The Wealth Accumulator: Pay yourself first

Many people pay the government (tax) first when they receive their paychecks. After pay their bills and everyone else, they save whatever is left for themselves. This often means they have little or nothing to save at all. To accumulate wealth, you need to reverse the order of payment and pay yourself first.

Where to put my retirement fund?
If you have access to tax-advantaged retirement accounts, use them! Examples include 401(k) plans, Roth IRA, and Traditional IRA in the US, Superannuation in Australia, RRSP in Canada, or KiwiSaver in New Zealand. Tax-advantaged retirement accounts allow you to either delay paying taxes until retirement, or pay taxes now and enjoy tax-free payouts in retirement. I would recommend maximizing the contribution you make to these tax-advantaged accounts, thereby minimizing tax on this portion of your income.

If you do not have the luxury of using tax-advantaged retirement accounts (for example, Taiwan has none), you should still set aside 10-20% of your gross income to a separate account for your retirement. It is important to keep your retirement fund separate from your regular account, otherwise you may be tempted to dip into your retirement fund to pay for your day-to-day expenses. By paying yourself first into a separate account, you can "fool yourself" into thinking you only have the cash left in your regular (spending) accounts. By spending only the cash that is left (instead of the other way around), you will ensure you have at least a portion of your income saved for your retirement - otherwise, you may end up at retirement with insufficient retirement funds!

Two tips on getting into the habit of paying yourself first
1. Setup automatic payment to your retirement account with your employer or your bank. By making it automatic, it will be less likely for you to "forget" to pay yourself and use the fund to pay for something else. If you don't see the money in your account to begin with, you can "forget" that you have the money, forcing you to only use what's left. This is one of the few times where separate mental accounting works in your favor.

2. Start small. You can start by paying yourself 2% of your gross income, and try to control your expenses with what's left. Once you get used to it, ask your employer or bank to bump the allocation up to 4%, then 6%, 8%, or 10% of your gross income. If your employer offers contribution matching (i.e. free money), make sure you take full advantage of it by increasing your contribution to the matching limit ASAP! Ideally, you will eventually allocate at least 20% of your gross income to your retirement fund (even if there's no employer matching). Of course, if you can contribute 20% (or more) without any problems, start now!

How much should I allocate for my retirement fund?
Many personal finance websites and books recommend allocating at least 10% of your gross income, with the common assumptions being you will need 80% of your current gross income (adjusted for inflation) to retire. I believe that this assumption does not sufficiently cover the costs of retirement.

No matter how healthy we are now, when we get old, we will have a higher probability of becoming sick. I believe that the aging population will overload the health care system and cause health care costs to rise at a rate much higher than the average inflation rate. To be on the safe side, I would allocate at least 20% of my gross income for my retirement fund, and I would save even more for retirement so long as I can afford it. I like to be conservative and save more because when we are retired and have no income, our retirement fund is all we can rely on.

What if I have debt? What if I can only contribute a small amount?
Even for those who still carry a lot of debts and can contribute very little, start contributing to your retirement fund now. I would limit my contribution to 5-10% of my gross income, and put all excess income into paying off all non-mortgage debts as soon as possible. When the non-mortgage debts have been eliminated, I would increase my contribution to 20% (or more) of my gross income.

The key is to start now. It is easy to say "I'll start next year", then next year becomes 2 years, then 3 years - that is procrastination. "The road to Someday, leads to the town of Nowhere." Stop waiting for the someday that you will start saving for retirement to come! Start today and begin your journey to financial independence!

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