How To Save More Than You Earn
Is it possible to save more money than you earn? Depending on how you want to look at the math, it is. The key to the math is to look at your earnings the same way your company does: total cost of payroll.
It should come as no surprise that the cost of an employee is more than the money you earn. The company likely has to pay for benefits such as medical insurance, workers compensation, disability costs, retirement costs and many other expenses.
Before you even start saving on your own, consider fully what your company can offer you in benefits for savings. The most advantageous kind of savings a company can offer you is what is called deferred compensation. This is money that you or the employer can set aside for future consumption.
If you don’t take advantage of these benefits, you may be leaving money on the table that you could use to increase your savings. Your employer sees these as costs of payroll, so if you don’t use them you are giving money back to your employer. If I could wave a magic wand, I would give the option to employees to take this money as increased wages if they so chose, but this usually isn’t an option. The only way around this would be to negotiate an employment contract that has such terms before you take the job.
Here are a few examples of deferred compensation:
- 401(k) or equivalent such as a SEP IRA or 403(b).
- Pension, traditional or Cash Balance Account (CBA)
- Stock options
- Discounted stock purchase plans
I’ve talked about CBAs before. These hybrid pension accounts have a cash value that is real and you can consider them as an asset like savings. Here are the deferred compensation benefits offered at my current employer:
- 6% payroll CBA pension contribution
- 6% company 401(k) match, first 6%.
- 4% CBA interest credit each year.
So, let’s take an example here using these numbers:
- Employee Salary: $100,000
- Employee Benefit costs: $5,000
- Employee Total taxes (20%): $20,000
- Employee CBA balance: $20,000
Using these numbers, this is the initial take home pay:
- Take home pay: $75,000.
Let’s look at maximum deferred compensation available for 2012 using the details noted above:
- 401(k): $17,000
- 401(k) match: $6,000
- CBA contribution: $6000
- CBA interest credit: $1,000 (4% of 25K)
- Total: $30,000.
When you put these numbers together, what you will find is that the savings rate for this works out the the following percentage:
$30,000 / $75,000 = 42%.
What this means is that by simply savings 17% of your gross pay, you have effectively saved over 40% of your take home pay when you add up all the deferred compensation. This is actually understating the savings because I didn’t consider the tax difference between saving within the retirement account versus saving outside of it (trying to keep the math simple).
When you subtract out the $17,000 from your take home pay you get $58,000 leftover. If you were able to save all of that you would be actually saving over 100% of your take home pay. Of course this is unrealistic, but the math does work out.