What Does Paying Yourself First Mean? How It Works and Goal

What Is Pay Yourself First?

"Pay yourself first" is an investor mentality and phrase popular in personal finance and retirement planning that encourages you to save money before you spend it. If you direct some of your paycheck to a savings or investment account—that is, pay yourself—before you do anything else with that money, your savings will grow.

However, this guidance isn't realistic for everyone.

Key Takeaways

"Pay yourself first" is a personal finance strategy of increased and consistent savings and investment.
The goal is to make sure that enough income is first saved or invested before monthly expenses or discretionary purchases are made.
Data from the Federal Reserve show that most Americans do not have enough money saved for retirement or for near-term emergencies.

Building Savings

Many personal finance professionals and retirement planners tout the "pay yourself first" method as an effective way to ensure you contribute to savings month after month. Regular savings contributions can go a long way toward building a long-term nest egg.

If you are using the "pay yourself first" method of personal finance, you may opt to put your money in a range of savings vehicles, depending on your financial objectives. The phrase can refer to earmarking a certain percentage of your paycheck to be contributed to your retirement accounts, such as a 401(k) or an individual retirement account (IRA). Alternatively, you may put the funds in a cash savings account.

"Paying yourself first" simply involves building up a retirement account, creating an emergency fund, or saving for other long-term goals, such as buying a home.

If you can manage it, paying yourself first will likely reduce your stress, as you'll have something saved for retirement and a way to pay for emergencies in cash, from your car breaking down to unexpected medical expenses.

What Percentage of Americans Are Saving Money?

In 2023, over a third (37%) of Americans could not cover a $400 emergency in cash or its equivalent, a Federal Reserve report found. This is the same as it was in 2022, but a bit higher than it was in 2021 (32%). In 2023, a similar percentage of people believed their retirement savings were on track (34%), which was about the same in 2022 (31%) but lower than it was in 2021 (40%).

According to Bankrate's Annual Emergency Savings Report, over 27% of respondents had no emergency savings at all, and about the same percentage (29%) had some savings, but less than 3 months' worth of living expenses. 16% had 3 to 5 months' worth of living expenses, and 28% had 6 months' worth of living expenses or more. The breakdown by age reveals that Baby Boomers had far more emergency savings than other generations: almost half (46%) of Baby Boomers had 6 months' worth of living expenses or more, compared to 25% of Gen X, 20% of Millennials, and 11% of Gen Z.

What Is the Average Retirement Savings by Income?

The Federal Reserve Board found that in surveys conducted from 2016-2022, the average retirement savings among everyone who responded (35 years old to 64 years old) was about $331,000.

The number of families who participated in retirement plans increased to the highest level since 2010.

For those with incomes in the bottom half, the average savings was about $55,000. For those with mid-to-high incomes, the average savings was about $227,000. For those in the top 10%, the average savings was about $913,000.

Can You Use a Roth IRA As an Emergency Fund?

Some people may avoid contributing to tax-advantaged retirement savings plans because they worry about having no money for emergencies. It's important to know, however, that the contributions you set aside for retirement in a Roth IRA are, in fact, accessible if needed. Though financial planners caution that this should only be done in emergencies—because withdrawals take money away from your future—the fact is that you can withdraw however much you contributed to the account because you already paid taxes on those funds. These withdrawals are tax and penalty-free.

The rules for earnings are different, however. The earnings in the account (the money your contributions made) are not accessible unless you have had the account for over five years. And if you're younger than age 59 ½, it's considered an early withdrawal, and you'll pay a 10% tax penalty to the Internal Revenue Service (IRS).

There is an exception to this: you can withdraw earnings tax and penalty-free if you make what's called a qualified withdrawal. For it to be a qualified withdrawal, you must have had the account for over five years, and the withdrawal must either be due to a disability, for a first-time home purchase (or building / rebuilding a first home), up to $10,000, or be for a beneficiary after your death.

And if you're willing to pay taxes on the earnings (though you wouldn't if you wait until you're 59 ½, as long as you've had the account for five years), there are several exceptions to the 10% penalty, including withdrawals for higher education expenses or for the birth of a child.

The Bottom Line

"Pay yourself first" means when you get paid, you should try to put money away in your own savings before you spend money on anything else, whether it's your regular monthly living expenses or discretionary purchases.

If you can do this, you'll be able to build up an account that will secure your future, and create a cushion for financial emergencies.

However, for many people, this adage isn't realistic. You might simply not earn enough money to pay yourself first—that is, to save before covering your bills. If that's the case, start small. Even really small. Save whenever and wherever you can. Making it a habit is a good place to start.