What should you do with your money when you get a raise?

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With an annual inflation rate of 7.9% – the highest in nearly 40 years – employees are asking their employers for raises to cope with the rising cost of living, which has affected everything from prices gasoline at the races. A tight labor market and the Great Resignation caused nearly 47 million workers to leave their jobs in 2021; now, workers demand more from their employers, whether in the form of extra money and other desired benefits.

That said, the raises employers give their workers often don’t keep up with inflation. While a 2022 JobList survey found that 53% of employees had received a raise, it also showed that more than half (58%) of them had only received a raise of less than 5%.

While it can be exciting to be rewarded with a higher salary, it’s important to plan how you’ll allocate the extra money if you’re not spending it on higher living expenses.

Select spoke with Barbara Ginty CFP®, certified financial planner and host of the Future Rich podcast, about how people can figure out what to do with their money after getting a raise.

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You just got a raise. Now what?

What you choose to do with your raise depends on the financial goals you had before you received it. If you find yourself spending more money on your grocery bills or on a new car you just bought, the effects of inflation could end up wiping out your raise.

If your increase is greater than the effects of inflation, Ginty suggests clients split their increase, saving half for the future and using the other half for current needs and wants.

For example, if you receive an 8% raise, ensure that 4% of your paycheck is automatically allocated to your retirement account and keep the remaining 4% for day-to-day purchases.

Saving for retirement

If you haven’t already, be sure to contribute to your 401(k) and take advantage of your employer benefits. 401(k) correspondence. If you’ve already met the match, you can increase your 401(k) contributions or put more money into your Traditional IRA or Roth IRA, both of which offer unique tax benefits. With a Roth IRA, individuals pay taxes on their initial contributions; these contributions grow tax-free and can be withdrawn tax-free once you reach age 59.5. A Roth IRA is a good option for those planning to be in a higher tax bracket later in life, as they will pay no tax on withdrawals and gains.

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Pay off the debt

However, if you have debt (especially high-interest debt), you should pay it off first before focusing on investing in retirement, says Ginty, because debt often comes with investment costs. interest that can quickly add up.

There are several different methods for paying off debt, and two of the most popular are the snowball and avalanche methods. With the snowball method, people first focus on paying off the smallest amount of debt they have, working their way up to the larger amount. On the other hand, people using the avalanche method focus on paying off the debt with the highest APR first. While the snowball method will end up costing you more in the long run than the avalanche method, those motivated by small wins might still prefer it over the avalanche method.

Contribute to an emergency fund

And if you’ve paid off your debt but don’t have a fully funded emergency fund, consider setting one up that can cover three to six months of expenses. You can put your money in a high-yield savings account like Marcus from Goldman Sachs or Ally Online Savings Account.

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Avoid lifestyle creep

Ginty warns against people using their raises to dramatically increase their standard of living even when they cannot afford to do so. This is called lifestyle creep, where people find themselves slowly developing a more expensive lifestyle when they get a raise, and often a lifestyle that ‘they can’t reasonably afford.

For example, someone may find themselves upgraded to a one-bedroom apartment instead of a studio, even though the studio is more affordable and meets all of their needs. Or someone may choose a more expensive gym membership over the most economical option. Ginty suggests thinking about your true financial priorities and making sure the most expensive purchases fit into your new budget.

Conclusion

After you receive a raise, be sure to use it to achieve your financial goals, whether it’s covering more expensive monthly rent, contributing to an emergency fund, or maximizing your Roth IRA for the future. year. Regardless of your financial situation, you don’t want to use your new salary to fund a lifestyle you can’t afford.

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Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.

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