Getting A Raise At Work: What Should You Do With The Money?

Getting a salary raise at work is usually a great thing, but it can be hard to know how to responsibly handle that extra cash. Should you invest it somewhere? Should you catch up on bills? Is now the time to make those purchases you’ve been eyeing for a while? Or is the right move to simply save the cash?

Let’s walk through a somewhat brief but detailed list of what to do when you get a raise so you can make the best decision for your personal finances.

Spending Your Extra Money (Wisely)

Some people who get a raise immediately begin contemplating how they can spend their additional income. While saving and investing can be great choices in some cases, spending part of your pay raise isn’t necessarily a bad idea. Just try to avoid the trap of “lifestyle creep,” where you end up spending your entire raise.

Consider the cost of living in your area when making any decisions about where to allocate your additional cash. By the time you factor in inflation, you might need the extra raise money just to keep up with the historically high cost of products such as groceries. Also, be aware that getting a pay increase might put you in a higher tax bracket. Before increasing your spending, make sure you’ve prepared for tax season.

Now, let’s take a closer look at some potential moves you can make with your salary increase.

Pay Off Debts

Paying off any existing debts you have is one of the best ways to spend your extra money. You could use your raise to pay off credit card debt, close out personal loans, increase payments on student loans or get your debt-to-income ratio (DTI) to a more manageable level (especially if you’re in the market for a new house).

If you already have a mortgage, adding even a small amount of money to your monthly payments can lead to a massive long-term savings. For example, if you have a 30-year mortgage of $150,000 at 6% interest and you increase your monthly payments by $100, you could pay that loan off several years earlier and save over $45,000 in interest.

Paying off a mortgage early is just one example of how a raise can be of great value, though. It’s often a good idea to focus first on any high-interest debt you have, so you can save more money in the long run.

Fund Your Own Business

Another possibility is using your new income to pursue your dreams. With the money you earn from a salary increase, consider putting it toward a side hustle or business you’ve always wanted to pursue. Items you may want to buy include:

•  A laptop for freelance work
• Materials for arts and crafts to sell online
• Cookware for homemade baked goods

Upgrade Your Personal Life

Improving your physical and mental health is also a worthwhile goal. Massage services, exercise equipment, therapy sessions, new bedding for better sleep, and maid services for keeping the house clean are all potentially excellent ways to spend your hard-earned cash. Your health affects the rest of your life, after all.

Some purchases that fall into this category – such as gym memberships – are ongoing expenses, so be sure to plan ahead and create a budget for that added monthly expense.

Saving Your Extra Money

Conventional wisdom says it’s better to save than spend extra money in your checking account – and this is true in many instances. One strategy for saving new income toward future gains is the 50/30/20 rule, which breaks down your savings like this:

• 50% of your income: Spend on necessities and living expenses such as food, shelter and utilities.
• 30% of your income: Spend on discretionary items such as entertainment and dining out.
• 20% of your income: Save or spend on debt repayment.

Ideally, you would factor your raise into your budgeting process, redo your percentages and adhere to the 50/30/20 rule. However, due to increases in costs of living, many people these days spend more than 50% of their income on necessities. With this in mind, the 70/20/10 rule might be a more realistic fit for your lifestyle. With the 70/20/10 rule, you’d budget 70% of your post-tax income on wants and needs, put 20% toward savings and investments, and use the remaining 10% to pay yourself – building your savings. The rule is just a starting point to base a budget off of – you don’t need to follow it to the letter if it doesn’t work for you.

Start Or Increase An Emergency Fund

Life is unpredictable. An emergency fund will help ensure you have cash on hand for unplanned expenses such as medical bills, car repairs or visits to the veterinarian for a sick pet. If you don’t have an emergency fund, you might want to set aside a portion of your raise for this type of safety net. If you already have an emergency fund, consider investing in a high-yield savings account once your fund hits $1,500. A high-yield account can be a terrific way to save for short-term expenses, such as a wedding or a home purchase, because the interest you’ll earn is higher than what’s typical for most accounts and there’s no penalty for taking your money out at any time.

An emergency fund can help you:

• Recover from job loss
• Avoid having to borrow from family members or friends
• Take on less debt with a credit card
• Decrease your stress and increase your peace of mind

Investing Your Extra Money

Many folks may want to take a work raise and invest it rather than spend it right away or stash it for a rainy day. Of course, long-term investment carries significant risks, so it’s always important to consult a financial planner before making any serious moves.

Secure Your Future With A Retirement Plan

A popular way of investing in yourself is by creating a retirement plan. Many options are available, from 401(k)s to pension plans to IRAs, and they offer different risks and opportunities. For instance, the type of retirement plan you decide on will determine how much (if any) your employer contributes to your retirement, and it’ll also dictate your annual contribution limit and when and how your retirement money is taxed.

The guiding rule is to build up a retirement savings of at least 25 times your estimated yearly expenses. For example, if you believe you’ll spend roughly $30,000 each year once retired, you’ll want to save at least $750,000 by the time you retire. Since estimating expenses can be tough, you may want to attempt to save around 10 times your salary by the time you reach retirement age, with a goal of saving at least $1 million toward your retirement goals if your financial situation allows.

Dip Into The Stock Market

Rather than a traditional retirement account, you could use your extra income to invest in other opportunities connected with the stock market. These could include:

• Education plans (for example, 529 plans)
• Brokerage accounts
• Index funds such as the S&P 500
• Socially responsible investment plans

When making decisions on when, where and how to invest your money, it’s important to remember the key components of good stock market investment strategies. The first component is evaluating your personal risk tolerance levels and letting that evaluation guide your choices. Also, diversify your portfolio by investing in a variety of asset types (stocks, bonds, real estate, etc.) and industries. This can help shield you from unnecessary risk and minimize your losses if the market takes a turn. Check with a financial advisor before investing to make sure you understand and are comfortable with the risks involved.

The Bottom Line: Make Smart Choices With Your Additional Income

What you do with a raise is a personal decision. After all, a pay increase is a testament to the hard work you’ve put in at your job. It’s best, however, to have a plan in place for any additional income you receive. Spending the money on your personal health, pursuing your dreams, building up savings for a rainy day, playing the stock market or preparing for retirement could all be the right choice for you, depending on your financial goals and circumstances.

Get help creating a budget, trimming expenses and setting up a financial plan for your future by downloading the Rocket Money℠ app today.