Pay Yourself First: Reverse Budgeting Explained

Most budgets are built around your expenses. But the pay-yourself-first method flips that approach on its head.

What does it mean to pay yourself first?

'Pay yourself first' is a reverse budgeting strategy where you build your spending plan around savings goals, such as retirement, instead of focusing on fixed and variable expenses. This prioritizes savings, but not at the expense of necessary expenses like housing, utilities and insurance.

How pay yourself first budgeting works

Use these steps to set up your own reverse budget.

Step 1: Assess your spending

To make this budget successful, you’ll have to prepare. Rachel Podnos O’Leary, a certified financial planner in Austin, Texas, recommends reviewing your typical spending by pulling up your bank and credit card statements.

“Do the math and start conservative,” Podnos O’Leary says. “You can always increase [your savings contributions] later. You don’t want to risk an overdraft or bounced check or something like that.”

Step 2: Determine how much to pay yourself

Pinpoint a realistic amount using the 50/30/20 approach. This method allocates 20% of your monthly income to savings and debt repayment, 50% to necessities and 30% to wants. With a $3,400 monthly income, for example, you’d reserve no more than $680 for savings and debt repayment, $1,700 for needs and $1,020 for wants. Keep in mind that the numbers are flexible, and you can tweak them to suit your budget and goals. For instance, you could make your savings and debt repayment bucket bigger and reduce your wants bucket to help reach your goals faster.

Step 3: Identify your savings goals

Make a list of your short-term and long-term savings goals. Saving for retirement and building an emergency fund should be your first priorities, followed by other goals, like travel, new appliances, or a house.

You can contribute a small amount to each goal or pick a couple to focus on first. Decide how much you need to save to reach those goals and how much you can afford to sock away each month, using the 50/30/20 guideline.

Let’s say your monthly income is $3,400. If you’re following the 50/30/20 budget, 20% of that income — which is $680 — would go towards savings and debt repayment beyond the minimums. Let’s assume your monthly savings goals include putting $200 into your emergency fund and saving $250 for retirement. That’s a total of $450. You would pay yourself that $450 first and then could put the remaining $230 from your savings category toward debt repayment beyond the minimums. The $2,720 that’s left of your monthly take-home income would go toward your wants and needs.

If you have a handle of your budget and would like to save more aggressively, you could pull some money from your 30% wants bucket when paying yourself first.

Note: The 20% toward savings and debt repayment category includes an emergency fund and retirement contributions. Money for savings goals, such as travel, a wedding or a new motorcycle, would come from your wants.

Step 4: Adjust as needed

Ideally, you have enough money coming in to cover your needs, wants and savings goals. But if you find yourself coming up short, look for ways to scale back. That might mean focusing on one savings goal at a time, or finding ways to trim expenses from your needs and wants categories, or all of the above. You can also explore supplementing your income with side gigs.

The pros and cons of paying yourself first

Pros

The pay-yourself-first budgeting method is low maintenance compared with others, such as zero-based budgeting. It doesn’t require you to categorize every expense or keep a detailed record of your spending.

It can also help you focus on the big picture and reduce impulsive purchases. When people save first, they have less money to spend and tend to use the remainder on things they need or value.

Automation is a simple way to pay yourself first. Set up contributions from your pre-tax salary to your 401(k), if you have one. And use an app or log onto your bank’s website to arrange automatic transfers from your checking account to your savings account or IRA.

Cons

Prioritizing savings over other goals might not always be in your best financial interest. For example, if you have toxic debt — such as a high-interest credit card balance — we recommend tackling that before saving up for a vacation or a new car. Podnos O’Leary suggests classifying your debt payments as savings to help resolve that issue.

Ready, set, save

Paying yourself first is a great option if you prefer a hands-off budgeting system or don't want to feel as though you’re budgeting at all. Remember to automate your savings for an easier experience.