I’m getting a raise!

This year, my city council voted to give every city employee a 2.5% raise, effective July 1. They also adopted an education incentive program for our public safety employees. Every police officer and firefighter with a college degree (associate to doctorate) will get a bump in pay, based on the level of degree they have and their salary. My bachelor’s degree will get me an extra 3% of my salary on every paycheck. (Yes, I know all about the education vs. experience argument. I believe that neither is mutually exclusive, and that you need both to become a well-rounded public servant. I’m actually going back to school for another degree, but more about that later.)

My next paycheck will be 5.5% more than my last one! Awesome, except that I won’t actually see any of that money.

New truck? Motorcycle? Take a cruise? Nah…

I’ll be directing my new raise into my Roth 401(k) account. I can put up to $18,000 per year into a 401(k), and right now I don’t come anywhere close to that. We max out our Roth IRAs every year, but I still have work to do to max out my 401(k). With a Roth, I fund the account with after-tax money. I’ll never have to pay tax again on those contributions. I’ll also never be taxed on the earnings, which is a major motivator for owning Roths.

Sure I may deserve to treat myself to something new and shiny, but I don’t really need (or want) anything. We have a very comfortable life, and live well within our means. We can afford the things we need, and don’t have an extravagant lifestyle that requires frequent expensive purchases. Don’t get me wrong – I’m not advocating for depravity. I still buy things that are wants and not needs, just not very often. I’d rather have that money available to me in retirement, when my earning potential is much lower. I’d like to actually act retired in retirement, and not have to work to make ends meet.

Lifestyle Inflation

If you get a raise or promotion, direct that increase in your income into savings. By squirreling it away before its available for you to spend, you reduce the chance of blowing that money on a big purchase (or several, smaller purchases). If you don’t save it up front, you might find yourself increasing your food budget, taking more expensive vacations, driving a newer car, or eating out more often. Before you know it, you’ve gotten used to having that extra money come in, and you’ve also become accustomed to spending it. This is called lifestyle inflation. Once you are used to your new lifestyle, the chance that any of the money from your raise makes it into savings drops dramatically.

The best way to avoid lifestyle inflation is to automate your savings – have your HR people direct deposit your raise into your retirement or savings account. Even if you aren’t due for a raise, you can still deposit your year-end bonus, any money you get from a side job, gifts you receive, and your tax refund into a savings account. You never see the money, so you don’t miss it.

Other Ways to Use Your Raise

If you don’t want to make your newfound income inaccessible until retirement, there are several other ways you can put it to work for you instead of spending it away:

• Save for a home down payment
• Fund an education (either yours or your children’s)
• Build an emergency fund
• Pay off debt (credit cards, car loan, student loans)
• Prepay your mortgage

Of course, if you’re struggling to pay the bills of buy food, then using your raise to keep you head above water makes sense. Once your basic needs are met, see if you can challenge yourself to live on your current income and save your raise.

Good luck!