Automating good decisions

In short

A friend of mine kept a coffee can on his kitchen shelf, and every payday he meant to drop some cash in it. Some months he did. Other months he found a good reason not to. If you have ever meant to save and then let the month slip by, you are in fine company. The fix is not more willpower. Set up one automatic transfer from your paycheck or checking account to a savings or retirement account, and do it on the day you get paid. Start with an amount so small you barely notice it, such as 1 percent of pay. Raise it each time you get a raise, before the new money reaches your hand. Check once a year that the plan still fits your life. That is the whole idea.

The whole of it

What it is

I once watched a neighbor of mine turn a lazy water hose into a garden sprinkler on a timer. He did not get more disciplined about watering. He just stopped having to remember. That is what automating good decisions means. You make a choice one time, on a calm day, and then you set it up so the choice keeps happening without you.

You have probably noticed that the you who makes plans on Sunday is not always the you who shops on Friday. Nobody scolds a sprinkler for forgetting to water. So do not scold yourself for forgetting to save. Pick a good moment, make the decision, and let a machine carry it out.

In money terms, this means three kinds of settings. One is a payroll deduction, where your employer sends part of each paycheck straight into a retirement plan like a 401(k). Another is a standing transfer from checking to savings or to an IRA, which is an individual retirement account you open yourself. The third is an automatic bill payment, so a due date never sneaks past you. Each one takes a few minutes to set up. Then they run.

How it works

If you are holding a pay stub right now, you can see the first step on it. Many employers let you pick a percent of pay to send to the plan. The money leaves before you ever see it in your account. People often say they do not miss what they never held, and there is a lot of sense in that.

Here is the part I find most kind about the method. It works with human nature instead of against it. Many of us put off hard choices and stick with whatever is already set. When saving is the thing that is already set, staying put becomes the good habit. Doing nothing turns into doing the right thing.

There is a second piece, and it matters just as much. Some plans can raise your saving rate on their own each year. This is sometimes called auto escalation. Ask your plan whether it offers it. If it does, you pick a step, say 1 percentage point, and a month, and the plan does the rest. Your saving grows a little each year, and your paycheck never takes a sudden hit.

You do want to pick the day with care. Set the transfer for the day your pay lands, or the day after. If it runs a week later, the money may already be gone. I once knew a fellow who set his transfer for the last day of the month, and by then the account was always thin. Timing is half the trick.

The numbers, and where to find yours

Some numbers here are set by law, and they change with the years. I will not guess at them. Where a limit or an age matters, the figure below is filled in by the site from the official source.

The most you can put into a 401(k) from your own pay in one year is the current figure, which the official source publishes each year. The most you can put into an IRA in one year is the current figure, which the official source publishes each year. If you are old enough, you may be allowed an extra catch up amount on top, and the age for that is the current figure, which the official source publishes each year. Your automatic settings should stay under these lines. If you set a percent that runs past the limit, your plan or your account may stop the deposits, or you may owe a fix later.

You can find your own numbers in a few plain places. Your pay stub shows what comes out each period. Your plan's website shows your current percent and whether auto escalation is on. Your employer's benefits office can tell you if there is a match, which is extra money the company adds when you save. The IRS publishes the yearly limits on its own website, in its pages about retirement plans and IRAs. That is the primary source, and it beats any headline you read.

Take a look at three figures of your own. Write down your pay each period, the percent you now save, and the match your employer offers, if any. With those three in hand, everything else is simple arithmetic.

A worked example

Let me tell you about a woman I will call Denise. She is 34, works as a dental office manager, and earns a salary of 52,000 dollars a year. Her employer matches her saving dollar for dollar up to 3 percent of pay. Denise had never signed up for the plan. She kept meaning to.

One afternoon she sat down for twenty minutes and set it all up. She chose to save 6 percent of pay through payroll.

Here is the math, with every input shown. Her yearly salary is 52,000 dollars. Six percent of 52,000 is 52,000 times 0.06, which equals 3,120 dollars saved from her own pay. Her employer matches up to 3 percent. Three percent of 52,000 is 52,000 times 0.03, which equals 1,560 dollars. The match is that 1,560 dollars, added on top of her own 3,120 dollars. Together that is 3,120 plus 1,560, or 4,680 dollars going in for the year.

Now look at what it cost her paycheck. She is paid every two weeks, which is 26 paychecks a year. Her own 3,120 dollars divided by 26 comes to 120 dollars per paycheck, before tax. Her plan takes the money out before income tax, so the drop in her take home pay is smaller than 120 dollars. The exact amount depends on her tax bracket, so I will not guess at it.

Then Denise added one more setting. Her plan offered auto escalation, so she told it to raise her rate by 1 percentage point every January. Next year her rate becomes 7 percent. One percent of 52,000 is 520 dollars, so her yearly saving rises from 3,120 to 3,640 dollars. If she gets a raise, that lift will hardly show.

She never had to think about it again. She did the work once, and it kept on working.

Where it goes wrong

I would be a poor friend if I told you this never stumbles. It does, and the trouble is often small and quiet.

The first snag is set and forget. You set it up, and five years later your pay has changed, your bills have changed, and the plan has not. A yearly check fixes this. Pick a date you will remember, like your birthday, and glance at your settings.

The second snag is an empty checking account. If your automatic transfer pulls more than your account holds, you can pay an overdraft fee. Keep a small cushion in checking, and do not set a transfer so large that one surprise bill sinks you. Start small. You can always raise it.

The third snag is the match. If your employer offers one, you may leave free money on the table by saving less than the match asks for. Read the plan rules to see what percent earns the full match. Some plans also have a vesting schedule. That is a rule about how long a worker must stay at the job before the match is fully theirs. Ask your benefits office how yours works.

The fourth is a plain old mistake. A stale bank account number, a plan that changed providers, a form never finished. Look at your first statement to be sure the money actually arrived. Trust, but check.

Last, automatic does not mean you stop caring. It means you stop needing to remember. Those are different things.

Questions to answer before you leave this page

What is the one small amount you could send to savings on payday without feeling it? Which day does your pay actually land, and can you set the transfer for that day or the day after? Does your employer offer a match, and do you know the percent it takes to earn all of it? Is there a setting in your plan that raises your saving rate each year, and would you turn it on? What cushion sits in your checking account, and is it enough to cover a surprise? On what date each year will you look these settings over again? And who is the friend you could tell, so that someone besides you knows you have started?