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What It Actually Means to ‘Pay Yourself First’

By: David Bach  |  Last Updated: February 22, 2021
Financial Expert & 10x New York Times Bestseller
IN THIS ARTICLEWhat does pay yourself first mean?
How much should you pay yourself first?
The pay yourself first formula
Where should you pay yourself first?

Millions of Americans are living paycheck to paycheck. Some surveys show that as many as 78% of employees earn just enough to cover their bills each month — and that was before the Covid-19 pandemic rocked the economy.

Clearly, many U.S. adults are not putting themselves in a good position to build long-term wealth. But it’s entirely possible for you to get rich, even if you don’t earn a massive salary. All you have to do is make a decision to do something that most people don’t do: To pay yourself first.

What most people do when they earn a dollar is pay everyone else first. They pay the landlord, the credit card company, the government and on and on. Then, at the end of the month or the year or their working life, they will have something “left over” to pay themselves. 

This is absolutely, positively financially backwards. That’s why so many Americans are incredibly behind when it comes to retirement savings. 

What you need to be doing is paying yourself first. It’s the only proven, easy way to build wealth and retire rich. Read on and I’ll explain why.

What does pay yourself first mean?

Chances are, you’ve heard the phrase “pay yourself first” before. It’s not an original idea. I’ve been teaching it for years and it had already been around for a long time when I started. But just because you’ve heard of the concept doesn’t mean you fully understand it — or, more importantly, are living it.

I’m going to ask you a few questions: Do you know how much you should pay yourself first? Do you know where to put the money you pay yourself first? Are you actually doing it? Is your pay yourself first plan automatic? 

If your answer to some or all of the questions is “no,” don’t beat yourself up. You’re not alone. Most people don’t pay themselves first, nor do they have an automatic plan. Most people are only hoping to get rich. But hoping rarely works.

So what exactly does it mean to pay yourself first? Well, it means just what it says: When you earn a dollar, the first person you pay is you. Surprisingly, most people don’t do this. When most people earn a dollar, the first person they pay is Uncle Sam. They earn a dollar, and before it even makes it onto their paycheck, they pay the government as much as 30 to 40 cents of their hard-earned dollar.  

What you need to do is set up a system that guarantees your future self will also get paid — a system in which you pay yourself first automatically. This is surprisingly easy to do. It all boils down to contributing a portion of your paycheck to a pre-tax retirement account, like a 401(k), 403(b) or IRA, where your money will grow effortlessly over time. But more on those later.

How much should you pay yourself first?

As for how much to set aside for your future self, a good benchmark to aim for is between 10% and 15% of your gross income. But I’m going to encourage you to think beyond these percentages. I want you to figure out how many hours you worked for yourself last week. If that sentence stumped you, bear with me. 

To find out how many hours you worked for yourself last week, you first need to ask yourself how much money you saved last week. If your answer is zero, then you worked zero hours for yourself last week. If you did save something, then divide the amount of money you put aside for retirement last week by your hourly income. For example, if your income before taxes (also called your “pre-tax” or “gross” income) averages $25 an hour and you put aside $50 last week, you would divide $50 by $25, which gives you two. That means you worked two hours for yourself last week.

The answer you got can tell you a lot about the kind of future you can expect to have. I know from years of working as a money coach that most people work less than one hour a week for themselves. That’s not nearly enough.

Let’s look at an example. Say someone earns $50,000 a year. That’s about $1,000 a week, or $25 an hour (for a 40-hour week). How much should they be saving each week? If a good benchmark is to save 10-15% of your gross income, let’s split the difference and say this person should save 12.5% — 12.5% of $1,000 is $125, meaning that if you’re earning a gross income of $1,000 a week, you should aim to save $125 a week. Figuring a five-day workweek, that comes to $25 a day. In other words, you should be saving the equivalent of one hour’s worth of income each day.

Unfortunately, most people don’t even come close to saving that much. That means most people are getting out of bed and spending most of their waking hours taking care of business for someone else and not working even just one hour a day for themselves. 

Most financial education focuses on numbers and not on people’s lives. Instead of thinking about percentages of income, think about hours of your life. How many hours were you planning on working for yourself this year, instead of for your employer, the government, the credit card companies and everyone else who wants a piece of what you earn? How many hours do you want to spend today working for your future?

An hour a day for your future seems very reasonable. If you’re not saving that much of your income right now, you are working too much for others and not enough for you. You deserve better.

The pay yourself first formula

Like I mentioned earlier, paying yourself first can help you get rich — if you do it consistently and commit to setting aside enough of your income, that is. 

Everyone’s situation is different, but here’s a useful formula that will help you decide how much of your income to save. To be …

Dead broke: Don’t pay yourself first. Spend more than you make. Borrow money on credit cards and carry debt you can’t pay off.

Poor: Think about paying yourself first, but don’t actually do it. Spend everything you make each month and save nothing. Keep telling yourself, “someday…”

Middle class: Pay yourself first 5-10% of your gross income.

Rich: Pay yourself first 15-20% of your gross income.

Rich enough to retire early: Pay yourself first at least 20% of your gross income.

Where should you pay yourself first?

To be clear, I don’t want you to just save this money under the mattress or in your checking or savings account. This money needs to go into a tax-deferred investment account, where it can grow and accumulate over time.

The simplest way to pay yourself first is to contribute to a 401(k) plan. (If you work for a nonprofit, you will likely be offered a similar plan called a 403(b).) If your employer offers one of these plans, make sure you’re enrolled and contributing consistently because they offer a ton of benefits: 

  • You don’t pay any income tax on the money you put into the plan or on any of the returns it earns for you over the years — not a cent in taxes until you take it out.
  • In 2021, you can contribute $19,500 a year (plus, $6,000 more in “catch-up contributions” if you’re over age 50).
  • Your contributions will be automatically deducted from your paycheck, so you’ll never even see this money. 
  • You may even get free money from your employer if they offer a match. 
  • By contributing to your plan from every paycheck, you’ll enjoy the miracle of compound interest, which is ultimately what will enable you to retire rich.

If your employer doesn’t offer a 401(k) or 403(b), don’t worry. You have options. An IRA, which stands for Individual Retirement Account, is a personal retirement plan that most anyone who earns an income can set up at a bank, brokerage firm or online. In 2021, you can make contributions of up to $6,000 a year ($7,000 a year if you are age 50 or older) int0 an IRA.

There are two types of IRAs you should consider: the traditional IRA and the Roth IRA. Read my guide on how to choose which one is right for you

If you’re self-employed, you have the option of contributing to what’s called a SEP IRA, which is incredibly straightforward and easy to set up. In short, it’s an excellent retirement savings vehicle that allows you to contribute a lot of your gross income.

In conclusion, if you’re not already automatically setting aside a portion of your paycheck for your future self, you need to do so starting today. The simplest way to pay yourself first is to contribute to a 401(k) plan, but if that’s not an option for you, look into opening an IRA or SEP IRA. Then, work your way up to contributing 10-15% of your paycheck and you’ll be well on your way to retiring rich.

Read next: 3 Simple Steps to Save For Retirement if You’re Self-Employed