A big raise or commission check is enough to make anyone want to run out and spend, spend, spend. But is that the wisest move?
Over the past three years, Jill Jacinto, 29, has seen her salary more than double, thanks to pay raise negotiations and a new commission system at work. But she didn't squander all the extra cash on personal luxuries — tempting as the thought was.
“Your eyes open up and you think, ‘Oooh, what should I do with that?” said Jacinto, an associate director for WORKS by Nicole Williams, a US women’s lifestyle and career website. “But, inherently I’ve always been a saver.”
First, Jacinto used the extra money to set up and fund a retirement account. Now she contributes the maximum to that account every year. Fortunately, she was debt-free so she turned toward less pressing issues, such as moving to an apartment in a better neighborhood in New York City and upgrading her work wardrobe. Only after covering the basics does she now splurge with any extra funds, taking several international trips a year.
Whether you’ve gotten a large raise or just a small bump in pay, figuring out how to allocate the extra cash can be tricky. Some steps are smarter than others.
What it will take: You’ll need enough self-control to keep from binging on unnecessary luxuries and the discipline to make smart financial decisions about your new income and to stick with that plan
How long you need to prepare: Most people don’t have much warning on a salary boost. One day you’re making X, and the next day you’re making Y. If anything, you should not plan on a raise, which might tempt you to start spending money that you’re not making yet.
Do it now: Indulge yourself — a little. It’s appealing to take your bump in salary and use the extra for fun. You need a new car! You want to take a nice trip! It’s okay to have that feeling, but don’t go on a spending spree. Take up to 10% of your new-found funds for a little splurge, but be smart with the rest. “I often say to clients that if they have worked hard and earned a promotion or a pay raise that they should reward themselves,” said Brett Evans, executive director of Atlas Wealth Management in Southport, Australia. “Whether that would be a holiday or a new suit, something that will give them a pat on the back.”
Pay down debt. Do not splash out on new purchases if you owe money elsewhere — particularly to credit cards or student loans. “Paying down consumer debt is usually the first place I would allocate new money,” said Shannon Lee Simmons, a financial planner with Simmons Financial Planning in Toronto. “Debt is so expensive.” You might try the ‘snowball’ approach, in which you pay off your smallest debt first, then roll that debt payment toward the next-smallest loan, and so on. In this way, you gain momentum — financially and psychologically — as you eliminate one loan at a time.
Pad your emergency fund. Are you prepared if you or your spouse were unemployed tomorrow, or if you were hit with a major illness or disaster? You should have three to six months of living expenses in a liquid account. Use your new funds to beef this up until you’re adequately covered.
Save for retirement. Depending on where you live, you might be woefully underprepared for the latter part of your life — sans paycheck. If you aren’t putting the maximum into your retirement accounts, bump up your contributions accordingly. “Even if you’re not behind, it’s difficult, if not impossible, to over save for retirement,” said Brian Frederick, a financial planner with Stillwater Financial Planners in Arizona in the US.
Sock even more money away. You surely have other goals in your life — college for your kids? A bigger house or a vacation home? Now is the time to redouble your efforts to save up for it. “Unless your new role contributes to an increase in living costs, you should be able to allocate at least 60% to 70% of your salary raise toward your savings goals,” Evans said.
Do it later: Consider your tax situation. In some countries, your tax rates will adjust automatically to a pay raise, but you should be mindful of any tax breaks you might lose if they’re income specific. In the US, for instance, “you might lose credits such as Earned Income or the Child Tax Credit,” Frederick said. “To a certain degree, this can be counteracted by increasing 401(k) contributions.”
Update your resume. Sure, you just got a great new job or a sweet promotion, but you never know when the next great opportunity will come knocking. So, make sure you put this accomplishment on your CV. “The best time to update your resume is not when you’re looking for a job, but instead as accomplishments actually happen,” Frederick said. “That way, you’ll be ready if any new opportunities become available.”
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