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How Disposable is Your Income?

Written by: Kristy Welsh

written by Bonnie Conrad

I don't know about you but I have never cared much for the term "disposal income." That term seems to imply that there is all this extra money just floating around out there waiting to be put to use. While I'm sure there are some people out there who are awash in cash they have no way to spend, that is certainly not the case for most of us. From my perspective it seems that more and more workers are having to work harder and harder just to stay even. Getting ahead often seems like a distant dream, and it can be difficult just to make ends meet. The idea of disposable income can seem quite remote to most of us.

Even though the term may be misleading, however, there are some important lessons to be learned from the concept. Even if it seems that every penny is needed and there is simply nothing left to save, in many cases it is possible to eke out some savings from even the most modest income. There are some tried and true techniques that workers can use to maximize their income and their savings. While these techniques may not create mountains of so-called disposable income, they can at least help you find some money to put away for the future.

What to do With Your Tax Refund

Many workers are thrilled at the dawn of every year when they do their taxes and find that they are due a big refund. While the idea of getting a big check from the government is understandably attractive, a big refund simply means that you have been loaning money to the government, interest free, for the past 12 months. While this is certainly a good deal for the U.S. Treasury, it is not such a good deal for you. Even in a low interest rate environment like the one we find ourselves in now it would have been possible to earn some interest on those extra funds.

One of the best things workers can do to boost their savings is to adjust their withholding to even things out. This change in withholding will typically result in more take home pay — and a smaller refund the following year. This strategy works best if the "found money" in the paycheck is directed to a high yield savings account. If you follow this strategy for the entire year the balance of that account should be larger than any anticipated refund. You will have stopped lending interest free money to the government and started to pay yourself instead.

Make Your Savings Automatic

The above strategy works so well because it is automatic — the "extra" funds recovered through the change in withholding is automatically directed to a savings account. It never reaches your hands, and therefore the temptation to spend it all is reduced. This automatic savings program can be used to direct other funds to savings and investments as well, and many workers have used this technique as the basis of their retirement plan.

With more and more employers abandoning the traditional defined benefit pension plan in favor of 401(k) programs, this automatic savings has become easier than ever before. Most workers in large companies already have access to a 401(k) program, and many smaller employers are following suit with programs of their own. A 401(k) program allows those workers to direct a percentage of their income to fund their future retirement, and this has a number of important benefits.

One of the most significant benefits is that the money placed in a 401(k) program is not subject to current taxes. This allows the worker to keep more of his or her money by reducing his or her tax liability. Participating in a 401(k) program also helps to make retirement savings automatic. The money is invested week after week, year after year, with no further action required on the part of the employee. As the savings grow over time, workers can see the benefits of compound interest and investment returns.

Automatic savings plans like 401(k) programs can also give workers the fiscal discipline they will need to grow their savings over time. Many people find it difficult to get started on a savings program, especially since that so-called "disposable income" can be so hard to find. The beauty of a forced savings program is that the money is removed from the worker's paycheck just like taxes and other deductions. This can allow the individual consumer to learn to live on less than they make — a key foundation for financial success.