Why “Paying Yourself First” Should Include Your Retirement Accounts

Written by , August 24, 2014

Why Paying Yourself First Should Include Your Retirement AccountsThe concept of “paying yourself first” is one we’ve discussed here before, so it’s likely one you’re quite familiar with. If not, the idea of paying yourself first means that you treat your savings contributions as you would any other bill or financial obligation. In other words, rather than waiting to see what you have left at the end of the month before deciding what you’re able to save, your saving becomes a financial obligation that you fulfill along with your other obligations.

Part of paying yourself first should include contributions to your retirement accounts. This is true regardless of your income level, and regardless of how much you’ve already saved for retirement.

Here is some retirement advice on the most important reasons why you should pay yourself first:

  • To Avoid Missing Annual Contribution Options. Tax-advantaged accounts such as IRAs and 401(k)s are designed to encourage a behavior of long-term saving. One way this policy tries to get people to save consistently is by imposing maximum annual contribution limits.
    • This means that every individual is limited in how much they can contribute to their account each year, regardless of whether they have more funds available to save. For contributions to IRAs in 2014, for example, the annual limit is $5,500 (or $6,500 for individuals age 50 or older) across all accounts.
      These annual contribution limits are “use it or lose it” in the sense that if you fail to maximize your contribution in any given year, you won’t have the opportunity to go back next year (or in any subsequent year) in order to contribute more. If you don’t pay yourself first with contributions to these accounts, you may be less likely to maximize your contributions each year.
  • To Give Your Money Time to Grow. Another reason it’s so important to pay yourself first is that doing so will give your savings as much time as possible to grow. Over the course of several decades of retirement saving, most of your account balance will be comprised of interest and earnings, rather than your contributions. This is true even if you aren’t maximizing your contributions every year.
  • To Avoid Unnecessary Spending. Unfortunately, there are plenty of people who simply haven’t developed the personal discipline necessary to keep their savings intact. Setting up a separate savings account and contributing to it regularly won’t provide a lot of benefit if you just as often withdraw money from that account to go shopping or to go out to eat.
    • By making those contributions into your retirement accounts, you will effectively be denying yourself the opportunity to spend that money impulsively or rationally. Making early withdrawals from retirement accounts will trigger penalties and (depending on the type of account) potentially a higher tax bill, which provides a strong disincentive to using the contributed funds for other purposes.

    The habits we create for ourselves can be good ones or bad ones. Paying yourself first, and being sure to include contributions to your retirement accounts as part of those payments, is one of the best habits you can create.

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