How to Handle a Pay Raise

Lifestyle creep can burn your boosted income right through your budget without even the slightest notice. Here’s how to handle a pay raise responsibly.

Adjust your budget

Adjust your budget soon after receiving a pay raise, but do it strategically. Before you start spending, take a close look at your budget to determine how the additional income fits into your financial circumstances. If you’ve been tight in some spending categories, you can now increase your allotted amount. If your budget has been working well for you, there’s no need to make changes just because you have a little more breathing room.

Pay off debt

If you have a lot of unsecured debt, you may be paying hundreds toward interest charges each month, and barely chipping away at your actual debt. Take the opportunity your pay raise has given you to kick that debt for good.

First, decide on a debt payoff plan. You can choose the avalanche method, which pays off the largest debt balance first and then moves on to the next largest and so forth. Or, you can go with the snowball method, which starts with the smallest balance, pays it off, and then moves on to the next smallest.

Whichever you choose, put part of your additional income toward maximizing payments on your chosen debt until you’ve paid it all.

Maximize your savings

Take some time to review your short- and long-term saving goals and your timelines for each one. Which are important for you to reach sooner than planned? Use your additional income to make it happen quicker! Or, set a new goal and allocate all the funds toward it.

Boost your emergency fund

Aim to have three to six months’ worth of expenses saved for emergencies. If your fund is lacking, use part of your raise to beef it up. If you don’t have an emergency fund, use your increased income to start building one now.

Increase your contributions to employer-sponsored benefits

With a higher salary, you may have room in your budget to take better advantage of workplace benefits. Options include:

• Retirement plans. Consider upping your contributions to a 401(k) or IRA. If your employer offers a match, take full advantage of it.
• Health Savings Accounts (HSAs). If you’re eligible, maxing out contributions can provide tax advantages and help with future medical expenses.

Tax implications to consider                                                                                                                                         

A higher income could place you in a new tax bracket, potentially increasing your tax liability. It’s a good idea to review your tax withholding to ensure you’re not caught off-guard during tax season.

Have fun!

It’s perfectly OK to set aside a small portion of your raise for discretionary spending. You’ve earned it! To stay financially responsible, though, remember your overall goals, plan and take strategic action before lifestyle creep takes hold.