Save First, Pay Taxes Later

An article that talks about paying yourself first? And also talks about lowering taxes? I'm all over it! Plus, it's written by David Bach, author of The Automatic Millionaire, one of my recommended personal finance books.  Here's a summary of his "pay yourself first" thoughts:

Most people pay everyone else first -- taxman, landlord, credit-card company, and so on. They try and budget every week, month, and year hoping that if they're careful they'll have some money left over. This is absolutely, positively backwards. And because of it over 70 percent of Americans continue to live paycheck to paycheck regardless of increasing incomes. We make more. We spend more. And at the end of the day we're still broke. Are you tired of this game?

"Pay yourself first" means just what it says: When you earn a dollar, the first person you pay is you. Sounds simple, but most people don't do it.

Most people think they have to pay taxes first. Is this correct? Nope. Here's his thought:

You have a right to legally avoid federal and state taxes on the money you earn. You can legally pay yourself first by simply using a retirement account. There are many different types, including 401(k) and 403(b) plans, IRAs and SEP IRAs. The one thing that makes all of these "pay yourself first" accounts is that the money you put in them is either pre-tax or tax deductible.

And using these investment vehicles, you can pile you a significant net worth:

Your goal should be to save one hour a day of your income.

Let's assume you make $50,000 a year. That's about $2,000 every two weeks. If you invested $200 every two weeks for 35 years in a retirement account that earned an annual return of 10 percent what would you have? Quite a pot of gold: $1,678,293.78.

Here's the bottom line:

The point is you can make a lot by setting up a retirement account that pays you before Uncle Sam takes his cut.

Simply great advice all the way around. It's stuff like this that makes The Automatic Millionaire so valuable -- an investment with an almost infinite return.

"Pay yourself first" is also one of the key messages in another of my favorite personal finance books, The Richest Man in Babylon. It's a cheap, quick read that will really help you grow your net worth. If you don't have a copy, get one today, read it, study it, apply it and you'll be on your way to a better bottom line.

Comments

[srh]

While overall I agree with this advice, it's always important to remember that $1M in 35 years isn't a "pot of gold". I wrote a little about this:
http://ramblingsbysam.blogspot.com/2005/12/why-millionaire-is-useless-term.html

One thing I've found useful in the vein of "Paying Yourself First" is actually _really_ "Paying Yourself".. I.e. deposit all your income into a "slush fund", and automatically transfer enough to cover your monthly expenses to your checking account each month. See:
http://ramblingsbysam.blogspot.com/2005/12/paying-yourself-first.html

[FMF]

1. It's $1.7 million in the example above, not $1 MM.

2. While $1 million might not be a "pot of gold", it's more than most people have (or will ever see) at retirement.

3. Don't get stuck on $1MM. Apply the information and you can have much, much more than that (per the example above).

4. Careful on the linkfest. I'll let it go this time, but please try to keep it in check. If you write a great comment, people will click through to your site based on that alone (hyperlinked from your name) -- you don't need to call special attention to yourself. Thanks.

[srh]

Sorry -- didn't mean to call any attention to myself, the thoughts seemed germane to this article and it would be a lot to retype.

I think ultimately a lot of people will have $1M or more at retirement, again keeping in mind that $1M may not be all that much when we retire.. "Pot of gold" wasn't my quote, it was the author's, and I think it's true only if one fails to include inflation.

What I'm concerned about is the "easy way to a million" type articles that imply that wealth awaits those who save $14/day. So long as the future millionairs remember to increase their savings rate along with the salary increases!

[FMF]

No problem.

Generally, I agree -- in concept. However, most people are so far from $1 million, if I can help to just get them up to that point, I'd be happy! ;-)

[Personal Finance book]

Hello:

Your article is very interesting and attention grabbing when you mentioned David Bach's "Automatic millionaire" book.

That book is one of the most eye-opening books about personal money management and all those who have read it have very glowing report about how it changed their financial situations for the better.

Ikey Benney
http://maychic.com/clickbankbuddy/index.cgi

[Dr. Housing Bubble]

This is great advice straight from the book. It should be recommended reading for all. However there is a couple of things David Bach fails to discuss. In certain areas of the country his example of buying a home does not hold water. Given that the national median is over $200,000, there are many areas on the coastal regions where prices are commanding over $500,000 for a starter home and millions of folks live there.

He also quotes a stat that homeowners have a net worth of over $100,000 while renters have on average a net worth of $5,000. Again, regional difference are the caveat emptor. I think it is important regardless of where you live to save 10% at a minimum in pretax accounts. Yet when housing is taken into account it becomes more apparent why many have a hard time saving even this small amount.

Even in his book, he discusses a couple with a modest income of $50,000 yet their housing was low cost as well. Try saving 15% of your income in Los Angeles or Orange County where rents are $2,000 - $2,500 for modest dwellings and your PITI would run about $3,000.

Dr. Housing Bubble
http://drhousingbubble.blogspot.com/

[Artfredo C. Abella, Ph.D. - Los Angeles, California, U.S.A.]

Pay yourself first is the Midas touch that can make one a rich person without which we only exists to satisfy our instant gratifications. Paying your self first is adhering to what the Richest Man in Babylon advocates; " Part of what you earn is yours to keep." Paying yourself first by having 10% automatic deductions in your income or salary would afford one to invest and make his money work wonders for him. Spending money indiscriminately is definitely a sure formula to become poor. Save first with what you earn and the rest you can think of overheads like the payment of taxes. The rule of the thumb is make your money first then save 10% of your income or salary and the rest think of expenses. Remember, the seeds of greatness is not in you if you cannot save money as one author would recant.