Remember when you were younger and thought your finances would be fixed when you could one day make more money? Do you also remember making more money at an older age and still saying the same thing? You are not alone. Here is how it works. We get pay raises and immediately think our financial problems will be forever vanished.........
But in reality, our pay raises usually only end up creating bigger financial problems. This is because if you don't have an action plan for how you will handle this increase in pay, it has been proven time and time again you will spend it on things that don't help your finances. You will spend that raise on things that immediately make you feel good. Besides, you deserve a treat for all your hard work!
We are not saying you shouldn't enjoy life or reward yourself for this pay raise. By all means, celebrate!! But you need to be careful spending without thinking about the consequences.
Here are a couple examples of how poor planning after a pay raise can actually get you in more trouble than if you never got the raise:
1. You get a $5,000 pay raise and immediately book a one-week trip to Hawaii for your family of four. The plane tickets and hotel cost you $4,000. Then food and entertainment costs you another $1,500, for a total trip cost of $5,500. You have overspent your raise by $500 right? Not so fast. In your excitement, you forgot the $5,000 pay raise is taxable income. So it really amounts to $3,500 after taxes which means the $5,000 pay raise ended up putting you $2,000 in debt! ($3,500 net income after taxes, minus $5,500 you spent on the trip)
2. You get a $10,000 pay raise. Suddenly your 5-year old car that was perfectly reliable last week, no longer works for you. With your new higher status, you must "look the part" and drive a nicer car. So you go out and buy a new $35,000 car. This move just cost you 3.5 years of that increased pay, right? Wrong! Remember, the $10,000 pay raise is more like $7,000 after taxes. So this new car purchase just ate up five years of your increased pay. Ouch!
So how do you make sure you aren't wishing five years down the line that you never got that pay raise today? Have a plan!
The next time you get a bump in pay, make it a rule that you will also bump your retirement contributions. Or decide in advance that you will use that pay increase to get rid of your debt.
The key is to have goals for your finances. Establish in advance what your next money moves will be for those windfalls of cash!
Contact us if you would like to inquire about our Personal Finance Coaching Program. We will help you establish an action plan for your finances to ensure you are accomplishing your goals!
What did you do with your last pay raise? Looking back, what would you do differently?