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If you’ve been lucky enough to keep your job this year and expect to get a raise, congratulations! Keep in mind, though, that it’s very easy to increase your spending when your salary goes up, especially if the salary increase seems small to you.
Instead of falling into bad financial habits, you can direct this additional money towards your financial goals. Here are some tips on managing your finances after a raise, big or small.
Figure out how much your raise changes your take-home pay
After receiving a raise, the first thing you want to do is understand how that raise affects your take-home pay. Doing so will help you get into the right mindset. A larger raise can help you accelerate your financial goals, while a smaller raise (such as a cost-of-living adjustment) may not amount to much per paycheck. We’ll discuss more below.
Online paycheck calculators will help you estimate how much you will receive after taxes. It’s also helpful to wait for your first paycheck after the raise to see how much you actually receive (versus the gross amount).
A good rule of thumb is to try and save at least 75% of every raise
It’s essential to understand the concept of lifestyle creep so you can avoid it at all costs. While it’s OK to set aside a small amount for yourself or use a portion of your raise for something fun, you don’t want to get into the habit of consistently spending more after each raise.
When you want to splurge on a purchase, think about items that may make your life more comfortable or happier. Make sure you’re not just spending more because you can. The more you align your spending with your values and goals, the less likely you are to have buyer’s remorse.
Be proactive about how you’ll use your raise
Last but not least, you want to be proactive. Have a budget, goals, and a plan. A budget is essential, since your ability to manage your cash flow directly impacts your ability to achieve financial goals. Setting goals gives you the motivation to stay on track, and a well-thought-out plan is the roadmap to achieving your goals. When you have these three items in place, it’s easier to know how you should allocate additional cash from a raise.
Another way to be proactive is to set rules ahead of time for how to treat raises or other unexpected money. For example, you could allocate a certain percentage to increase savings or pay off debt, a certain percentage for charitable giving, and a certain percentage for fun. The specific percentages and categories are up to you.
How to handle small raises vs. large raises
Your approach to handling your finances after a raise can be different based on the size of the raise.
Small raises may not amount to much of an increase in your take-home pay, but consider using them to increase contributions to your employer-sponsored plans. For example, if you receive a 3% raise, you could increase your 401(k) contributions by another 1-2%. Another option is to increase contributions to your Health Savings Account. Either way, small savings increases build up over time. Don’t let those small raises slip through your fingers!
What if you receive a large raise? I highly recommend redirecting the money right away so you’re not tempted to spend it.
The first thing you should do is revisit your income tax withholding. In some cases, a large raise can push you into a higher tax bracket. Check with a tax professional to determine if the amount you’re withholding from your paycheck is sufficient. If it’s not, adjust your tax withholding or plan to make estimated tax payments so there are no surprises on April 15.
Assuming your lifestyle is comfortable, you can use large raises to accelerate savings and debt payments. Prioritize building an emergency fund and paying off high-interest debt. From there, allocate your raise to other financial priorities that match your goals. If you have automatic savings contributions or debt payments, increase those before the money touches your hands.
If you’re still working towards a comfortable lifestyle, take baby steps. Don’t make a lot of major purchases right away, especially ones where you take on debt. Committing to more debt and higher monthly expenses after a large raise is a money mistake that sometimes leads to financial regrets.
If you were fortunate to receive a raise recently, use it wisely! Having the right money mindset, goals, and plan can help you use salary increases to accelerate your path toward financial independence.
