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The Danger of Getting a Pay Increase

December 03, 2015 at 12:00 AM

As year-end approaches, I know that’s when plenty of you will be sitting down with your manager for a year-end review. I sure hope there’s a pay raise involved.

Given how stingy raises have been since the Great Recession, I want to make sure that you don’t blow it. Literally.

3 Steps to Making the Most of a Pay Raise

  1. Don’t spend a penny. I totally understand that given how hard you work, it’s only natural to start thinking about a splurge purchase when you get a raise. Yes, you deserve a splurge. But I happen to think you deserve even more: less worry about your finances. Please resist the temptation to spend your raise-especially around the holidays-and make it a bigger priority to use the extra cash to build your financial security.
  2. Immediately earmark at least half of the raise for your retirement savings. For example, if you receive a 4% raise, I want you to commit to immediately siphoning off half of that-2% of your salary-to increase what you are saving for retirement.

    If for some reason you aren’t already contributing enough to a workplace 401(k) to get the maximum employer match, that’s obviously where you want to do more retirement saving. But if you’re already contributing enough to get the maximum match, I think you should focus the next $5,500 of your annual retirement savings on a Roth IRA. (If you are at least 50 years old you are allowed to contribute an additional $1,000 each year, so in 2016 your maximum contribution is $6,500.) If you are already maxing out on the Roth IRA, then by all means increase your contribution rate to your workplace 401(k).

  3. Pay down credit card debt, ASAP. The average interest charged on credit cards these days is around 15%. (And if you’ve somehow triggered a penalty rate you can be paying nearly double that rate.) Paying off that debt is the equivalent of earning a 15% return. Just to be clear: that’s a seriously great return on your money.

  4. Boost your emergency savings. If you’ve yet to sock away at least eight months of living expenses in an emergency fund, increase the amount you’re having automatically sent to your savings account each month. 

If you have all those goals polished off then you have my permission to use the remainder of your raise on a well-earned splurge.

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