Congratulations! You’ve just received a pay raise. What are you going to do with it? “Don’t spend your raise.” That’s easy for folks to say when they’re already earning big bucks. But for young adults, it’s mighty tempting to want to splurge on your new pay.
Whether you’re blessed with a bonus or raise, the important thing to remember is you need to spend that money wisely. For young adults, getting a first bonus or raise is a cause for celebration.
Many young workers might immediately feel inclined to splurge. An increase in pay might spur you to look up vacation hotspots or to shop online for the latest gadgets. A survey by the job-searching website Monster found that most workers would splurge on a new car if they got a big salary bump, followed by a new wardrobe and home entertainment technology. It’s not surprising to hear that these aren’t really wise ways to spend a new raise. So, what are the best ways to spend a raise?
Before you start swiping your debit card, you need to understand that a raise in pay might not end up as big as you thought. Here’s what you know about your promotion and the best ways to spend a raise.
It will raise your taxes
Unless your raise is large enough to push you to a new tax bracket (in which case, we say congratulations!), your tax rate won’t go up. But your taxes will. When your pay increases, the taxes you pay do too. You can try to reduce your taxes by contributing more to your retirement (because you are saving for retirement, right?), opening a flexible spending account, or contributing to charity.
Once you realize that more taxes will be taken out of your paycheck and you divide the amount that’s left over 26 pay periods, you might be surprised to find out that there’s not much more left. In fact, a survey by the human resources consulting firm Mercer found that the average rise in base pay in 2014 would be just 2.9 percent. Performance-based increases, though, are typically more generous with a high of 5 percent awarded to a company’s top performer.
It will increase your retirement contribution
Besides raising your taxes, if you are contributing to a retirement plan (and you should be) a pay raise will also lead to an increase in your contributions. Work retirement plans are typically set up so that your contribution is taken as a percentage of your salary. If your salary increases to $50,000 and you chose to contribute 5 percent to your 401(k) plan, your contributions will add up to $2,500 per year. Increasing your retirement contribution is one way that you can really stretch your money.
Strategies and the best ways to spend a raise
The best thing you can do with your raise is to strategize how to spend it — and let it grow. Some experts say you should not spend any part of your raise at all, pretending instead that you didn’t even get a raise. Others say you should aim to spend just 50 percent of it and save the rest.
Truthfully, there’s no foolproof strategy to spending a raise. It’s unrealistic to think that you won’t spend at least part of your well-deserved pay increase on something for yourself. So yes, you can spend a small portion of it on something that you would like. Keywords: small portion. With the extra pay you are bringing in each week, the key to using it wisely is finding ways to let it grow.
What are your goals?
This is where smart strategies come into the picture. Do you have financial goals in mind? Would you like to retire early, buy a condo, or start a business? These are worthwhile goals that you can achieve if you save and invest your money wisely. Clearly, you won’t be able to achieve these goals overnight. But because you’re young and time is on your side, the money moves you make now will pay off tenfold down the road.
Pay off debt
There are many ways that you can use your pay raise to help your money grow. We’ve already mentioned contributing more to your retirement, but do you have a ton of credit card debt? Using your raise to pay that debt down will help your money grow in the long run because you will be able to get rid of the interest you’re paying on that debt, which is currently hurting your ability to save even more income. You might consider paying off a credit card that charges 17.99 percent interest equal to earning that amount on an investment.
Build an emergency fund
Do you have an emergency fund? If you don’t have adequate money saved in your fund, you can use some of your pay raise to beef it up. Where’s the growth potential in that? If you avoid paying for an emergency by taking out a loan or using your credit card, that’s money — and interest — you won’t have to pay back. And it’s a lot easier to save money with a bonus than it is to save money by cutting back.
If you don’t have major debt or a need to save money for an emergency fund, consider investing in yourself. Would a professional certificate or workshop help increase your long-term earnings potential? You might consider using your pay raise to invest in your education.
One other way you can help your pay raise grow is by investing it. Have you considered opening a Roth IRA or money market account? Because you’re young and likely inexperienced at investing, you might prefer to just park your money into a savings account.
Saving your money in a high interest savings account will help you earn more money over time. An online savings account offers even higher savings rates, so you might consider parking your money there. If it’s too tempting to spend your money, you might reduce your accessibility to it by direct depositing it into your savings account. Check out the best savings rates in the table below:
The salary outlook for young employees
A recent survey of 1,064 companies by the human resources services firm Aon Hewitt found that firms are spending a record amount of their payroll, 12.7 percent, on variable pay. Variable pay includes bonuses paid when employees meet certain goals.
That’s good news for young workers, whose chances for receiving a bonus are greater now than in years past. The record spending on performance-based bonuses signals a shift away from long-term salary increases. That means today’s workers might not receive huge salary increases throughout their careers — both good and bad news for working young adults. Good news because it means today’s young workers might be able to receive a merit increase based on their hard work rather than the years they put in at a job. Bad news because it means today’s workers might not receive an expected increase in pay over time.
Understandably, these aren’t the sexiest ways you can spend your pay raise, but wouldn’t you rather see your pay raise grow rather than spending it all on a fleeting item or experience? Plus, you can still spend a small portion of it on yourself.
While getting a raise is indeed reason to celebrate, you must invest the money wisely so that you can experience real growth with it. And remember, once you get a raise, you need to continue to show your boss that you deserve it. Continuing to work hard will help you move up at your company and will allow you to achieve the financial independence you crave.