The 401(k) Hack that Rescued My Family Finances

Finance Friday

It seems like so long ago these days, but there was a time when my wife and I had money. Things like vacations, decent cars, and dinners out were actually parts of our lives. We did silly things like paying money for flowers to plant in the yard, keeping our wardrobes within 3-4 years of current trends, buying treats just to keep around the house, and even starting to furnish the house. It was crazy, crazy, crazy middle class times, but a dark cloud was looming and these carefree days of spending whimsy were about to abruptly cease. My first daughter was on the way, and our lives and finances would never be the same.

Kids are expensive and making the transition from two spouses to a family of three, four, five, or more (masochists) comes with the realization that money is going to be a larger part of the spousal relationship. It can be fairly easy to survive financially if your lifecycle hits that intersection of still early career but beyond entry level wages and no kids and few responsibilities. In that phase, you may not be making good money but whatever you do make seems like plenty without much coming out. There’s little need for things like financial planning, budgets, and investing because life is simple and easy money is flowing.

Then a kid enters your life and chaos ensues. Budgeting becomes a necessity. Life insurance is a thing. Retirement. Mortgage. Hospital bills. As your family grows, so does the tangled web of your finances. It becomes increasingly difficult to juggle all the different responsibilities of your life while also transitioning personally as a parent. We get older though, and, despite our best intentions, start to mature slowly and make responsible decisions for our families and our futures.

One of the foreign topics that suddenly grows in relevance as you mature is retirement. In the midst of having kids, most people will begin taking jobs that offer 401(k)’s or different retirement savings vehicles. Hopefully, you’re one of those people and your employer has a big fat match. Whether you have a 401(k) or not, there is one retirement advice tidbit that has been circulating for years and can help you in all areas of your finances. The idea is that, assuming you’re having difficulty hitting an ideal savings rate, you use raises, bonuses, promotions, and new jobs as opportunities to increase your 401(k) rate. For example, let’s say your desired savings rate is the oft-quoted 15%. Perhaps you started your 401(k) enrollment at just 5% and now a spouse, kids, and a house have entered the picture and a quick jump to 15% doesn’t seem possible. Let’s assume you receive a 5% raise; one painless way to increase your contribution is to take that raise and split it. Perhaps 2% goes to your 401(k) while you keep 3% to yourself. Do this for a few years and reaching 15% will come easily; the greatest benefit of this strategy is that it is relatively painless as you haven’t yet received the money yet so it doesn’t feel like a sacrifice.

While this strategy is usually focused only on retirement saving, I like to employ the tactic in a variety of situations. Perhaps your 401(k) just isn’t a priority currently; what is the financial goal you’re working towards? Let’s say you’re working towards paying down a debt like a student loan and you receive a 3% raise. Rather than enjoy the raise (and possibly fritter the extra cash down the drain), you can divert the 3% through an auto-withdrawal to the account paying the debt. Or, maybe you keep 2% and just throw a single percentage point towards the debt. Perhaps it’s saving for a vacation or a new vehicle and you divert 2 or 3% towards a separate savings account each paycheck. Or perhaps paying down the mortgage is a goal and you use progressing percentage points to hammer away against the principal. The system functions almost like compound interest, where the amount continually increases each year so it snowballs towards your objectives. This works just as easily with bonuses or found money (x% goes towards the goal, the rest towards normal spending) and also for promotions and new jobs (the easiest of all; increase your savings rate and still receive a large raise).

One of the greatest examples for the stateside readers was the tax cuts implemented this past year. The vast majority of Americans received a 1-3% reduction in taxes in February or March. So the question is: did that extra $10, $20, $50, or $100 go towards one of your financial goals or did it just get absorbed into your living expenses? I’m guessing that most people barely noticed and the cash vanished as money tends to do. Being the nerd that I am, that extra 1% was immediately diverted to my 401(k) (which isn’t yet where I’d like it to be) and I never saw the tax cut on my final paycheck. The money was gone before I had the chance to blow it. I live with three females…if the money doesn’t get tucked away quickly, it will disappear in a flash.

So take a tip out of my playbook and take your raises, bonuses, promotions, and new jobs and leverage those increases against your financial goals. Whether you’re paying down a debt, saving for a dream purchase, or attacking a mortgage, make your increases work for you rather than against you. Many people have a tendency to file those raises into the ‘lifestyle creep’ bin and raise their lifestyles right alongside their income while never quite nailing down retirement or existing debt. Perhaps if I never had kids, I wouldn’t have to resort to tips and tricks to meet financial goals but, as it is with two daughters, I have to scrape and hustle if I don’t want to live in the cardboard box my daughter currently plays in.

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