This One Decision Turned My Entire Financial Situation Around

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For years, I found myself facing the same problem. I would create a household budget that included a little money left over for savings. However, month after month, I found myself short.  If there was any money left, I'd think of a million things I needed to do with it and months would go by with a penny going into our savings account.

It wasn't until I admitted that something had to change that I turned to a practice called "reverse budgeting." Here's how that single decision made all the difference.

It was always something

Like most people, my husband and I have faced ups and downs -- and many changes. We've been part-time students, full-time students, parents, and eventually nomads as we moved from state to state and country to country. It felt as though we always had something huge going on (even if it was just huge in our minds).

We'd get one step ahead of our personal finances , then take several steps back. Whether our latest financial challenge was due to problems with an old car, a house that always required maintenance, or a serious illness, it was always something. I suspect it's the same for 99.9% of the population. You just never know what's around the corner.

It eventually became clear that my traditional method of budgeting was not doing us any favors. How were we supposed to build an emergency fund or retirement account if we spent everything we earned (and then some)?

A simple but effective solution

It never occurred to me to pay myself first, but that's what reverse budgeting requires. You figure out how much you want to put into savings and how much you want to contribute to retirement. That amount of money comes off the top of your income. Then, you build a budget around the rest. In other words, before our mortgage, utilities, or groceries are paid for, money for the future is safely tucked away.

I know it may sound impossible, and at first, it feels a little impossible. The point is, you can start small. For example, after years of finding it difficult to put anything away, we started contributing to my husband's 401(k). At first, it was just the percentage his employer would match. If we contributed 3% of his pre-tax income, we would actually get 6% after the employer match.

What's cool about pre-tax retirement plans is that you contribute to your future while receiving an immediate tax break. Here's how it works:

• For simplicity sake, let's say you earn $3,000 monthly.
• How much you'll pay in taxes depends on the state in which you work, but let's say you live in Nebraska.
• A single taxpayer taking zero deductions and earning $3,000 per month would be hit with a tax bill of $537. That includes $195 to the federal government, $112 to Nebraska, and $230 to Social Security and Medicare taxes.
• You're left with take-home pay of $2,463 per month.

Now, look at this:

• You decide to contribute 3% to a 401(k).
• Instead of taxing you on $3,000 a month, you pay taxes on $2,910 ($3,000 - $90, or 3% of your monthly income).
• Now, instead of paying $537 per month in taxes, you owe $513 because neither the federal or state government is taxing your retirement contribution.
• Saving $24 per month on taxes may not seem like a lot, but when you factor in the tax savings, your "real" out-of-pocket contribution is only $66. That means you only need to adjust your household budget by roughly $15.25 per week.
• If your employer matches your contribution, even better. For example, if it matches 3%, that means you're contributing $90 and your employer is contributing $90, for a total of $180.

The bottom line: For only $66 per month, you have a total of $180 going toward retirement. You can plan to raise your contribution by 1% a year or come up with another way to increase your contribution as your career progresses.

Your emergency fund

Unfortunately, there's no one volunteering to match money you put into an emergency fund. However, every dollar you contribute is a dollar you won't have to borrow if you find yourself in a pickle, like a car broken down on the side of the highway. Paying cash in emergency situations ultimately saves money in the way of interest payments you never have to make.

Reverse budgeting

Imagine what it would look like for you. We'll use the same $3,000 per month scenario:

• You contribute $90 (3% of your income) to a retirement account.
• You pay $513 in taxes withheld from your paycheck.
• You put another $60 into an emergency savings account.
• You're left with $2,337 after paying yourself first.
• You build the remainder of your monthly budget around $2,337.

Your numbers may vary, but the idea remains the same. You place saving for the future firmly on the front burner. Move as slowly (or quickly) as you're comfortable. The big payoff is watching how quickly your money grows and knowing that you'll thank yourself one day for being so forward-thinking.

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