You’re Spending Your Pay Raise All Wrong – Here’s What You Need To Do

by Hank Coleman

Are you spending your pay raise all wrong?What should you do with a pay raise? I have a feeling that many of you are spending it without a second thought.

The other half of you are probably wondering, “What pay raise?”. I can understand. Many people have been operating on the same salary for quite a while. But, many of us have gotten a little bump in pay over the years.

In 2016, CNN estimates that American workers will receive a 3% pay increase in their paychecks. President Obama said that the US military would see a 1.3% increase in their paychecks this January.

So, what do you do with that money? Far too many of us simply do nothing. We treat it like the pay raise didn’t even exist. Many of us find ourselves simply spending more without even realizing it – granted it’s often on $50 or so each month, 

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A friend and I were talking after work one day, and she told me that she’s been living off the same paycheck figure that her employer paid her five years ago, despite having earned a promotion and a couple of pay raises since that time.

I’ve actually been doing the same thing. I simply pretended that my new promotion at work didn’t include a pay raise. Instead, I diverted that extra money each month into separate savings accounts automatically. I’ve been fooling myself into living off my lower salary from a few years ago.

So, what should you do with your next pay raise? Here are a few tactics for you to make the most of your pay raise.

Pay Off High Interest Rate Debt

One great thing that you can do with a pay raise is to pay off high interest rate debt or any debt for that matter. You can like that the annual percentage rate (APR) that you would have paid on your debt as your rate of return.

Who would not kill for a rate of return on your investments to be 18% or more? You have to think of paying off your debt as earning a return on your investment.

You’ve gone into debt. There is nothing that you can do about the past. You have to look towards the future. Paying off your debt is the same as investing in your future. You can look at using the debt snowball plan to help you come up with your plan of attack. 

Start Investing for Retirement

Another great use of for your pay raise is to start saving for your retirement. Or, if you’ve already begun saving, increase your retirement savings.

Any pay raise that you earn is “found money”. It’s money that wasn’t there before in your budget. It’s new money. If you allocate it to add to your retirement investments, you’ll never realize that the money is missing. 

You’ll never miss that money. You didn’t even realize it was there. Increase your automatic allotments to your 401k retirement plan or Roth IRA by the same amount you receive in a pay raise. Live off of your last year’s salary. Pretend like you never even got that raise. 

Far too many investors choose to reduce their Roth IRA contributions when times get tough. Time is the most important factor that young investors have going for them. You will never be able to get these years back that you have not been investing in the stock market. Now is the time to slowly work your way back into maximizing your Roth IRA contributions. Using your new pay raise is an excellent task for that new money.

Build Up Your Emergency Fund

We all know that we should have three to six months of living expenses saved in a fully funded emergency fund. But, for many Americans, that’s a lot of money to set aside.

Now is the time to pump up your emergency fund with your new pay raise. You should consider doing it now while you are still living off your old salary and won’t miss the new money as it is deposited atomically into the savings account or money market fund where you keep your emergency fund stashed.

For example, if you earn $60,000 per year, you would need to have approximately $10,000 to $20,000 set aside just for living expenses. If you wanted to continue with your current standard of living, you’d need to increase your emergency fund to $15,000 to $30,000 to cover your entire take home pay amount.

I know that I have struggled in the past with building up that much of a stockpile of cash in an emergency fund. You can add your new pay raise each month to your emergency fund as another way to help you build up to that level.

Almost every financial planner on the planet shouts from the rooftops that we should all have at least three to six months of living expenses saved in an emergency fund. But, far too many people have not been able to reach that mark.

Add Some Insurance That You Are Missing

Do you have enough life insurance to cover your family? Most people recognize the fact that we need life insurance to protect our loved ones who rely on our incomes to survive. But, do you have umbrella insurance in case you were to get sued? Do you have enough disability insurance?

Disability insurance is one of the most underinsured areas where American workers are prone to be severely lacking in coverage, and it is one of the most needed areas of insurance coverage. One out of three American workers can expect to be disabled and unable to work for a significant amount of time at some point during their careers. That is too big of a gamble not to have insurance in place.

Spend A Little Of Your Pay Raise

Finally, many experts recommend that you use a little bit of your new pay raise as well. You earned it. You should reward yourself. One thought or rule of thumb may be to spend a certain percentage of your new pay raise on yourself or on something that you truly want to buy or do and have been waiting. This isn’t a carte blanche to go further into debt.

But, there is nothing wrong with using 10% of a pay raise to go to the spa, take a long weekend vacation, celebrate with a nice dinner out on the town, or any other similar things.

The Danger of Lifestyle Creep 

There is a danger of lifestyle creep when you receive a small pay raise. If you earn $5,000 per month before taxes and earn a 3% pay raise, you’ll only see an additional $75 in each two-week paycheck.

When you start talking about such small amounts, it is very easy to simply roll that money into your spending without realizing it. Your new pay raise could very easily equate into an additional night out on the town, a movie, eating out at a restaurant, and other fun activities.

Before you know it, you will simply just have absorbed that pay raise into your life. That’s lifestyle creep.

Is lifestyle creep necessarily a bad thing? Should we not enjoy a few of the fruits of our labor? Splurging every once in a while isn’t a bad thing. The danger comes from simply looking the other way and not deliberately and thoughtfully putting our pay raises to good use. 

Now is the time to use your next pay raise to shore up your financial plan. If you have not been as diligent a saver or investor as you should have been, using a pay raise can be a great way to get you back up on the horse to a more consistent and better financial future.

A pay raise is like found money. You were living fine without it the month before. Using your new pay raise for an emergency fund, increase your investing, or shore up your insurance plan will allow you to do those things without sacrificing your current standard of living. Live off of your old paycheck and put your new pay raise to good use.

Are you receiving a pay raise this year? What do you plan to do with it?

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About Hank Coleman

Hank Coleman is the founder of Money Q&A, an Iraq combat veteran, a Dr. Pepper addict, and a self-proclaimed investing junkie. He has written extensively for many nationally known financial websites and publications. Hank holds a Master’s Degree in Finance and a graduate certificate in personal financial planning. Email him directly at Hank[at]MoneyQandA.com.


Hank Coleman has written 575 articles on Money Q&A. Learn more about Money Q&A on Twitter @MoneyQandA and @HankColeman.


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{ 3 comments… read them below or add one }

The DeLeon

For all pay raises I immediately setup a transfer for 80-90% of that pay raise into my brokerage account to save for the future. This is obviously after being free of his cost debt. The other 10-20% I enjoy life with. Yes it may be small but over the year it will be something and allows me to reward the hard work. I’m not saying you have to spend it but worse case it’s at least budgeted and with an auto transfer, what we don’t see we don’t spend.

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Hank Coleman

You definitely make a great point! You definitely should splurge a little bit with any raise. 10% is a great figure to spend as you wish on something to reward yourself after working so hard.

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Simon @ CafeCredit

You’d have to be crazy to always waste a pay raise (or bonus, etc) on frivolous stuff… almost every time I come into extra money, I always look for ways to invest it or make it work for me. Of course I have fun sometimes, but you shouldn’t make that your priority and do it all the time.

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