How To Save More Money - Focus On Your Paycheck

How To Save More Money - Focus On Your Paycheck

How To Structure Your Pay Check To Save More Money

If you want to be serious about saving and really dominate your savings plans, there is no better way to accomplish it than to focus on how you structure your paycheck. Your paycheck is the point of attack to control your finances. Allowing too much money from your paycheck into your checking account is like opening the flood gates and letting your money flow out the door. It’s human nature that if you have the money available, you’ll spend it. If this is how your personal finances are set up, chances are you’re picking up what I’m putting down and like many others (you’re not alone!) find yourself spending more than you should on things you don’t need. So what should you do?

Aggressively break up your paycheck into automatic savings

The best way to save money is to save it before you can spend it. Once you’ve set your financial goals, break up your paycheck to meet those goals, and you’ll be achieving your goals in no time. I am a fan of simple systems and it doesn’t get much more simple than that. It’s truly a set it and forget it type of system.

Direct deposit your savings goals into a savings account, IRA, HSA, or whatever your goals are and never let it hit your checking account. You’ll be setting up a way to automatically reach your savings goals without having to do anything other than dealing with whatever money you are left with. That’s a good thing. We are survivalists, we all can survive on much less than we currently are spending, I guarantee it. So don’t wait, change that amount today. If you went into your payroll system right now and changed it so you automatically invested 1% more into your 401k, you won’t even notice the difference. Mostly because your 401k is tax deferred so that 1% is more like .75%, or even 66% depending on your tax bracket. That’s why its so valuable to have a purpose for your money and if you can, invest it before you see it. So what happens with the rest of your money?

Everything left over after your savings goals goes into checking

If you did things right, it feels like you just got a demotion. Which you did in terms of what you can spend in ‘fun’ money but that’s only because you’ve made a decision that having more to invest in what matters, your long term wealth, is more important than being able to spend your disposable income on a whim. This system forces you to be mindful of the money you do spend and can spend every two weeks until the next paycheck. The great thing about this system is even though it feels you like you got a pay decrease, all you really did is set yourself up to get ahead financially. If you can stick to the plan, you’ll be shocked by how much you have in one year, not to mention three to five years. With your new found savings you can invest in whatever matters to you. Your retirement, a brokerage account, investments properties, your kids college funds, or even a dream home. Whatever you are saving for you will be in a better position because you paid yourself first.

Here are two examples of what your paycheck could look like for someone making 75k a year:

The Retirement Saver

Here is an example of what an aggressive saver’s paycheck might look like who is focusing on building their retirement savings. This saver is maxing out their 401k ($19,000 per year), Roth IRA ($6,000 per year), and HSA ($7,000 per year for a family plan) with direct deposits into each account assuming 24 pay periods a year. The numbers are rounded to the nearest dollar for ease of reading but this saver is getting the benefit of roughly $1,084 in tax free/deferred savings with their $292 and $792 for HSA and 401k respectively. Additionally, they are saving $250 per pay after tax for a total of $6,000 in their Roth IRA. With the $625 going into a savings account this worker is saving an additional $15,000 in after tax money for a grand total of $47,000. That’s almost a 63% savings rate.

This worker saves $122 more per pay period ($2,928 per year) than the after tax saver due to focusing on investing in tax advantaged accounts.

This worker saves $122 more per pay period ($2,928 per year) than the after tax saver due to focusing on investing in tax advantaged accounts.

The After Tax Saver

Here is an example of what an aggressive saver’s paycheck might look like who is focusing on building after tax savings. This saver is ‘only’ contributing 10% of their paycheck into their 401k ($7,488 per year) and $1,920 to their HSA, however they are saving a whopping $1,445 per pay period into their savings account which amounts to $36,680 in after tax savings. This would likely be someone who is saving for a big goal, like paying off their house or perhaps trying to build up their savings to invest in rental properties or a business. The numbers are again rounded to the nearest dollar for ease of reading and all in all this saver is saving $44,088. Still an impressive number at a little over 58% savings rate.

This worker saves $122  less  per pay period ($2,928 less per year) because they are being taxed on more of their income.

This worker saves $122 less per pay period ($2,928 less per year) because they are being taxed on more of their income.

Why It Works - The Safety Net

Okay who are these crazy people who can save this much. Don’t freak out. First off, you don’t have to save that much, these are just examples and perhaps an ideal savings rate if you’re looking to retire early, but that’s not for everyone. It’s certainly not a necessity. However, if you can use these models to build your personal version of your paycheck you’ll find yourself ahead financially way faster than you were before. If you follow this method and aggressively change your take home pay you will have less coming into checking every pay. And that can be scary. We personally are often floating around with only a few hundred dollars in our checking account.

So if and when that random expense comes up, you might not have enough in your account to cover it. You can do one of two things, put it on a credit card and pay it off with savings later is one option. Or another option, and my personal favorite, is to go through the painful action of having to transfer your hard earned money from savings into your checking account to cover your additional expenses and pay for them with your debit card. If it was worth it, its okay and you feel good about it. More importantly, if it wasn’t worth it, you feel the pain of seeing that money leave your savings account. And that’s why this system works. It creates an environment where you are a little deprived of money in your checking but you have the safety net of savings so you don’t have to go into credit card debt to cover random expenses.

I also don’t like extreme budgeting and this method makes you have to know how much is left in your checking account and you naturally try to make sure you don’t overdraw your account. And that’s all the budgeting you need. If you don’t have the money in your account, you have to wait or feel the pain of transferring your money from savings. Hopefully something you grow to be uncomfortable with if you’re not already.

This method also works because it keeps you from dipping into debt. If you can’t afford to pay for something and you have no money to pull from, you’ll have to go further into debt. That’s painful and not going to be sustainable. This method prevents the issue because you have access to the money if it’s an emergency, but you have to make a deliberate effort to get it. Then you have to make a conscientious decision to move money from your savings into checking. A move that is manual and deliberate so it’s less likely to happen as often. It’s the closest way I’ve been able to replicate paying cash without having to actually go to the bank, take out cash, and put money into an envelope to pay for stuff. Dave Ramsey recommends this method and I think it can work for people, but the problem is it’s not sustainable. It’s like a diet. You can only count your calories so long. The method outlined in this post focuses on building a lifestyle shift, and it’s not just a budgeting fad.

Once you’ve made the change, my recommendation is to settle in for a couple of paychecks to get used to your new checking account money, and once you’re comfortable, start transferring that money out of your savings account to fund your goals, whatever they may be.

Bonus Tips

How your income tax bracket impacts your take home pay - The higher your tax rate, the more benefit you’ll see in putting more savings into your 401k, HSA, or any other tax deferred accounts. You’ll feel less pain. That’s why it’s always recommended to save as much as you can into those types of investments.

Invest any bonuses or windfalls - Invest bonuses or windfalls right away into savings. You didn’t have a plan for that money anyways, so why not put it somewhere that allows you to pay down debt, invest more, and meet whatever your long terms goals might be.

Invest your raises immediately into one of your savings/investments with your direct deposits - This one is huge in the long run and the best way to prevent lifestyle inflation. As you get raises, calculate how much more per pay you’re getting and put it into one of your investing goals. I do this every year and it’s the most sure fire way to increase your savings rate. It’s how you will eventually be maxing out your 401k, paying off all your debt, or funding your kids college. Do it before you even see your first pay raise paycheck and you don’t even notice the difference. I know, it’s not as exciting and buying a new boat or car, but most raises or bonuses are only 3-5% anyways, so its not like spending it will changes your life. But saving it can.

How do you split up your paycheck? Any ideas on how to improve this system?

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