Lifestyle Tip #5: Pay Yourself First

pay yourself first

In theory, I’m a fiscally responsible grown-up. Or at least I think enough of my financial skills to write about them on my blog. I read about a dozen frugality and early retirement blogs regularly, own and have given away copies of “Your Money or Your Life.” I employ the services of a fee-only financial planner, and have never bounced a check or had a bill go into collection. I’m the chief financial officer of our household.

But I’ve got a dark secret.

what's in wallet
Q: What’s in your wallet? A: Nothing!

You ready? I’m actually not that good at hanging onto our money. Left to my own devices, I’d probably spend it all.

It’s true. Ever since I’ve had my own job and opened my first checking account, I’ve pretty much spent almost everything in it. While I’m a bit more cautious at 40 than I was at 17 and don’t typically let the bank balance drop into the triple digits, my habits have otherwise remained the same. We stick to our budget pretty closely, but anything extra typically gets spent.

And this is why I pay myself first.

What does paying yourself first mean? It means you have items in your budget*, and goals for your savings, and you put money toward those first, every time you get paid. Why? Saving for the future is hard, especially with other priorities competing for your salary. If that money hits your checking account and you’re like me, you’re likely to spend it on something else. So don’t let it hit your checking account at all.

*If you don’t have a budget, here’s a good place to start.

How to do it

The key is to have the money withdrawn directly from your paycheck and deposited somewhere other than your checking account (think employer-sponsored retirement plans or fractional direct deposits), or to set up an automatic withdrawal from your checking account on the same days you get paid.

Pay yourself first for retirement

Employer retirement plans, such as 401(k), 403(b) and 457(b) are awesome for a number of different reasons. First, many employers contribute a match. It’s free money! Second, the money is withdrawn from your paycheck before taxes. This reduces your taxable income and the amount of taxes you have to pay. Third, you never have to think about saving money for retirement because it’s already done before your salary hits your bank. You can set up automatic contributions from your bank to fund a Roth IRA or the various self-employed retirement plans too.

Pay yourself first for budgeted savings

360 savingsWe’ve been Capital One 360 (previously ING Direct) customers for years. This online bank offers free, unlimited savings accounts that you can name whatever you want. So Lindy and I use these in two ways: for savings goals, such as when we were saving to replace my Prius, and for budgeted expenses that aren’t the same every month. We pay our property taxes twice a year, so we use one savings account to hold the money until it’s due. We spend a fair amount on travel and use a Southwest Airlines Chase Visa to earn points, so we hold our travel budget in its own savings account and use that to pay off the credit card balance every month.

The car money would go straight from checking to the car savings account twice a month, the travel money from checking to the travel savings account, and the property taxes to the tax account twice a month. It’s always there when we need it. Anything that isn’t used can go toward a future month’s expenses. If we have a big expense coming, such as the biennial tax payment or a major trip, we have access to multiple months of savings immediately. This would never happen with the money just sitting in our checking account for months on end.

Pay yourself first for the future

To use these different ways of saving automatically is also to grow used to not having that money around for other things. It’s a bulletproof way to avoid succumbing to lifestyle inflation. If you get a raise, or a new job that pays more, simply increase your automatic savings more and more until you’ve maxed out your employer-sponsored retirement plan and have to start saving in other ways. Increase your automated savings too. Put all of your extra money into savings, or at least most of it, so it never feels like you’re getting a raise at all.

It’s okay to start small. We did. Set up an automatic savings plan for just $5 a paycheck. Then see if you can grow it to $10, $20 or more.

If you ask the experts — and I’m not one — the key to financial stability and later independence is maximizing the percentage of your income that you save. This works for two reasons. One, you’re increasing your savings faster, so they’ll be ready sooner when you want to use them to retire or work only when you want to. Two, you’re reducing your actual expenditures and becoming accustomed to living on less, so the amount of income you’ll need to cover your lifestyle during financial independence is less.

Making it easier for you to start saving and keep doing it is what paying yourself first is all about. It’s the reason Lindy and I are able to save about a third of what we earn, a number that will be much higher when we’re no longer paying for before- and after-school care or saving for college.

Paying yourself first is an easy way to make progress toward your financial goals. It’s also something that not everyone does. Whether you earn the “supersaver” name for yourself or just get closer to where you want to be in life, start today!

Also published on Medium.

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