How to Save >30% of Your Income
Wealth inequality. Financial illiteracy. The 99%. This is the other rampant pandemic of our time.
There’s no slew of vaccine candidates promising an end to this pandemic. The government is not going to rescue you from debt or support you in retirement. This one’s up to you.
Income
We’ll assume that you’re employed or otherwise earning a reasonable income for the rest of this article. That’s Step Zero — income before savings. If you’re not there yet, congratulations on thinking ahead; save this article and come back when you’re ready to implement it.
Budget
The dreaded B-word of personal finance. I’ll share a secret with you — I love budgets and really any kind of financial planning spreadsheet. The power of compound interest filling up the cells with exponentially higher numbers representing my growing future net worth — it’s a dream that the spreadsheet cements into reality. If I save $X each month and my savings appreciate by Y%, I’ll have a $Z net worth by a set future date.
Your aim with this budget is to set an ambitious but realistic amount for how much money you will save each month. You will record the necessities where your money is already committed (i.e., housing, insurance, food, taxes) and your total earnings. The remaining money should be divided between savings and discretionary expenses (i.e., fun) — because we all need to enjoy ourselves now, or this savings plan is headed for a quick nosedive. This must be sustainable, and you’ll need to determine what that means for you.
Over the next few sections, I’ll illustrate some specifics for expense categories in my personal budget. You’ll want to adjust these to fit your situation, depending on whether you own or rent or need to add a category like student loans.
Btw, if you don’t already have a spreadsheet (or other methods) for tracking your budget, start one now and add these categories to it!
Income
This is where you record the money you’re earning. It can be from wages or that new side hustle you started. You can add a line item for each type of income if you’re one of those multiple income-stream people. Having only one income right now is okay too. We’re going to work on that.
Insurance
Insurance is top on my list of necessary expenses. The purpose of insurance is to pay a small amount now to protect yourself from future disasters, which could otherwise devastate years of meticulous saving. I’m putting in the hard work now to not blow all my money; no way am I going to let another driver or a health crisis sweep it all away in an instant. Underinsurance, I currently have:
- Renter’s insurance (or Homeowner’s insurance if you own your home)
- Car insurance
- Health insurance
- Dental insurance
- FSA (or an HSA)
- Life and disability insurance
Hint: If you’re employed or looking for a new job, many of these expensive health-related insurance premiums and even health savings account contributions are likely subsidized or fully covered by your employer, at least in the US, home of the world’s most antiquated and high-cost healthcare system.
Housing
Housing includes both the cost to rent or own your home as well as the regular utility expenses. If you’re a homeowner, the cost to own your home should also include property taxes and maintenance expenses. My housing budget today includes:
- Rent (or a mortgage payment if you’re buying your home)
- Water/sewer
- Trash
- Electric (or any other form of power at your home)
- Internet
- Phone
Transportation
For me, transportation currently means owning a car. Although, as this current WFH situation continues, I’m starting to doubt the necessity of it. This represents my current expenses in this category, but you’ll want to adjust to reflect the types of transportation you use.
- Car payment
- Fuel
- Car maintenance
- Property taxes
Food
No question that food is a necessity — but it is a budget category that can wildly fluctuate depending on your eating habits. You should start by setting this expense to what you are spending on food, which includes both grocery and restaurants. If you get to the end of this exercise and there’s not enough remaining for the level of savings that you want to achieve, your food habits can be a category to revisit. I’ve found that cooking the majority of my meals at home can be both healthier and drastically reduce the expense of food. This category I have broken down simply into:
- Grocery
- Restaurants
Household
Household contains all those home expenses that you need to continue a normal life that isn’t directly falling into the Food or Housing categories. I leave a lump sum for this category in my monthly budget. Some items that you can consider when determining your expense are laundry, cleaning supplies, and personal care. Keep in mind — we’re talking about actual necessities (i.e., you need toothpaste and soap), not that new $3,000 espresso machine you are telling yourself that you can’t live without (aka. the definition of luxury item).
Taxes
😩 Unfortunately, most of us will have some substantial portion of our income that is allocated to income taxes. You can use the withheld portion of your income as an estimate of the taxes you pay, but I like to do this calculation myself as the withholding is never exactly correct.
A hypothetical example based on the true story of millions of Americans: We’ll call him Harry. Harry has $15,000 withheld from his pay over the course of the year for taxes owed to the government and then receives $3,000 back in April when he files his taxes. Interpretation #1: Harry has received a windfall and can contribute this to his savings or put it towards a fun trip. This is FALSE. Interpretation #2: (the TRUTH) Harry has loaned the government $3,000 over the course of 16 months, and they are now returning his money without interest. Assuming that Harry had instead invested that money as he received it over the year until the following April and earned a conservative 8% rate, he would now have $3,189!
Be informed about the taxes you pay. Don’t loan the government your money for free. Do the math and talk to your employer today about adjusting the amount withheld from your pay.
Now, the tax math. I include the following categories for income taxes. Any numbers pertain to the US in 2020, and you can find the specifics online each year.
- Federal tax
- Medicare tax = 1.45% on wages up to $200,000, and 2.35% on any wages above $200,000
- Social security tax = 6.2% on wages up to $137,700
- State tax
Your state income tax depends on where you live. I’m not one of those lucky people in a no-income-tax state, so for 2020, this amounts to 5.25% of my income after the standard deduction of $10,750.
The federal income tax you owe will vary depending on your income. Federal tax brackets can be found each year on sites such as IRS.gov and https://taxfoundation.org/publications/federal-tax-rates-and-tax-brackets/. In 2020, for an income in the range of $85,526 to $163,300 for a single individual, this will amount to $14605.5 + 24% of amount over $85,525 after the $12,400 standard deduction.
Hopefully, you can see that by quickly looking up a few numbers online, you can accurately calculate an estimate for your income taxes for the year. There are definitely cases where this will be more complex for you — if you own a business or have a variable income from month-to-month. In those cases, you can learn more about the additional factors you’ll need to add to these calculations and/or consult a tax professional to estimate this with you.
The fun part … made possible by MATH
By now, you may be well into thinking that there is nothing at all enjoyable about this budget. Okay. I can accept that. And, I promise, this is where the fun starts. I mean it — math can be fun!
You’ve recorded your income and all the necessary expenses. Now it’s time to do some calculations. Total your income. Add up the items within each expense category. Calculate the percent of your total income that is allocated to each category. For me in 2020, this looks something like:
- Insurance = 4%
- Housing = 15%
- Transportation = 4%
- Food = 6%
- Household = 1%
- Taxes = 25%
And …
drum roll …
Subtract your total expenses from total income. For me, in 2020, these remaining funds after the necessary expenses represent 45% of my income.
Forty-five percent! Your number’s not going to be the same as mine. Here’s where you can go back to the earlier expense categories if you’re not satisfied with your number. Look for categories where you’re spending at a higher rate than you’d expect — are you spending 20% of your income on food? or 50% of it on housing? Maybe try to cook some more meals at home, take your lunch to work, find a more affordable apartment, or rent out a spare room. There’s a near-endless list of creative ways you could decrease your expenses. But you can only decrease them so far. At some point, you may realize that the path to your number means increasing your income. Don’t stress. You can do it!
No matter where your number is today, you can still start on your savings journey. (As long as the number is positive! 😜) Don’t wait until you’ve perfected minimizing your expenses or reached your ideal income. You need to start saving today — remember compound interest? It’s going to be your new best friend.
Okay, so what’s the next step? You have a number representing the expendable percent of your income. You could allocate this full amount to savings — if you are a perfect specimen of a person with no need for enjoyment or if you want to go slowly insane. I wouldn’t recommend it unless your brain’s composed of metal and wires. So what’s a more realistic goal? Tbh, that’s up to you. You have to decide for yourself the pace at which you want to save money to reach your goals and the level of discretionary spending you need to enjoy your life now, tomorrow, and every day until you reach those future goals.
I’ll share my personal savings rate so you can see what’s working for me. In 2020, I’m saving roughly 38% of my total income. That leaves 7% for discretionary spending — takeout dinners, a socially-distanced drink with friends, clothes to fit the new WFH lifestyle, etc. My savings break down into 3 buckets: (1) Roth 401k, (2) Roth IRA, and (3) non-retirement account savings. For the Roth 401k, I’m contributing 5% of my income as I get a 5% match from my employer. If you can get a match, definitely make at least that level of contribution. Otherwise, you are literally saying “No” to that extra money. For the Roth IRA, I contribute to the maximum amount each year, which is $6,000 in 2020. I allocate the remainder of the 38% to non-retirement investment accounts. I have each of these savings amounts set up to auto-transfer each time I’m paid, which is the essential step to actually saving the money you planned.
I’m happy with my savings rate today. It hasn’t always been at this number, and I don’t want it to stay here either. When I started working in my early 20’s, I was earning half of what I am now, and my savings rate was at 25% (which was a stretch for me even though I still lived like a college student). I’m at the point where my expenses are pretty minimal for the lifestyle I want to have right now, so I’m focusing on developing my career and other income sources to raise the income side of the equation. With each year, higher-income means I’ll be able to have a higher savings rate, ultimately bringing me closer to my goals of financial independence and first-generation wealth.
I’ll talk in a future post about how you might calculate the amount you need to save depending on your goals as well as what you should do with the money that you’re accumulating — hint: you’re going to want to invest it. Stay tuned!
Disclaimer: I am not a financial or tax professional. All of the above is provided solely as entertainment. You are 100% responsible for your financial decisions and should consult professionals if you have any financial or tax questions.
