Pay yourself first: Budgeting to save more money

Is life getting in the way of your savings goals? It can be hard to tuck money away when you have bills to pay and essentials to buy. By the time you've taken care of your monthly needs (and maybe a few wants), your bank account might be just about empty. Then you're stuck waiting until your next paycheck before you can try to set aside some money for the future.

If you often find yourself in this predicament, you might benefit from the "pay yourself first" budgeting approach. This strategy places your savings goals at the top of your financial to-do list, ensuring you take action on them before your hard-earned cash goes anywhere else.

The "pay yourself first" method has you put a portion of your paycheck into your savings, retirement, emergency or other goal-based savings accounts before you do anything else with it. After a month or two, you likely won't even notice this sum is "gone" from your budget. When you add to your savings immediately after you get paid, your monthly spending naturally adjusts to what's left.

Paying yourself first can be effective because it ensures you save something every pay period, and it eliminates the possibility that you'll spend money you intended to save.

While paying yourself first may seem like a fresh approach to your budget – and is sometimes called “reverse budgeting” – you may have encountered it without knowing the name for it. Here are a few common examples:

• Your employer withdraws part of your paycheck for a retirement savings plan such as a 401(k) or 403(b).
• You set up direct deposit so that a portion of each paycheck goes to a savings account while the rest goes to checking.
• You pay monthly premiums to a life insurance policy which accumulates cash value over time.

Essentially, paying yourself first can describe any scenario in which you prioritize saving or investing for the future ahead of other expenses.

Keeping your savings in a separate account from your spending money can be helpful to track your goals and avoid temptation to spend your savings. Most banks and credit unions make it easy to transfer money from one account to another. You may also set up direct deposit of your paycheck so that the money you’ve earmarked for savings never enters your spending account.

Paying yourself first requires balance. You should choose a reasonable amount or percentage of your check that won't leave you unable to pay your bills or meet other financial obligations. But you'll still want to try to save enough to make a difference in your savings account balance. To find the sweet spot, you'll need to take a close look at your budget.

10 to 20% of your income is a good target for many people, although the right amount will vary based on your circumstances.

To determine the right amount for you to save each month, you'll need to craft a budget. Here's a rundown on how to pull together a fairly simple view of your income and expenses:

• Determine your monthly take-home pay, which is your income after taxes and retirement contributions are withheld.

• Set aside 10-20% for savings.

• Review your expenses—including housing, utilities, loan payments, transportation costs, childcare, food, medical expenses and other bills. Use a budgeting app or this cash flow worksheet to see where your money's going.

• Plug these numbers into this equation: Income – Savings – Expenses = Spendable. The result is your spendable income, or the amount of money that's available to spend without putting any essential bills, or your savings, in jeopardy.

Make sure you're happy with the amounts you're saving and spending, and ask yourself if there are opportunities to spend less. When you find ways to cut expenses, you can use the money you're freeing up to boost your savings.

Once you've arrived at a number you're comfortable with, you can set up automatic payments to ensure you always get paid first. This money shouldn't stay in the account that you use day-to-day because it would be too easy to accidentally spend or lose track of. Choose or create a specific savings or investment account that you'd like the money to get paid into.

One idea is to set up a split direct deposit so that for each paycheck, the pay-yourself-first money goes into your designated savings account while the rest goes to your general checking account. Another option is to set up a recurring transfer that moves money from your general account to your designated savings account at a certain time every month or pay period.

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Putting this strategy into action is pretty straightforward if you decide to do it. Before jumping in, though, give thought to whether paying yourself first will work for you and how it might affect your other financial goals.

If 100% of your earnings go to necessary bills, then you're living paycheck to paycheck and paying yourself first may not be possible. In that situation, you're better off focusing on other strategies to grow your income, make your lifestyle more affordable or decrease your debt.

Paying yourself first is also unlikely to be helpful if you don't adhere to a budget. Spending without limits or taking on credit card debt could outweigh the benefits of setting aside savings. You might benefit from controlling your discretionary spending before setting out on this strategy.

But if you have room in your budget for savings and can adjust your spending as needed, then paying yourself first might be a worthwhile endeavor.

Under this method, it's assumed that you're making at least the minimum monthly payments on debts as part of your mandatory expenses. That may not be enough, though, if you're trying to reduce significant debt.

The trade-off between growing savings and paying down debt is complex. But there are a few general guidelines to keep in mind:

• You may want to go ahead with paying yourself first—and stick with minimum monthly payments on debts for now—if you haven't established an emergency fund yet. Once you've built up some emergency savings, you could pause paying yourself first and instead direct as much money as you can to reduce your debt.

• Compare the interest rates you're paying on your debts with the rate of return you get on your savings. If you're dealing with high-interest debt, paying it down might be the more urgent priority. But you might want to go forward with paying yourself if, for example, the rate you earn on your savings exceeds the rate you're charged on a loan.

• Other factors that could tip the balance between debt payoff and savings are whether your debts are secured by collateral like your home or car, in which case it could make sense to prioritize paying them off. And if you haven't started saving for retirement yet, that could be a reason to put debts on the back burner and pay yourself first.

It doesn't have to be an either/or decision. If you calculate that you can save 40% of your discretionary spending, you might choose to pay yourself with 20% while using the other 20% to pay down debt. Then, you can increase the savings amount after you've made progress on your debts.

It can help to discuss this strategy with someone who has experience managing finances. A financial advisor can answer your questions and offer insight on the right approach for you to meet your long-term financial goals. They also can help troubleshoot any challenges you encounter along the way.

You also can sign up for Money Canvas from Thrivent, a free one-on-one coaching program that helps you budget with ease, trim bills and tame spending.