First of all, congratulations! Getting a raise is a big accomplishment- it’s a validation of the hard work you’ve put in at your job. Depending on your personality, you may just go on with life as usual, or you may want to go on a spending spree. But wait! Let’s run through a few things before making any decisions. Small increases to your current (good) habits will help you reach your financial goals. Following the steps below will help you put those extra funds to work.
Calculate Your New Take-Home Pay
First, calculate your new take-home pay. A $10,000 a year raise doesn’t equate to an increase in take-home pay of $10,000. The raise could put you in a higher income bracket, which means you’ll have more taxes and deductions. If you’re contributing a percentage to your employer retirement plan, that amount will also increase with your raise. Once you get your first paycheck after your raise, subtract your pre-raise take-home pay from your new take-home pay. This will help you determine the amount that will affect your monthly budget.
Pay off Debt
Assuming your Emergency Fund is in place (if not, do that first), if you have any debt- student loans, credit card, car loans- using your extra funds to accelerate the pay down of debts will not only help your financial and psychological health, but can improve your credit and increase your personal net worth. It’s not the instant-gratification that a splurge would be, but remember you’re in this for the long haul. The satisfaction of being debt free is a big victory. There are a few different ways you can approach debt pay down. The right choice for you will be the one that you feel comfortable with and can commit to.
If you’re not already saving 20% of your income, use your extra income to try to hit that target. If you’re there, amazing! Now you can think about some savings goals you have coming up. It could be something smaller like a vacation, or something large like a wedding or home down payment. Defining those goals and saving specifically for them will increase your chances of achieving them.
If your savings goals are longer term, consider investing your excess savings. It’s important to consider your risk tolerance and time frame when choosing the allocations for your portfolio. Shorter time frames should lean more conservatively, while longer ones can be more aggressive. Once you settle on an appropriate risk allocation, find the investment method you feel comfortable with.
Boost Your Retirement
Now take a look at your retirement contributions. More income will allow you to save more towards retirement. Even a small amount can equate to a big difference. According to MarketWatch, boosting monthly retirement savings by just 1%, or roughly $50 a month for a 35-year-old making $60,000, could lead to an additional $270 in monthly income in retirement (The study assumes a 7% rate of return and a retirement age of 67).
The graphic below shows the interest earnings of three people- Michael, Jennifer and Sam. Michael saved $1,000 per month from the time he turned 25 until he turned 35. Then he stopped saving but left his money in his investment account where it continued to accrue at a 7% rate until he retired at age 65. Jennifer started saving $1,000 a month from age 35 until she turned 45. Then she also left the balance in her investment account, where it continued to accrue at a rate of 7% until age 65. Sam didn’t start investing until age 45. He invested $1,000 per month for 10 years, halting his savings at age 55 and left his money to accrue at a 7% rate until his 65th birthday.
Each of them saved the same amount over the same period of time at the same rate. But the amount of time the money was invested made all the difference. Michael's ending balance was just under $1.5 million, while Jennifer's was around $735,000 and Sam ended at around $373,000.
If your employer offers a match, increase your contribution percentage to max out the match. If your employer doesn’t offer a retirement plan (or if you’re already reaching your yearly 401k contribution limit), you can contribute up to $6,000 a year to a Roth IRA ($7,000 if you’re over 50). You will pay taxes on the contributions, but the withdrawals in retirement will be tax free.
Do Something for Yourself
It is ok to treat yourself! Maybe there’s a new pair of shoes you’ve had your eye on. Or a massage/spa day. Or setting aside that money in a savings account toward your travel goal. Whatever it is, reward yourself for your hard work!
Keep these steps in mind each time you get an increase, no matter how small. Following these guidelines will help achieve your financial goals and reap long-term benefits. And ensure your income boost doesn’t disappear each paycheck!
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