? Cracked the screen on a smartphone? Gotten a flat tire? Setting aside 5% of monthly pay can also help with these “one-off” expenses. Don’t be tempted to pay for one by adding to an existing credit card balance. Over time, these balances can be hard to pay off. However, if you pay the entire credit card balance every month, and get points or cash back for purchases, using a credit card for one-off expenses may make sense.

How to get to 5%: Having this money automatically taken out of a paycheck and deposited in a separate account just for short-term savings can help a person reach this goal.

What next?

Our guidelines are intended to serve as a starting point. It is important to evaluate your situation and adjust these guidelines as necessary. If you’re close to the 50/15/5 target spending and saving amounts, good job. And for those staying within the guidelines, any remaining income is theirs to save or spend as they would like. Some ideas: First, pay down high-interest debt. For other goals, like paying for a child’s college or wedding, you could use the remaining income to save for them. And, finally, for those who want to retire early, or haven’t been saving diligently, putting it toward retirement savings may make sense.

The good news is that it isn’t about micromanaging every penny. Analyzing current spending and saving based on our three categories can give you control—and confidence. Undoubtedly, a financial situation will change over time. A new job, marriage, children, and other life events may change cash flow. It’s a good idea to revisit spending and saving regularly.

Key takeaways

✔ Allocating no more than 50% of take-home pay to essential expenses.

✔ Trying to save 15% of pretax income (including employer contributions) for retirement.

✔ Keeping 5% of take-home pay in short-term savings for unplanned expenses.