Have you ever received the thrilling news that a pay raise is coming your way? I still remember the elation my son felt when his manager called him into his office to announce an unexpected salary bump early in his working years. However, that excitement was tempered by some nerviness about how to make the most of his welcome development.
Are you in the same boat, and don’t know what to do with a raise too?
You see, throughout my over 25 years as a financial planner, I’ve seen firsthand how a pay raise, while undoubtedly positive, can also become precarious territory if not managed carefully. Too often, well-meaning clients of mine would undermine the long-term value of that extra income by making crucial missteps.
So if you’ve recently been granted a salary increase, congratulations! But before you splurge or shift into cruise control, let’s have a thoughtful discussion about avoiding common pitfalls.
My aim is to provide experienced guidance on key considerations when asking the question: “What should I do with a pay raise?” I want you to truly maximize the benefits of your hard-earned boost in compensation.
Key Takeaways: What To Do With a Raise?
- The primary action to take with a pay raise is to apply the Michael Ryan Money Rule of Thirds For Pay Raises; divide the extra income into three parts – taxes and debts, savings and investments, and personal enjoyment. This strategy ensures a balanced approach to financial well-being, yet there’s more beneath the surface to explore.
- Before indulging in lifestyle upgrades, prioritize debt repayment, especially high-interest debts, to alleviate financial burdens and pave the way for sustainable wealth building.
- Building future security: Incrementally boost your retirement contributions and emergency savings, leveraging the power of compound interest and preparing for unforeseen financial needs.
- Enjoying responsibly: Allocate a sensible portion of your raise towards personal rewards or lifestyle improvements, but consider additional savings or investments if there’s surplus, emphasizing the importance of financial discipline and long-term planning.
Quick Links: What To Do With a Raise?
Immediate Action Plan for Pay Raise Allocation
Receiving a pay raise can be both exhilarating and daunting, especially when you’re uncertain about the best ways to allocate this newfound income. It’s not just about enjoying the immediate perks; it’s about leveraging this opportunity to fortify your financial foundation and secure a prosperous future.
At the heart of any strategy lies a triadic allocation system: tax adjustments, debt reduction, and savings enhancement serve as the pillars for immediate financial stabilization.
This structured framework ensures that your pay raise not only addresses current financial obligations but also paves the way for long-term wealth accumulation and personal fulfillment. By adhering to this approach, you can turn a temporary pay increase into a lifetime of financial security.
| Priority | Action Item | Percentage of Raise | Purpose |
|---|---|---|---|
| 1 | Adjust Tax Withholdings | Varies | To ensure appropriate tax payments and avoid underpayment. |
| 2 | Pay Down High-Interest Debts | ~33% | To reduce financial liabilities and interest expenses. |
| 3 | Increase Retirement Contributions | ~33% | To leverage compound interest and secure long-term financial health. |
| 4 | Enhance Emergency Fund | Part of ~33% | To prepare for unforeseen financial needs. |
| 5 | Personal Enjoyment and Lifestyle Upgrades | Remaining balance of ~33% | To reward hard work while maintaining financial discipline. |
Other Considerations of Pay Raises
Here are a few considerations to take into account when you get a raise in pay, or a bonus
- Did you go into a higher tax bracket? Be sure to check your federal income tax bracket first.
- With an increase in your current lifestyle (be careful of becoming a victim of lifestyle creep), you may need to review your Life Insurance needs as well. Do you need to increase your coverage, and again that will increase your premiums. Here is a free Life Insurance Calculator from non-profit Life Happens.
- You now need to look at your Disability Insurance and review it. With a higher salary, you need to increase your coverage – and that will unexpectedly cost more in premiums.
- Do you need to adjust your Liability Insurance coverage and increase that? Do you now need or want an Umbrella Insurance Policy?
- Get a quick look at how you might be able to save money on your insurance with PolicyGenius
- Lastly, it is time to go back to your Spending Plan, and make the necessary adjustments to update it.
Common Mistakes I Have Seen people Make With Pay Raises
When individuals receive a bonus or increase in pay, they often make common mistakes that can have long-term consequences on their financial health.
Remember, I have personally seen what thousands of people do with their finances. Here are some typical errors I have observed, and why they can negatively impact long-term financial well-being:
Succumbing to Lifestyle Inflation
I get it. When you get a pay raise, it is tempting to try to keep up with your friends – or keep up with The Jones’s next door. Instead, by establishing good spending habits early on – you are setting yourself up for a lifetime of sucess.
- Mistake: Earmarking every extra dollar for increased spending on non-essential items like a nicer apartment or vacations, without making a bigger-picture plan for the money.
- Perspective: This can lead to lifestyle inflation, where increased income results in higher spending, making it challenging to build long-term savings and investments.
| Category | Pre-Raise Allocation | Post-Raise Allocation | Notes |
|---|---|---|---|
| Essential Expenses | 50% | 45% | Allocate less percentage, more in value |
| Debt Repayment | 20% | 25% | Increase to accelerate debt clearance |
| Savings | 10% | 15% | Boost emergency and long-term savings |
| Investments | 10% | 10% | Maintain or adjust based on goals |
| Discretionary Spending | 10% | 5% | Adjust to prioritize financial goals |
Forgetting About Retirement
- Mistake: Overlooking increasing retirement savings in line with the raise.
- Perspective: Failing to boost retirement savings can impact long-term financial security, especially considering the power of compounding over time.
| Mistake | Consequence | Prevention |
|---|---|---|
| Succumbing to Lifestyle Inflation | Leads to higher spending without corresponding savings, making long-term wealth building difficult. | Allocate a fixed percentage of the raise to discretionary spending, and save/invest the rest. |
| Forgetting About Retirement | Misses the opportunity for compound growth, affecting long-term financial security. | Increase retirement contributions proportionally with the pay raise. |
| Neglecting Debts | Continues financial burden and interest accrual, hindering wealth accumulation. | Prioritize high-interest debt repayment with part of the raise. |
| Assuming Pay Raises Will Keep Coming | Can lead to overreliance on future income increases, risking inadequate financial planning. | Adopt a conservative financial planning approach, considering potential income fluctuations. |
| Not Adjusting Tax Withholding | May result in underpayment of taxes and unexpected tax bills. | Consult with a tax advisor to adjust withholdings appropriately. |
Neglecting Debts
- Mistake: Failing to prioritize debt repayment, especially high-interest debt, despite the increased income.
- Perspective: Neglecting debt repayment can lead to prolonged financial burden and hinder the ability to build wealth over time.
Assuming Pay Raises Will Keep Coming
- Mistake: Overestimating future income growth and not planning for potential fluctuations in income.
- Perspective: Relying on consistent pay raises can lead to inadequate financial planning and preparation for income variability.
Calculating Pay Raise: Click either tab below and use the Annual Income Calculator, and then the Pay Raise Calculator
Annual Income Calculator
Pay Raise Calculator
Not Adjusting Tax Withholding
- Mistake: Not adjusting tax withholding after a raise, which can result in underpayment of taxes throughout the year.
- Perspective: Underpayment of taxes can lead to a significant tax bill at the end of the year, impacting cash flow and financial planning.
By understanding these unique perspectives, individuals can make informed decisions when managing a large pay raise and avoid common financial pitfalls.
The Importance of Smart Annual Raise Planning
When individuals receive a large pay raise, avoiding common financial pitfalls is crucial to ensuring that the additional income contributes to their financial well-being and future goals.
By sidestepping these mistakes, individuals can set the stage for long-term financial success and stability.
“Show me the money!”
– Rod Tidwell in Jerry McGuire movie
Significance of Avoiding Pitfalls:
Building Sustainable Wealth
By avoiding lifestyle inflation and prioritizing smart financial choices, individuals can build sustainable wealth over time, rather than increasing expenses in proportion to their income.
Securing Future Financial Freedom
Smart planning ensures that the pay raise is channeled towards securing future financial freedom, such as through increased retirement savings and debt reduction.
Minimizing Financial Stress
Avoiding common pay raise mistakes minimizes financial stress, as individuals are better prepared for potential income fluctuations and unexpected expenses.
Maximizing Long-Term Opportunities
By making informed financial decisions, individuals can maximize long-term opportunities, such as investing in education or skills development to enhance their earning potential.
Strategies to Avoid Common Pay Raise Mistakes
To sidestep common errors associated with a large pay raise, consider the following actionable tips:
| Segment | Action | Details |
|---|---|---|
| Paying Back Yesterday | Calculate for Taxes & Pay Down Debt | Allocate ~1/3 of the raise for taxes and reducing high-interest debts. |
| Planning for Today | Increase Savings & Investments | Dedicate ~1/3 of the raise to enhancing retirement contributions and building an emergency fund. |
| Rewarding Yourself Tomorrow | Allocate for Personal Enjoyment | Use ~1/3 of the raise for responsible personal spending, with surplus funds redirected to savings/investments. |
Implement the “Michael Ryan Rule of Thirds For Pay Raises”:
Allocate one-third of the raise to increasing savings and investments, one-third to paying down debt, and one-third to improving your lifestyle in a sustainable manner.
- Create a Detailed Budget: Develop a comprehensive budget that reflects the new income level, ensuring that spending aligns with both short- and long-term financial goals.
- Prioritize Retirement Contributions: Increase retirement contributions in line with the raise to take advantage of long-term compounding and secure future financial well-being.
You can learn more about the best free budgeting apps and Kakeibo budget by clicking the links.
Maximizing Your Pay Raise with the Michael Ryan Money MRM Rule of Thirds
Over my many years advising clients on financial planning, I developed a unique rule of thumb for managing windfalls and pay raises. I call it the Michael Ryan Rule of Thirds. Here’s how it works:
| Segment | Action | Details | Priority |
|---|---|---|---|
| Paying Back Yesterday | Calculate tax increase | Estimate the tax impact of your raise and adjust withholdings accordingly | High |
| Pay down high-interest debt | Allocate funds towards reducing debts starting with those carrying the highest interest rates | High | |
| Planning for Today | Increase retirement contributions | Boost your retirement fund contributions to leverage compound growth | Medium |
| Build emergency savings | Enhance your emergency fund to cover 3-6 months of living expenses | Medium | |
| Rewarding Yourself Tomorrow | Allocate for lifestyle improvements | Set aside a reasonable portion of the raise for personal enjoyment or indulgences | Low |
| Balance with additional savings | Consider directing any remaining funds towards additional savings goals before increasing discretionary spending | Low |
You take your pay raise and divide it into thirds:
Paying Back Yesterday (1/3)
- I recommend dedicating about a third of the raise to “yesterday” – accounting for taxes and paying down debt obligations from the past.
- Specifically, this portion covers inevitable tax increases and any outstanding debts that need priority repayment before allocating funds elsewhere.
- Calculate about a third of your raise to cover inevitable tax increases from the higher income. Adjust your tax withholdings accordingly.
- Dedicate a portion to paying down outstanding debt accounts, focusing first on high-interest debts.
- This segment ensures you start off strong by settling past-due commitments before enjoying the pay raise. This proactive approach ensures that individuals address financial obligations and minimize future financial stress.
Planning for Tomorrow (1/3)
- The next third should go towards your future financial security – your “tomorrow.”
- If you have no pressing debts, this portion can be directed to bulking up savings, retirement contributions, college funds, or other wealth-building vehicles.
- Build up emergency savings and other established financial goals. Then, increase retirement contributions to take advantage of compound growth.
- By prioritizing these areas, individuals can build a strong financial foundation and take advantage of the increased income to secure their future.
- It’s about paying yourself first and harnessing the raise to strengthen your financial trajectory.
Rewarding Yourself Today (1/3)
- The final third segment is for non-essential, quality-of-life upgrades – a reward for your hard work.
- Allocate up to a third of the raise for reasonable lifestyle expenses or indulgences.
- However, I typically recommend proceeding through the first two thirds before allocating these funds.
- Many clients discover they need less than a third for immediate lifestyle needs. Leftover funds can then be redirected towards additional financial security.
In this manner, the Michael Ryan Money Pay Raise Rule of Thirds provides an optimal, balanced approach to managing a pay raise for both short-term needs and long-term financial stability.
This three-step approach helps in balancing the immediate joy of extra income with the need for long-term financial planning and security.
Summary of Actionable Advice:
- Create a Comprehensive Budget: Utilize pay raise calculators to understand your new financial situation. Allocate funds for essential expenses, savings, and some discretionary spending.
- Balance Savings and Debt Repayment: Prioritize high-interest debts for repayment while simultaneously contributing to an emergency savings fund. This approach not only reduces financial liabilities but also builds a safety net.
- Invest Wisely: Diversify your investment portfolio according to your risk tolerance and long-term goals. Consider consulting a financial advisor for tailored advice, especially if you’re new to investing.
Next Steps: Following the Michael Ryan Money Rule of Thirds for a Pay Raise
Receiving a sizable pay raise is an exciting event, opening new possibilities for both short-term and long-term financial goals. However, as discussed in this article, it also brings potential pitfalls if not managed carefully.
By understanding common financial mistakes and implementing structured strategies like the Michael Ryan Rule of Thirds, individuals can maximize their pay raise for sustainable growth. Avoiding lifestyle inflation, prioritizing debt repayment and retirement contributions, and rewarding yourself responsibly are key to unlocking this raise’s full potential.
With smart planning, your pay increase can become a catalyst for securing your financial freedom for years to come. You have an incredible opportunity – now focus on making decisions to transform this income boost into lasting financial stability, security, and success.
Additional Financial Planning Resources
- Harvard: The payoffs of higher pay
- Forbes: Want a Pay Raise?
- Financial Goals Calculator from Bankrate
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Note: The content provided in this article is for informational purposes only and should not be considered as financial or legal advice. Consult with a professional advisor or accountant for personalized guidance.
