How to Manage Your Money After a Large Salary Increase

How to Manage Your Money After a Large Salary Increase

Got a big raise at work, and now you're worried about managing your money responsibly? Here's what to do.

Oct 19

How to Manage Your Money After a Large Salary Increase
Taxable

Taxable

High Yield Savings

High Yield Savings

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Real Estate

Do you have too much money? It’s a good problem to have. Yet it can be a problem nonetheless.

Receiving a large salary increase, especially when it's unexpected, could send you spinning. It’s the reason why 70% of lottery winners reportedly go bankrupt after a few years of YOLO living. 

When you don’t have a plan for your extra income or take time to prepare yourself for how unlocking that much more spending power is going to feel, it’s easy to come down with a bad case of the “why nots?” and treat everyone you know to bottomless mimosa brunches.

But before we stress you out and activate your internal wealth-blockers, remember it’s not all doom and gloom. You should definitely say “yes” to more money—it doesn’t have to equal more problems like Biggie said.

Let’s take a look at how you can tend to the basics and still make the most of your money.

Before you do anything: Calculate your real monthly boost

First things first: A $10,000 raise isn’t going to equal $10,000 cash in your pocket every year. Take into consideration your taxes and the possibility that your raise could bump you into a new tax bracket.

The IRS publishes inflation-adjusted tax brackets for the upcoming year around Q4. For tax year 2021, the top tax rate is a whopping 37% for individual single taxpayers with incomes greater than $523,600 ($628,300 for married couples filing jointly). 

Here are the other rates:

  •  35%, for incomes over $209,425 ($418,850 for married couples filing jointly)
  • 32% for incomes over $164,925 ($329,850 for married couples filing jointly)
  • 24% for incomes over $86,375 ($172,750 for married couples filing jointly)
  • 22% for incomes over $40,525 ($81,050 for married couples filing jointly)
  • 12% for incomes over $9,950 ($19,900 for married couples filing jointly)
  • 10% for incomes of single individuals with incomes of $9,950 or less ($19,900 for married couples filing jointly)

 

Even if you expect to get a tax return (you can also check that on the IRS website), withheld taxes will be taken out of your paycheck and cut into your monthly cash flow. For instance, if your raise takes you from a $150,000 salary to a $210,000 salary, plan on allocating 35% of your paycheck towards taxes when you create your new monthly budget. The exact amount may vary slightly, but at least by planning ahead you’ll be more than prepared.

Here’s what your monthly take-home pay might look like with a $210,000 salary:

Gross pay ($210,000 per year / 12 months) = $17,500 per month

Taxes ($17,500 x 0.35) = $6,125

Take-home pay ($17,500 - $6,125) = $11,375

It's worth noting that in reality, your taxes aren’t exactly this straightforward. Your money is actually taxed at the lower tax rates until each income threshold is crossed. The only percentage of your paycheck that will be taxed at the higher 35% rate is just the amount between $164,925 and your new salary. This is called a progressive tax system, and it’s how we’re taxed in the U.S. 

However, anticipating your taxes to the fullest extent accomplishes something important: It gives you a more conservative estimate of your monthly take-home pay, which means you probably won’t over-budget. If you end up bringing home more, have a plan for where you’ll put any surplus. 

We know. Realizing your monthly take-home pay won't increase as much as you thought after getting a big raise is kind of like a bummer. You can take advantage of pre-tax investments to recoup some of that money, but before we get to that, let’s make sure you cover the essentials.

Step one: Establish your priorities

To manage your money well, you have to know yourself well. And that means knowing where you’re putting your money and why.

“Establish priorities and goals before actually receiving that money or raise,”  says Nashville-based certified financial planner Jeanne Fisher.  “Then put safeguards in place to actually implement.”

Thinking ahead will give you the extra edge you need to have all systems a-go, so when the money starts flowing in, it’s as self-directed as a river. This step isn’t as critical for small influxes of cash, but it can make or break your success when you’re talking about getting a raise of several thousands of dollars or more.

 “Generally people handle small raises and promotions well,” says Fisher. “It’s the big pops that can quickly create bad decisions.”

To establish your priorities, ask yourself questions like:

  • Do I have debt to pay off? How fast do I want to pay it off?
  • Do I have enough in emergency savings?
  • Do I want to buy a house?
  • Am I saving enough for retirement?
  • Do I plan on having kids?
  • Do I need to buy a new car or make another major purchase?
  • Do I plan on taking time off from work in the next five years?
  • How much money do I need each month to live happily today? In five years? In ten years?
  • Is my money aligned with my values?

Step two: Cover the essentials

The window of time right after a big raise is a great opportunity to get ahead on debt and savings without it feeling like a sacrifice because you’re already used to your current lifestyle.

With an additional, say, $2,875 per month to use at your discretion, keep everything about your life the same for the first few months (though, maybe splurge on a celebratory dinner with your friends or your boo). During this time, put an extra $500, $1,000, or more towards debt payoff and/or emergency savings goals. That way, you can really spread your wings later and confidently make big life moves and handle the risk of the stock market or alternative investments one day.

In debt? List out your balances and how much they’re costing you in interest. Rank each balance from highest to lowest, or by highest APR to lowest APR. Pay off either the smallest balances first (the snowball method) or the highest-interest balances first (the avalanche method). 

“Go ahead and increase automatic debt payments,” says Fisher. “Or set up an automatic draft from your checking to savings account.”

If you have a 0% interest loan, such as a car loan or an intro period on your credit card, you can pay it off within the normal interest-free period. No rush to pay that down while you have the chance to use other people’s money for free—unless it’s driving you bonkers.

We know this phase isn’t the most fun, but remember: The benefit of taking care of the basics before you spend or invest that extra cash is that you will avoid getting stuck with way too much overhead from way-too-fast lifestyle upgrades. Don’t sign up to a bunch of new costs until your basics are covered first. As a general rule, you should aim to have at least six months’ worth of emergency savings put aside before you start living that YOLO lifestyle. Some experts even say it's worth having a years’ of expenses stashed in a savings account.

Step three: Max out tax-advantaged accounts

Next, you’ll want to look at maxing out tax-advantaged retirement accounts. There are two main opportunities here: maxing out your employee-sponsored 401(k) and opening a Roth IRA.

If you’re not already contributing the maximum to your 401(k), do so. Since 401(k) contributions are pre-tax, this will help keep a smaller percentage of your salary from being taxed at the higher tax bracket rate. It will also help you maximize the returns on your investments through compound interest over time. (Just remember you will have to pay taxes on the money you withdraw in retirement.)

The annual contribution maximums for 401(k)s in 2021 are $19,500 for most individuals, plus $6,500 in catch-up contributions allowed for people over age 50.

After maxing out your 401(k), you can also open a Roth IRA. With Roth accounts, the tax advantages are opposite—making them great choices for younger savers. You contribute after-tax dollars to your Roth IRA, and when you retire you won’t owe taxes on contributions or gains. This is great news if you expect to be rolling in dough in your 60s—pay taxes today while you’re at a lower tax bracket, and don’t worry about paying a higher rate when you’re a millionaire. 

The contribution limits for IRAs in 2021 are $6,000, or $7,000 for people over 50.

Step four: Save and invest for your goals

What you do with any extra money after steps two and three depends entirely on your own money goals. A good first step is to open a savings account that’s separate from your emergency fund to use just for the fun stuff, like planning trips, weddings, and birthday gifts.

For the longer-term goals, you can explore lots of options based on those priorities you set above. Do you want to buy a house in 5 years? Consider opening a brokerage account with an appropriate asset allocation for short-term investing, which might preference less volatile assets like bonds. 

Or maybe you don’t want to buy real estate, but still want to get in on the potential earnings. A lower-risk option for real estate commitment-phobes is to explore real estate investment trusts, or REITs. The platform Upside Avenue lets users access a diversified portfolio of multifamily real estate with a low-ish minimum investment of $2,000. REITs are arguably less of a hassle than buying and managing rental properties yourself, and many deliver returns between 10% and 20%.

upside-avenue

Upside Avenue

5.0

Real Estate

This is also a good time to do a gut check and decide if you’re willing to take on some risk for potentially larger returns. 

Planning on having kids? There are some surprisingly accessible alternatives to a 529 plan that can still help you pay for college tuition one day. With a self-directed IRA, you can invest in nearly any kind of alternative investment—including real estate, crypto, farmland, and art. Using a self-directed IRA to invest in commercial real estate investment platforms like CrowdStreet could get you a return of 9% to 24%. While this route is riskier than a 529 plan, achieving such returns would pay off.

crowdstreet

CrowdStreet

4.5

Real Estate

Truthfully, the opportunities are endless at this stage, assuming you’ve done the foundational work to save and pay off most of your debt ahead of time. You can even use this time to learn about sustainable investing trends and how to align your dollars with your values.

Bottom line

The true prize—beyond getting more money every month—is enjoying the sovereignty that comes from making your money work for you.

“You’ve worked hard for that promotion right?” asks Fisher. “You should get to enjoy it!” 

Lifestyle inflation, when sustainable, is perfectly normal and can be one of the best perks of adulting—but only if it comes with long-term planning.

“The issue is when lifestyle expenses actually inflate beyond growth in income,” says Fisher. If you follow these steps, that shouldn’t be an issue.

A backup to your backup?

Since you already paid taxes on your contributions, you can withdraw from a Roth IRA before age 59 ½ , so go ahead and use it as an extra layer of emergency savings.

But wait—you can’t withdraw everything from your Roth IRA before retirement age, can you? Are there limitations?

A backup to your backup?

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