What Is the 10% Savings Rule?

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DEFINITION

The 10% savings rule is a guideline that suggests setting aside 10% of your gross income for retirement or unexpected expenses. If you have no idea how much to save, it gives you a starting point, but it isn't a one-size-fits-all rule.

Definition and Examples of the 10% Savings Rule

The 10% savings rule is a guideline that suggests setting aside 10% of your gross income for retirement and other important savings. It's more of a personal commitment than an actual rule. Establishing a personal budget that sets aside 10% of your gross income every paycheck is a way of prioritizing savings.

Gross income is your total income from all sources (e.g., paychecks, tips, investments, and bonuses) before any taxes and expenses are taken out.

A retirement account is one of the places you can put this saved money, but it isn't the only option. The funds you set aside under the 10% rule also can be used to create an emergency fund, save for a down payment on a home, and more.

Saving 10% of your gross income is committing to a standard higher than what most individuals in the U.S. save. Since 1983, the personal savings rate in the United States most often has been in the single digits—and that calculation is based only on a percentage of disposable income, not on a percentage of gross income. In other words, average earners in the U.S. typically save less than 10% of their disposable income, which is only what's left over after taxes have been deducted, and necessary bills have been paid. This rate went up temporarily in 2020 and 2021, but by October 2021 it was back down to 7.3%.

How Do You Calculate the 10% Savings Rule?

Figuring out how much to save under the 10% savings rule is about as simple as an equation gets. It's even simpler if you are paid a fixed salary. In that case, your regular paychecks will all be the same, which means you only have to calculate the amount once. If you are paid hourly, your gross pay might vary from paycheck to paycheck.

Either way, take your gross earnings—the amount before taxes or other deductions are withheld—and multiply that number by 0.10. (This is the same as dividing by 10.) For example, if your biweekly paycheck has gross earnings of $1,350, that means you would set aside $135 for savings from each paycheck.

Formula for the 10% savings rule

How the 10% Savings Rule Works

Saving often is about self-discipline. It requires the restraint to set money aside for the future rather than spending it now. The sooner you start saving, the greater the impact due to the effect of compound interest. Understanding compound interest can help motivate you to save.

For example, the average median personal income in the U.S. at the end of 2020 was about $36,000 annually. That equates to about $3,000 per month. According to the 10% rule, that would mean saving $300 every month.

If you started following the 10% savings rule at age 25 and invested that fraction every month in a retirement account earning 5% interest, by age 65 you would have contributed $144,000. The account also could have earned $313,806.05 in interest, for a total of $457,806.05. But if you waited until age 30 to start saving, your account might have only $340,827.73 by the time you were 65. In other words, the five years that you saved from age 25 to 30 cost only $18,000 in contributions but earned nearly $100,000 in interest. You can see the impact of compound interest by using a compound interest calculator.

If your savings are starting from scratch, it's a good idea to put money in an emergency fund. This is money that should be easily accessible to help handle unexpected expenses that may come up. A basic interest-bearing savings account is a good option.

If saving for an expense that might be several months or even a few years down the road—such as a house or a wedding—CDs might be a good option. They're less accessible than savings accounts, but they typically earn more interest.

If your employer matches 401(k) funds up to a certain percentage of your income, count those matching funds as part of your gross income when calculating how much to save. For example, if you earn $36,000 annually, and your employer matches up to 3%, that's an additional $1,080 you are receiving from your employer each year, making your gross income $37,080 for the purposes of the 10% savings rule.

For retirement savings, you can use a 401(k) account or an IRA account. One of the benefits of 401(k)s is that they are good for anyone who might struggle with self-discipline, since the funds are withheld from your paycheck. The money never hits your bank account, so you cannot spend it. In fact, tax laws dissuade you from touching the money. There is a 10% penalty tax on most retirement account withdrawals before age 59 1/2.

When the 10% Savings Rule Doesn't Work

The less you earn, the more difficult it can be to save, especially if you are trying to set aside 10% of your gross pay. If you have a lower income or live in a very expensive area, rent, groceries, and utilities can cost so much that the 10% rule is an impossible standard to meet. In that case, save as much as possible, making it a goal to pay down any debts and increase your earnings to the point that 10% is more realistic.

Even if you have a high enough income to save 10%, you might want to reconsider that approach if you have a lot of high-interest debt. If, for example, you have a lot of credit card debt with interest rates around 20%, you will pay more in interest on your debt than you can earn in compound interest on your savings. In that case, you should set aside some money for emergencies (so you don't accumulate more debt) then focus on paying off your high-interest debt before you begin saving.

Key Takeaways

  • The 10% rule encourages you to save at least 10% of your income before taxes and expenses.
  • Calculating the 10% savings rule is a simple equation: divide your gross earnings by 10.
  • The money you save can help build a retirement account, establish an emergency fund, or go toward a down payment on a mortgage.
  • Adjust your savings accordingly if faced with a low income or severe debt, but don't give up entirely.

Article Sources

  1. Federal Reserve Bank of St. Louis Economic Data. "Personal Saving Rate." Accessed Dec. 11, 2021.

  2. Bureau of Economic Analysis. "Personal Saving Rate." Accessed Dec. 11, 2021

  3. Federal Reserve Bank of St. Louis Economic Data. "Median Personal Income in the United States." Accessed Dec. 11, 2021.

  4. Internal Revenue Service. "Exceptions to Tax on Early Withdrawals." Accessed Dec. 11, 2021.