Episode #18: What To Do With Your Paycheck - 7 Steps To Take EVERY Time You Get Paid
What do you do when you get a paycheck? Whether you’re an employee, or self employed, what do you do? If your first answer was either, I go buy wings and beer, or ‘ummm I deposit it?’ then this episode is for you. Most of us are never taught even the basics of personal finance growing up, so it’s completely understandable that when you first start to receive a paycheck, or lets be honest when you’re even years into receiving a paycheck, you don’t have a solid plan of what to do with that money.
The basic rule of thumb is that every dollar you earn should have a job, and you are the person who has to assign it to that job, so today I’m going to walk you through the 7 steps you should be taking every time you get paid. The good news? Most of this is something you can automate, so you don’t even have to think about most of these steps, and can deposit your paycheck knowing that every dollar is headed off like one of the 7 dwarves to do its job, your expenses are covered, future you is covered, and you do get to go order dinner in because you’ve got your bases covered. Ready? Let’s dive in.
1. Set aside money for taxes
Step number one, will be a freebie to many of you, because this step only applies to self employed people or people with side hustles, but it was so important that I had to include it here. Step number one, every time you get paid by a client, is to make sure you’re setting aside enough money for taxes. This means both your HST AND your income taxes, because really this money is not yours, should not be treated as yours, and should straight away go to live in a separate account where you will not spend it. Now HST is an easy one, the rate depends on your province, but in Ontario that’s 13% that you need to set aside right away. The really cool thing about HST is that at the end of the year it’s a tax credit when you write your business expenses off against your sales, so you’ll actually get to keep some of that 13% that you safely tucked away when you were first paid. Still though, tuck it safely away, and when you file your taxes and know your exact numbers, then you can go ahead and pay yourself a little HST bonus. Also, make sure you’re putting aside money for your income taxes. If you’re an employee your employer takes care of this for you, but if you’re self employed this is up to you. Figure out what tax bracket you’ll be in, and set aside roughly the correct percentage into a separate account that you can then use to pay your income taxes at the end of the year.
2. Set aside money to pay for your necessary life expenses.
Now this will look different for every person, and if you’re not sure how to calculate your necessary life expenses you need to go and sign up for the free 7 day money course that’s currently being offered by the how to adult school. Part of the course will walk you through how to start getting a handle on what your expenses are, fixed vs variable, necessary vs discretionary, things like that. Once you know what your fixed life expenses are, the easiest way to manage separating your paycheck is to use percentages. So you know what your annual salary is, you have a pretty good idea of what your annual fixed expenses are, and you calculate what percentage of your salary you have to pay out in fixed expenses. Whether this number is 50%, 70%, 90%, figure it out and set up that percentage of your paycheck to automatically go into an account specifically for paying your fixed expenses. Once you know that’s taken care of, you can sleep soundly at night knowing that your expenses are covered, and you’re on the right track. From there you can look at ways to either increase your income, or decrease your expenses if your percentage isn’t where you want it to be.
3. Put money into your emergency savings fund
If you don’t have an emergency savings fund yet, I want you to promise me that you’re going to go and tune into episode #6: How To Start Saving For An Emergency Fund to learn how to start creating one of these for yourself. This is one of the key basic finance concepts we start with at the How To Adult School It is SO important that you create an emergency savings fund for yourself, so that’s why this is step #3, and it comes before the next steps. You need to have this set up, and until you do the goal is to funnel as much money as you possibly can into creating one for yourself. Once you have an emergency fund that’s fully funded you can skip this step, unless you find that your life expenses change and you need to top up your fund again one day. Also, if you have a fund but it’s not yet set up in a HYSA, you need to get it into one of these accounts so that it’s at least earning you some interest and not just sitting dead in the water. You can find The High Interest Savings Account I recommend here.
4. Pay off debt.
Whatever your debt repayment strategy is, it’s important to not leave this until last, or after your discretionary spending, when you maybe don’t have enough left to pay it off as you should be doing. Again, this step is temporary, and only really applies to consumer debt. Once that is paid off, if you even have any, then you can drop this step as well. See, those 7 steps are getting easier and easier by the minute! Now, there are different kinds of debt, and truthfully these fall into different categories. You’ll have debt like student loans, or mortgage payments, which actually fall under step #2 paying for your fixed life expenses. This step is specifically for types of consumer debt like credit card debt if you need to handle that. Depending on your debt situation, sometimes you do have to pay off debt before you contribute to your emergency savings account, this could be if your interest rate is massively high, you’re nearing the last possible end date of a repayment term, things like that. Overall though, if you can, you definitely want to get that emergency fund topped up first.
5. Pay yourself for the future.
Now if you’ve already gone ahead and read any of the personal finance books I recommended last week in episode #17: The Top 5 Books for Making and Managing Money, you’ll have read about the concept of paying yourself first. A lot of financial gurus argue that you should in fact literally pay yourself first, but this really only ever becomes a realistic possibility for people when they’re on financially secure ground. If you don’t have an emergency fund, build that up first, if you’re having a hard time managing your basic living expenses definitely take the time to get back on your feet there first, if you’re being crushed under credit card debt, pay that off first. But, once you’ve got your personal finance ducks in a row, which you will one day, I promise, then you can start to pay yourself first. This means contributing a percentage of your whole salary to your retirement savings. Some people recommend always contributing 10% of your salary, with my first business I aimed for 20%, if you’re not there yet though then it’s also okay if you can only contribute 1% of your salary. The goal is to start saving for your retirement as young as possible, and to use the power of compound interest to your best advantage. Simplified this means that, especially when you’re young, the amount of time you can be invested in the market for, is so much more important than the amount of money you can invest. So, look at your numbers, what you need to pay in your life, and calculate what percentage of the leftover can go towards your retirement savings. Automate this amount so that it comes straight out of your bank account, and you’re not tempted to spend it, because this is important.
6. Set aside money for your large financial goals.
It’s always good to be working towards some sort of financial goal, it helps keep you on track, keep you motivated, and helps you say ‘whoah girl, do I really need that third matching exercise set, or would I rather reach my goal of getting to wear my first two matching exercise sets in the home gym I’m going to be able to build for myself’. Larger financial goals can be absolutely anything. Whether it’s saving up a down payment for a house, saving to buy a car outright, saving for a glorious round the world trip of a lifetime, whatever it is that makes you excited, set up a separate bank account, nickname it to remind yourself what you’re working towards, and save save save that extra cash into that account. This one’s fun, I promise.
7. Allocate whatever is remaining as your discretionary income, to spend on something fun!
Maybe for you that means saving up for your larger goal faster, but it is good to use at least some of your money for immediate reward fun things. Whether for you that’s shopping, taking little trips, going out with friends, enjoying your morning latte. Whatever it is, the idea is you can freely spend in this area, knowing full well that you’ve taken care of everything else important, and the remainder is for you to enjoy. How much more will you enjoy treating your friends to a night out when you know that all your expenses are covered, your emergency fund is topped up and working for ya, your taxes are paid, you’re paying off debt efficiently and responsibly, you’re saving for your retirement early, and you’re working towards a bigger financial goal or purpose that you’ve set for yourself. Now that is something to go and buy an overpriced bottle of real champagne to celebrate.
Set Up Different Accounts
As I went through this list, you probably noticed that I kept telling you to transfer money out to different accounts. This part of the system is truly the key. If you keep all your cash lumped into one or two accounts, you’re never going to be able to remember what’s what, and you’re never going to get the satisfaction of watching your savings accounts grow. I recommend setting up separate savings accounts for your taxes, your daily needs, expenses and debt payments , your emergency savings fund, your retirement savings, and your larger savings goals. For your emergency fund AND your larger savings goals, I highly recommend opening up a high interest savings account. This is a type of account that offers you a higher interest rate than the savings accounts from most banks, and is perfect for storing money that you need to keep accessible, but that will be stored for long periods of time and should be earning you some interest rather than just sitting there. Speaking of special accounts it’s also important that your retirement savings go into an RRSP and/or a TFSA. These are both what’s known as ‘tax sheltered’ accounts that you can save your money in and then invest it. There are pro’s and con’s to each, which I’ll go through in another episode, the important thing to know is that you should not just be putting your retirement savings into another HISA and then letting it sit there and not grow. Open up an RRSP and a TFSA ideally, and start to use those accounts strategically for your retirement savings.
So, if you’re keen on getting started with this, I recommend signing up for the free 7 day mini money course. As always, if you have any questions I’m here to help! Drop your questions in the comment section below and I will answer them. Thanks so much for tuning in to the How To Adult Show!
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