With many companies experiencing strong profits and the S&P 500 gaining 31% in 2019 including dividends, many professionals, executives and senior-level managers are getting well-deserved raises in 2020.
But be careful. With each new pay raise, people tend to increase their lifestyle — they take on a bigger mortgage, buy a luxury car or install a large swimming pool in the backyard. Yet these expenses don’t have long-term financial benefits.
With the right planning, it’s possible to treat yourself within reason and still maximize your new financial opportunity.
When it comes to balancing spending and saving, I recommend always hitting your savings targets first, and then you are free to spend the rest with no guilt. For example, commit to saving 50% of your after-tax raise, allocating 25% to paying down debt, and 25% for fun! If you have a plan in place before the new money arrives, you are more likely to make good decisions.
To make the most of your new compensation, here are some easy steps you could take:
Contribute the Maximum Amount to Your 401(k), 403(b) or Other Retirement Plan
One of the best ways to save your big raise is to increase your pre-tax 401(k) contribution. To maximize this benefit, contribute up to $19,500 annually if you are under age 50 and $26,000 for those over age 50. (For more, read How Much Can You Contribute to a 401(k) for 2020? And How Much Can You Contribute to a 403(b) for 2020? ) If you weren’t already doing this, now is the time.
For people with access to a deferred compensation plan, you can defer an additional amount of your higher salary and bonus, saving even more in taxes. This tactic forces you to save — if you never see the extra cash in your checking account, you won’t start spending it.
Automate Other Key Accounts
Next, consider setting up an automatic monthly deposit into certain investment accounts, such as IRAs, college 529 plans and Health Savings Accounts (HSAs). This move will help accumulate wealth over a long period by saving regularly. A 30-year-old needs to save half as much money over a career compared to someone who starts saving when they are 40 years old, assuming similar market returns on their portfolios. (For more, see Health Savings Account Limits for 2020, How Much Can You Contribute to a Traditional IRA for 2020? and How Much Can You Contribute to a Roth IRA for 2020? )
Make Extra Monthly Principal Payments on your Mortgage, Credit Cards and Other Consumer Debt
One of my clients is doing just this. After earning her big promotion last year, she immediately took the extra income from her monthly paycheck and sent it directly to the mortgage company. As a result, she’ll be able to get out of debt at least five years sooner. For her, paying down debt was more important than spending that extra on lifestyle, and her annual savings was already in good shape.
Get More Insurance
There is one category where spending some of your new income makes financial sense — more insurance. A higher income means you need more life insurance to protect your family, and adding more disability insurance could be a wise move too. The higher your income, the more protection you may need if you suffer a serious illness or injury and can no longer work full-time.
Professionals and senior-level managers may also consider buying personal excess liability insurance. A new, higher profile job can increase the risk of a lawsuit; an excess liability policy can help protect your family’s assets should there be a future personal judgment against you.
Fill Out Those Forms
Finally, if you have received a new promotion on top of a pay increase, you may be eligible for new types of compensation and benefits plans, some which require a beneficiary designation (such as life insurance and retirement accounts). These new plans may have complex tax ramifications, so meet with your professional advisers to make sure you are making the right elections and filling out the beneficiary and tax forms correctly.
A promotion means more responsibility and longer hours. But make the most of your higher pay by focusing on your finances and increasing the returns on your money before time slips away.
Lisa Brown, CFP®, CIMA®, is author of "Girl Talk, Money Talk, The Smart Girl's Guide to Money After College” and “Girl Talk, Money Talk II, Financially Fit and Fabulous in Your 40s and 50s". She is the Practice Area Leader for corporate professionals and executives at wealth management firm CI Brightworth in Atlanta. Advising busy corporate executives on their finances for nearly 20 years has been her passion inside the office. Outside the office she's an avid runner, cyclist and supporter of charitable causes focused on homeless children and their families.