### Author Topic: What does "Saving 50% of Income" mean?  (Read 11168 times)

#### YTProphet

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##### What does "Saving 50% of Income" mean?
« on: April 06, 2015, 08:08:06 AM »
This post is a bit Pharisaical in that saving 50% of income, regardless of whether it's gross or net, is a good thing. However, I'm still curious to hear from other Mustachian's as to what they consider a true 50% income savings.

Let's take a hypothetical person whose gross pay is \$125,000 and that it's down to \$120,000/year after monthly pre-tax healthcare expenses. She takes home \$10,000/month. She saves \$1500/month for her 401k, so she's down to having a \$8500/month check. Take out taxes (lets make them easy for mathematical purposes) and she's down to \$7000 net. She saves \$915/month to max out her Roth and her spouse's. So she's down to \$6085. She spends \$4000/month to live on and saves the remaining \$2085, for a total of \$4500/month savings.

Do you think she is 50% of her income? Assume her husband doesn't work so he can watch the kids and there's no other income.

#### netskyblue

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##### Re: What does "Saving 50% of Income" mean?
« Reply #1 on: April 06, 2015, 08:11:07 AM »
I think around here, the general consensus is add up everything you take home each year in your paycheck (after taxes, your true take-home pay), plus your and your employer's 401k (or whatever retirement plan) contributions.  Divide that number by 2.

ETA: Yes, I'd say your case is 50%.  \$7000/mo net, plus \$1500 in 401k contributions = \$8500.  Half that is \$4250.
« Last Edit: April 06, 2015, 08:13:08 AM by netskyblue »

#### forummm

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##### Re: What does "Saving 50% of Income" mean?
« Reply #2 on: April 06, 2015, 08:37:55 AM »
I think around here, the general consensus is add up everything you take home each year in your paycheck (after taxes, your true take-home pay), plus your and your employer's 401k (or whatever retirement plan) contributions.  Divide that number by 2.

ETA: Yes, I'd say your case is 50%.  \$7000/mo net, plus \$1500 in 401k contributions = \$8500.  Half that is \$4250.

Agreed.

#### nereo

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##### Re: What does "Saving 50% of Income" mean?
« Reply #3 on: April 06, 2015, 08:45:10 AM »
I think around here, the general consensus is add up everything you take home each year in your paycheck (after taxes, your true take-home pay), plus your and your employer's 401k (or whatever retirement plan) contributions.  Divide that number by 2.

ETA: Yes, I'd say your case is 50%.  \$7000/mo net, plus \$1500 in 401k contributions = \$8500.  Half that is \$4250.
yup.  Don't even bother with pre-tax income, because tax rates change so drastically with income fluctuations (both due to progressive tax code and due to earned income limits on tax-deferred accounts).

However, never loose sight of the forest because you're looking at all the trees.  The 'shockingly simple math' is at best just a way of visualizing how many years you might have to work at a particular savings rate.  However, what really matters is how many dollars* you save and how many dollars you spend.  If you are saving 50% of your income, get a \$20k raise and increase both your spending and saving amounts by \$10k you will still have a 50% savings rate, but it's very likely your "FI number" will be further away (because you just increased your spending).

*Dollars for most people around here, but it could be Euros or Pesos or Pounds or...
EDIT: fixed typo
« Last Edit: April 06, 2015, 10:19:20 AM by nereo »

#### velocistar237

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##### Re: What does "Saving 50% of Income" mean?
« Reply #4 on: April 06, 2015, 09:47:04 AM »
There's so much variation in income, expenses, taxes, inflation, laws, market return, etc., that any reasonable calculation will do.

I enjoy PF navel gazing, so here's my take. The point of the calculation is estimating time to retirement, which will happen when your net investment income covers your post-FIRE expenses and inflation, assuming some safe withdrawal rate. So the savings rate should reflect how much money you save and how much money you will spend later:

Effective savings rate = (Amount saved)/(Amount saved + retirement expenses)

= 4500/(4500 + 4000 + retirement health care + retirement taxes +/- other adjustments)

Taxes could be pretty low, and maybe health care, too, and business related expenses will go down, so 50% is about right.

But again, most of these calculations give you about the same estimate. By the time you reach FIRE, these estimates will be a thing of the past, and you'll base your decisions on current numbers, kind of like what nereo said.

Just don't use gross income, or the OMY goblins will eat your children.

#### midweststache

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##### Re: What does "Saving 50% of Income" mean?
« Reply #5 on: April 06, 2015, 10:02:34 AM »
Just don't use gross income, or the OMY goblins will eat your children.

This statement wins today.

#### RunHappy

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##### Re: What does "Saving 50% of Income" mean?
« Reply #6 on: April 06, 2015, 10:05:04 AM »
I think most people on here count 50% of take home pay.

I started with that goal too, to save 50% of my take home pay.  It took me a couple of years but I hit it.  Since then I've set a goal to save 50% of my pre-tax pay.  This has been a little more difficult but I'm making slow progress.

#### ac

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##### Re: What does "Saving 50% of Income" mean?
« Reply #7 on: April 06, 2015, 10:11:35 AM »
If you plan on buying health insurance when you're FI, make sure to include that in future spending forecast.  Makes a big difference!

And so if you're using your current spending with the 4% rule, again - include health insurance payments in your current spending.

#### SK Joyous

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##### Re: What does "Saving 50% of Income" mean?
« Reply #8 on: April 06, 2015, 03:19:23 PM »
Just for fun (I heart numbers! <- nerd) I have done a variety of calculations to find our percentage; for example

34.3% of gross income (everything before any deductions)
51.7% of net income (the net dollars on each paycheque added together for the year)
46.8% of net income + employer pension contributions (because this is part of income, but income we could never get 'paid')

Being in Canada, our taxes are probably a bit higher, but I never have to budget for health care, so there's that.

I didn't realize our numbers were so good until I did the calculations thanks to MMM and this forum.  It's a nice feels boost

#### Lookie Loo

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##### Re: What does "Saving 50% of Income" mean?
« Reply #9 on: May 15, 2015, 05:53:10 AM »
Do you include your 401k contributions as part of your 50% savings?

#### SnackDog

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##### Re: What does "Saving 50% of Income" mean?
« Reply #10 on: May 15, 2015, 05:58:51 AM »
Forget about the numbers and just save every nickel you possibly can. Always. That's the best you can do!

#### Thegoblinchief

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##### Re: What does "Saving 50% of Income" mean?
« Reply #11 on: May 15, 2015, 06:11:22 AM »
Forget about the numbers and just save every nickel you possibly can. Always. That's the best you can do!

+1

Either you are spending something that's needing or worth it, or a purchase is "wasted" and should have been saved. Everyone's evaluation is different.

Savings rate is just a goal, it's rather meaningless as a calculation, so it doesn't matter how you calculate it. The reason I say it's meaningless is that nearly 100% of retirees will have spending at drastically different levels (some lower, some higher) upon RE, so the "simple math" does nothing to give you a stash relevant to THAT spending level.

#### alsoknownasDean

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##### Re: What does "Saving 50% of Income" mean?
« Reply #12 on: May 15, 2015, 06:13:06 AM »
I tend to base it on my net pay, excluding superannuation, and after the deductions made for my HECS (government funded student loan) and train ticket (which I should cancel now I ride my bike to work).

Based on that, assuming I stick to my fortnightly allowance (a few face punches are in order as I haven't lately), I'd be at a 41% savings rate. Once I take the HECS and train ticket deduction out of the picture, I'll be at 46%.

Health insurance is counted as one of my normal monthly expenditures (it's not that expensive here in Australia).

I don't count super as I can't touch it until I'm 60, and I plan to have been retired quite a while by then :)

#### velocistar237

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##### Re: What does "Saving 50% of Income" mean?
« Reply #13 on: May 15, 2015, 09:17:59 AM »
Do you include your 401k contributions as part of your 50% savings?

Yes, it counts as part of your savings.

The reason I say it's meaningless is that nearly 100% of retirees will have spending at drastically different levels (some lower, some higher) upon RE, so the "simple math" does nothing to give you a stash relevant to THAT spending level.

Hence my comment above.

Effective savings rate = (Amount saved)/(Amount saved + retirement expenses)

As far as I know, this is most useful for predicting time to retirement of any definition I've seen. But you're still right about it not being that useful, because

There's so much variation in income, expenses, taxes, inflation, laws, market return, etc., that any reasonable calculation will do.

Savings rate is primarily a conceptual and motivational tool for people early on in the process, as well as a rough check to make sure you're not fooling yourself. The further along you get, the more you focus on your actual savings history, your current invested assets minus debt, and your goal amount.

#### I'm a red panda

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##### Re: What does "Saving 50% of Income" mean?
« Reply #14 on: May 15, 2015, 09:40:33 AM »
I consider 50% savings to be based on pre-tax pay.

Last year our combined salaries were X. We put 0.5X into savings; 401k, 403b, Roth IRAs, taxable investments, and our savings account.   We have a 50% savings rate for our household.

Taxes (and there are way more than just income taxes) are our biggest expense. It makes no sense to me to not count them as such.

But what does percent matter?  The dollar amount I'm saving is what matters.
« Last Edit: May 15, 2015, 09:43:06 AM by iowajes »

#### Spork

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##### Re: What does "Saving 50% of Income" mean?
« Reply #15 on: May 15, 2015, 10:35:26 AM »

The most important thing is to do something and be consistent.   If you want to compare to someone else... then you both need to be consistent.

Personally: I treat it as close as I can to my understanding of accounting.  I treat every thing as an income or an expense.  I start pre tax (and include taxes as an expense).  This makes the formula incredibly easy.

(income - expense) / income = savings

Now if you're doing after tax and I'm doing before tax... you may see a drastically higher savings rate than I do.

#### lavar

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##### Re: What does "Saving 50% of Income" mean?
« Reply #16 on: May 15, 2015, 11:13:09 AM »

The most important thing is to do something and be consistent.   If you want to compare to someone else... then you both need to be consistent.

Personally: I treat it as close as I can to my understanding of accounting.  I treat every thing as an income or an expense.  I start pre tax (and include taxes as an expense).  This makes the formula incredibly easy.

(income - expense) / income = savings

Now if you're doing after tax and I'm doing before tax... you may see a drastically higher savings rate than I do.

I treat savings  as an expense (my monthly expense tracker nets to 0), then back-out my savings rate as a % of total expenditures - which is what I have control of. I would find it a little dis-empowering to try and do it on the gross where I can't really control things and which would cap my savings rate at about 68%.

Its not a complete or philosophically sound approach in many ways, since I take the net I also ignore contributions to a defined benefit pension, and it also doesn't include the equity portion of my mortgage or additional principal mortgage payments which some might include in savings as it increases "net worth".

#### velocistar237

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##### Re: What does "Saving 50% of Income" mean?
« Reply #17 on: May 15, 2015, 11:14:41 AM »
But what does percent matter?  The dollar amount I'm saving is what matters.

With savings percentage you can predict your time to retirement, as in this classic post, The Shockingly Simple Math Behind Early Retirement. For example, a savings rate of 50% means 17 years from start to retirement, and 65% means 10.5 years. The prediction is most accurate for the specific definition of savings rate that went into the derivation.

Taxes (and there are way more than just income taxes) are our biggest expense. It makes no sense to me to not count them as such.

When you calculate time to retirement, the expenses that go into the equation are your future expenses. It is typically said that you need to save 25 times your expenses in order to retire, and those expenses are your expenses during retirement. In the future, your taxes will likely be a lot lower. If you include your current taxes, then your prediction will be inaccurate.

To be most accurate, do this:
(Amount saved)/(Amount saved + retirement expenses)

If my gross income is \$300K, my take-home is \$200K, my savings are \$50K, and my expected retirement expenses are \$10K (e.g., moving overseas), then even though I'm spending \$150K/year now, I will still save \$250K in about 5 years, which is 25 times my retirement expenses. According to the Shockingly Simple Math, 5 years corresponds to a savings rate between 80% and 85%. Surprise, according to my formula above, 50/(50+10) = 83%. Going by current expenses, you get a savings rate of 50/200=25%, which would mean 32 years until retirement, and using gross income, you have 50/300=17%, or about 40 years, both of which are very inaccurate.

But if you expect your future expenses to be the same as now, then they're equivalent, and if you don't ever calculate estimated time to retirement, then it's moo.

#### Spork

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##### Re: What does "Saving 50% of Income" mean?
« Reply #18 on: May 15, 2015, 12:53:54 PM »

The most important thing is to do something and be consistent.   If you want to compare to someone else... then you both need to be consistent.

Personally: I treat it as close as I can to my understanding of accounting.  I treat every thing as an income or an expense.  I start pre tax (and include taxes as an expense).  This makes the formula incredibly easy.

(income - expense) / income = savings

Now if you're doing after tax and I'm doing before tax... you may see a drastically higher savings rate than I do.

I treat savings  as an expense (my monthly expense tracker nets to 0), then back-out my savings rate as a % of total expenditures - which is what I have control of. I would find it a little dis-empowering to try and do it on the gross where I can't really control things and which would cap my savings rate at about 68%.

Its not a complete or philosophically sound approach in many ways, since I take the net I also ignore contributions to a defined benefit pension, and it also doesn't include the equity portion of my mortgage or additional principal mortgage payments which some might include in savings as it increases "net worth".

If that works for you... Then cool.    But I think you are using generally accepted terms incorrectly, which will be confusing to pretty much anyone.

And if your savings rate is 68% on gross... that should NOT be dis-empowering.  68% is pretty awesome!

#### I'm a red panda

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##### Re: What does "Saving 50% of Income" mean?
« Reply #19 on: May 15, 2015, 01:09:53 PM »
Quote
But if you expect your future expenses to be the same as now, then they're equivalent, and if you don't ever calculate estimated time to retirement, then it's moo.

Ah, there you go.
The cow is of the opinion that I don't calculate it with regards to retirement.

I just do it year to year to see what percentage I put away that year vs. what I spent.  Even if taxes are out of my control in how much I spend, they are still spending.

#### use2betrix

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##### Re: What does "Saving 50% of Income" mean?
« Reply #20 on: May 15, 2015, 02:34:45 PM »
I consider saving 50% of income to mean:

Take your pay after taxes/benefits are taken out. Divide that by two. That's half your "income" in that sense.

I.e. If you take home 8k/mo, and save/invest 4k/mo, you're saving 50%.

#### I'm a red panda

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##### Re: What does "Saving 50% of Income" mean?
« Reply #21 on: May 15, 2015, 02:38:58 PM »
I consider saving 50% of income to mean:

Take your pay after taxes/benefits are taken out. Divide that by two. That's half your "income" in that sense.

I.e. If you take home 8k/mo, and save/invest 4k/mo, you're saving 50%.

So do you assume that your tax return is always 0?

Because what you take home month to month isn't your real income if you owe or get money back at the end of the year.

You also don't count things like insurance as expenses? (Since you say after your benefits are taken out.)  Won't you still have to pay for retirement, life insurance, whatever after you FIRE?
Do you consider your 401k savings? Because if it is taken out before you get the number you are counting as income.

#### Sid Hoffman

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##### Re: What does "Saving 50% of Income" mean?
« Reply #22 on: May 15, 2015, 04:01:27 PM »
You also don't count things like insurance as expenses? (Since you say after your benefits are taken out.)  Won't you still have to pay for retirement, life insurance, whatever after you FIRE?

I suspect a lot of people in the USA do overlook health insurance at first glance if they currently have that being paid via payroll deduction from their employer pay check.  You are correct that's something to plan for.

As for 401k, if you're retired with no ordinary (as defined by the IRS) income, you legally cannot be putting money in a 401k or IRA of any kind.  Dividend and capital gains income doesn't count; you can't put money in a retirement account unless it's classified as ordinary income.  Besides which; at that point you're blurring the line between what is or isn't retirement.  If you're still working and putting money in a 401k, are you really retired?  Legally you're not, you're still working, even if its only part-time.

As for life insurance, there's a MMM article on that topic.  Bottom line is that any significant life insurance policy is a statistically bad bet for someone who's already financially independent.  If you're retired, the implication is that you already have \$700k - \$1M or more.  If you're young, then a term insurance policy would be fairly affordable, but only at smaller payouts like \$250k and you're very unlikely to ever collect.  Meanwhile your expenses are higher by however much that insurance payment is.  You have to ask yourself: if I die, does my spouse really need an extra \$250k on top of the million dollars they already have?  If you're older, then the insurance will be expensive, and you might only get good pricing on a \$25-50k policy.  Now it sounds really ridiculous.  Why increase your expenses with a \$50k life insurance policy when you already have 15-30x as much money saved up?

It's always good to plan and health insurance (at least for Americans) is a big expense you have to pay for yourself when you retire, but at the same time a lot of expenses go away, too.  I think this is why most people are comfortable with the notion of saving to reach 25-50x their present expenses.  They know they'll have a couple new expenses, but that some of the old expenses will be gone, too.  This is especially true for people living & working in a high COL area but retiring to a low COL area.

#### use2betrix

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##### Re: What does "Saving 50% of Income" mean?
« Reply #23 on: May 15, 2015, 04:16:29 PM »
I consider saving 50% of income to mean:

Take your pay after taxes/benefits are taken out. Divide that by two. That's half your "income" in that sense.

I.e. If you take home 8k/mo, and save/invest 4k/mo, you're saving 50%.

So do you assume that your tax return is always 0?

Because what you take home month to month isn't your real income if you owe or get money back at the end of the year.

You also don't count things like insurance as expenses? (Since you say after your benefits are taken out.)  Won't you still have to pay for retirement, life insurance, whatever after you FIRE?
Do you consider your 401k savings? Because if it is taken out before you get the number you are counting as income.

Yes, I always assume a 0 tax return. It's never been over \$2000. I use my small return as a bonus, not as a guarantee.

My income is so messed up that it's difficult to factor in stuff like insurance costs, plus, my insurance is only about 3% of my take home pay. I could just tack that 3% on elsewhere I suppose.

I don't pay for gas now, and will after retirement. I get \$3445/mo in tax free per firm/truck allowance, won't get that.

Maybe it's due to my situation being more complicated than most, which is why I consider 50% to be different than some peoples.

It's sort of like counting equity in a vehicle towards your "net worth." Some people do, some don't. I personally don't in most circumstances.

#### Spork

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##### Re: What does "Saving 50% of Income" mean?
« Reply #24 on: May 15, 2015, 05:14:48 PM »
I consider saving 50% of income to mean:

Take your pay after taxes/benefits are taken out. Divide that by two. That's half your "income" in that sense.

I.e. If you take home 8k/mo, and save/invest 4k/mo, you're saving 50%.

So do you assume that your tax return is always 0?

Because what you take home month to month isn't your real income if you owe or get money back at the end of the year.

You also don't count things like insurance as expenses? (Since you say after your benefits are taken out.)  Won't you still have to pay for retirement, life insurance, whatever after you FIRE?
Do you consider your 401k savings? Because if it is taken out before you get the number you are counting as income.

Yes, I always assume a 0 tax return. It's never been over \$2000. I use my small return as a bonus, not as a guarantee.

My income is so messed up that it's difficult to factor in stuff like insurance costs, plus, my insurance is only about 3% of my take home pay. I could just tack that 3% on elsewhere I suppose.

I don't pay for gas now, and will after retirement. I get \$3445/mo in tax free per firm/truck allowance, won't get that.

Maybe it's due to my situation being more complicated than most, which is why I consider 50% to be different than some peoples.

It's sort of like counting equity in a vehicle towards your "net worth." Some people do, some don't. I personally don't in most circumstances.

If you just categorize your "ins" and "outs" as income/expenses.... even complicated situations become easy to compute.

as to cars in net worth:  I do it.  But it makes little difference to net worth.  Where it comes in handy is this.  Once a year I re-evaluate the worth of the vehicles and take that as a depreciation expense.  THIS becomes worthwhile as you learn over time what your real annual auto expenses are.

#### Sid Hoffman

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##### Re: What does "Saving 50% of Income" mean?
« Reply #25 on: May 15, 2015, 05:30:35 PM »
Yes, I always assume a 0 tax return. It's never been over \$2000. I use my small return as a bonus, not as a guarantee.

What you're describing is a tax refund.  A tax return is your 1040A form that you file to manage however much federal income tax you own.  So somebody saying \$0 tax return means paying \$0 in federal (and implied state) income taxes.  That's generally very possible for a retiree living off dividends and long term capital gains (and some Social Security) as long as they're not above the 15% federal income tax bracket.

#### minority_finance_mo

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##### Re: What does "Saving 50% of Income" mean?
« Reply #26 on: May 15, 2015, 09:51:34 PM »
I'm in the forest and trees camp (did I get that right?): worry less about net vs. gross savings, and more about optimizing.

That said, when trying to choose whether to calculate off of net or gross savings rate for the "shockingly simple math" calculation, a very crude rule of thumb I've been using is: the higher your spending requirements in retirement, the more sense gross savings rate makes sense. The login behind this is those spending less in retirement will need to draw less from their investments, thus paying less (in some cases no) taxes. Again, super crude but one way to look at it.