It’s Kind of a Forced Savings Account

Forced Savings Account

I want you...to save!

No one’s forcing you!

Well, actually they are.

The “forced” savings account is being used in several areas of our lives.

In some cases, you may even be forcing yourself to save. Which isn’t necessarily a bad thing.

The biggest forced savings account that we all participate in here in the U.S. is the Federal Old-Age, Survivors, and Disability Insurance program (i.e. Social Security).

We are forced, by federal law, to pay 6.2% (temporarily reduced to 4.2%) of our income into this program. Our employer is required to chip in another 6.2%.

What do you get for this forced savings? For me, the future equivalent of around $1,100 each month when I retire at 67.

Depending on your income, your ability to save money elsewhere on your own, or your thoughts on the general liberties granted by our Constitution, you may view this forced savings account as a good or a bad thing.

Your Home as a Forced Savings Account

The most classic example of the forced savings account comes in the form of your own home. The idea is that you spend your working years paying off your home. By the time you retire, you will have paid off your mortgage, and you’ll have a nice bit of savings in the form of home equity. You can use this equity to pass wealth on to your heirs.

When doing a rent vs buy analysis, many proponents of buying (vs renting) point to this forced savings as one of the major benefits of home ownership. Home equity ends up being the biggest asset for many when they retire.

According to AmericaSaves.org, over four-fifths of the assets of lower income homeowners represent home equity. But just because it is the biggest asset, it doesn’t mean it should be.

With mortgage interest, property taxes, and the cost of maintenance, a home is one of worst places to save money.

Big Tax Refund: Not the Smartest Forced Savings?

Another frequently cited form of forced savings, at least on the annual basis, is the federal tax refund. By adjusting your W-4 to include fewer allowances, you will have more money withheld from your paycheck.

The government will then hold this money until you file your taxes, and they’ll pay it back to you in the form of a tax refund. Some taxpayers prefer this method because they feel it forces them to save money that they wouldn’t.

In the past I could understand this strategy. But today, with online savings and easy automation of periodic contributions, it’s just lazy.

So those are the big three types of forced savings accounts. But, they aren’t the best, most efficient way of building wealth through savings. In fact, they mostly suck.

You can do much better, on your own, using some of the other methods below.

Other Forms of Forced Savings Accounts

If you have a job with good benefits, your employer may force you to begin saving money by automatically enrolling you in the 401K. An increasing number of companies are using automatic enrollment these days.

I tend to think this is a good thing. I wish someone would have forced me to start with a 401K right away after college. I missed out on a lot of free money in the form of a matching contribution.

That leads me to the next, more subtle, form of forced savings: the 401K match. Companies dangle free money, typically 2% to 5% of your earnings, for you to participate in their 401K program. This money makes it very hard to pass on at least participating at the minimum level.

Another subtle form of forced savings plan is through the use of tax-advantaged savings accounts. Examples include the IRA, 401K, HSA, FSA, 529 Plan, Solo 401K, etc. Each of these types of accounts has a tax-advantage to reward you for saving more of your money.

Most of them also have specific annual minimums that give you a target to shoot for each year. Knowing that these accounts exist (and that I can use them to reduce my tax burden) in a subtle way, forces me to use these accounts over other forms of saving or spending.

With the exception of the 401K, you’ll likely have to setup your own forced savings account with these types of accounts. You can do it in two simple steps. Step one is to open the account. Step two is to create a periodic automatic contribution to the account from your employer. Pay yourself first!

What about you? Are you forced to save, or do you force yourself to save in any way?

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Last Edited: October 24, 2012 @ 9:15 pm
About Philip Taylor

Philip Taylor, aka "PT", is a husband and father of two. He created PT Money back in 2007 to share his thoughts on money and to meet others passionate about managing their finances. All the content on this blog is original, and created or edited by PT. Read more about Philip Taylor, and be sure to connect with him on Twitter, Facebook, or view the Philip Taylor+ Google profile.

10 comments
Russell Abravanel
Russell Abravanel

It is a great idea to get younger people into a buy if i have it mentality. We need to break the instant gratification credit addiction we have inherited from older generations.

MJTM
MJTM

For me I have a forced savings by keeping my checking accounts artificially low (shockingly low) just so I can't spend money.  So everything is forced savings lol.  

 

Another general example like the house, ss, etc., is Whole Life insurance.  

Bill McNulty
Bill McNulty

Forced savings through automatic enrollment in IRAs may be added soon to the list. (PT may have covered this elsewhere.) A White House budget proposal calls for employers with less than 10 employees to set up and auto enroll employees in an IRA. Just a proposal for now but the govt is really pushing to lessen reliance on Social Security, which may become even less of a good deal for savers in the future.

krantcents
krantcents

I have always been a natural saver. I save for investments (outside of a tax deferred account), travel or anything I want. Savings help me achieve financial freedom.

InvestItWisely
InvestItWisely like.author.displayName 1 Like

Social security, and its equivalent here in Canada, is not what I consider to be "forced savings". It is more like a forced wealth transfer since that money is not actually being saved. In order for younger people today to collect in the future, others will have to pay into the system, and that assumes that laws and regulations don't change in the meantime.

I prefer my voluntary method of forced savings -- an automatic transfer from the chequing to the savings, twice a month. ;)

Philip Taylor
Philip Taylor moderator

@InvestItWisely I would prefer that too. But our "wise" politicians made that choice for us back in the 30s. No doubt SS is needed now because of the entitlement state. But I wish we could do without it for sure.

AverageJoeMoney
AverageJoeMoney like.author.displayName 1 Like

I'm also split on forced savings....on one hand, I'm a "I like my liberty" kind of dude. On the other, I also would have saved more earlier if I'd had someone stick my nose in it. Maybe the true issue is better financial education in our schools? They're teaching my son engineering in 11th grade (awesome) but basic money practices are an elective.

Philip Taylor
Philip Taylor moderator

@AverageJoeMoney I definitely could have used a Dave Ramsey type class in high school. I actually think we're getting better with regard to starting early. Most people are aware of the powerful affects of automatic investing now. Studies have cited this. But I still think people have trouble living within their means and avoiding the once every ten year raid of their savings due to credit card debt. Irresponsible people will find a way to screw themselves.

Dollar Disciple
Dollar Disciple like.author.displayName 1 Like

I think it's pretty funny when people say they love getting back a big tax return. Seriously? Couldn't you have used that money over the course of the year??

Jeffrey Trull
Jeffrey Trull

I'm not sure if it's a good or bad thing that forced savings accounts don't work very well. It would be great if everyone would be disciplined enough to do a better job saving, but that clearly doesn't happen on it's own. On the plus side, if you're already good at saving money, it's great to be able to find better savings options than a mortgage or a tax refund.