3 in 4 Americans live paycheck to paycheck. Among high earners (those making over $100,000) 1 in 10 are living paycheck to paycheck. There’s no reason for this! If you are making that much money, pay off your debt. Once your debt is paid, plan for your future. To do this, use the Pay Yourself First Budget.
I previously wrote about creating a budget for getting out of debt. That strategy might be particularly useful for people who recently graduated and are trying to pay off loans while making little money. Using that Zero Sum budget, expenses are drastically reduced and necessities for living are paid first (e.g., food, housing, utilities) then every other cent is devoted to paying off debt.
But what if you are debt-free? How do you budget for your life goals?
Good Income But Broke
You often hear about athletes or other high earning celebrities who go broke. You may think, “Didn’t they realize they wouldn’t be making that kind of money forever? Why didn’t they save some?” But the reality is, most of us do the same thing. Sure, our earning and spending is not quite on the same level as people who make millions, but none of us will be able to work forever. Yet we spend like there’s no tomorrow.
We Can’t Work Forever
As an oncology psychologist, I know so many people who suddenly fall ill and become unable to work. It breaks my heart so see people who are really sick drag themselves into work each day because otherwise they cannot afford to eat. None of us are immune to illness. There will be a day when each of us cannot work.
When I paid off my debt and had excess money each month, I got scared that I would blow it.
Around me I saw people spending their paychecks on gourmet coffee, luxury cars, designer clothes/shoes/bags/sunglasses, housing in posh areas of town, yoga classes, hair/nail/massage services, dinners at places where people are hired to carry food from the kitchen to your table.
I was afraid that if I started to act like them, I would be like them (good income but broke).
So what did I do? I made my paycheck as small as possible. No, I didn’t take reduced pay, I actually paid myself first so I didn’t have access to money that I know I will need in the future.
How to Get Started
First, I determined what my goals are (e.g., retirement, HSA, mortgage repayment, kids’ educations).
Second, I identified tax advantage accounts consistent with my goals. For example, employer-sponsored retirement account, Individual Retirement Account (IRA), Health Savings Account. (See Which Benefits Should I Sign Up for At Work)
Third, I prioritized my goals.
- Being a one-income household, keeping a roof over our head is a priority. Should I become unable (or unwilling) to work, I want to ensure we have a place to live. So paying off my mortgage is my first priority.
- Because I spent so long without working as I pursued my education (and my husband cashed in his retirement 10 years ago when he stopped working), saving for retirement is my second priority.
- Third, because I have a high deductible health insurance plan, having enough money in my HSA to pay my (very large) deductible is another priority.
- Kids’ education is not a priority for me now, but will move up on the list after my home is paid off and I am contributing up to the limit on my retirement.
My Thoughts on Automating Transfers
Scott at Making Momentum also recently wrote about Pay Yourself First. He suggests automating transfers. I do have my employer-sponsored retirement and HSA taken directly out of my pay. However, I don’t set anything on autopay (not even to a savings account). I like being in complete control of my money. I’ve heard too many horror stories of “system errors” or “glitches.”
Just a couple weeks ago someone I know did not receive his direct deposit due to some error. He had all his bills set on autopay and guess what? He spent over a week trying to clean up the mess!
Instead of using autopay, I pay all my bills on the first of each month. Then I know exactly how much is left.
Creating Your Budget
Like the zero sum budget for paying off debt, we are still assigning every dollar a job to do. But with the Pay Yourself First Budget, you are taking from the top the money that is consistent with your values and goals. Then pay for living expenses. This will help you reach your goal faster than if you put “whatever is left” toward them.
So if maxing out your Roth IRA, paying off your mortgage early, and saving for your kids education are your priorities, pay those first. Then whatever is left is how much you can spend on food, entertainment, and miscellaneous expenses.
Example Monthly Budget
This example is based on someone earning $78,000 after taxes and insurance who has no debt other than their mortgage. Goals for this person are to 1) max out 401k and Roth IRA retirement accounts , 2) pay off their mortgage, and 3) save for kids’ college.
401k automatic deduction -1,500.00*
HSA automatic deduction -575.00*
(after deductions, you have +4,425.00)
Paying Yourself First
IRA retirement (max 5,500 per year) -458.33*
Mortgage (with extra toward principle) -2,500.00
529 or pre-paid college plan -300.00*
(after paying yourself first, you have +1,166.67)
Cell phone -70.00
Credit cards (paid off!) 0.00
Student loans (paid off!) 0.00
Car payment (paid off!) 0.00
Car insurance -100.00
Gasoline to get to work/school -55.00
Kids’ activities/School supplies -150.00
(Extra for clothes, entertainment, misc. +121.67)
This example may not fit your life exactly, but it illustrates how paying yourself first can move you closer to your values. If you spend on food, entertainment, and clothes first, then put whatever is left over toward your goals, then you will not be living consistent with your values. And you likely won’t be building wealth.
*Check with the IRS for maximum contribution limits, which can change year to year.
What would your budget look like if you paid yourself first?