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!
Auto Savings Apps
There’s a whole new category of forced savings tools out there: automatic savings apps that connect to your banking accounts and facilitate automatic savings deposits. I’ve used one of these apps, Digit, to save over $1,000 without lifting a finger.
What about you? Are you forced to save, or do you force yourself to save in any way?