Pay Yourself First: What to Do When You Receive a Raise

February 26, 2024  | By David Lowe

Many companies conduct performance reviews and announce employee pay raises toward the end of February or in March. As a smart, creative go-getter, you most likely have great news on the way!

But how do you put your higher pay to the best use? You may have experienced a scenario like this in the past: you get a healthy raise, continue with your busy life for the next few months and then find that you don’t “feel” any wealthier. Where did the extra money go?

We don’t want you to fall into that trap this year – especially after you worked so hard to earn a pay increase! Instead, now is a perfect time to implement a system to put your raise to work for you. That way, when bigger paychecks start rolling in, you already know where to put the extra dollars.

Here are a few key ways to build wealth (and have some fun, too) when you get a raise. 

Bump up your saving rate:

Step 1 is the concept of “paying yourself first.” Before any part of the raise goes to extra spending, commit to saving a bit more. Remember, the more you save now, the more flexibility you create for yourself later. Flexibility is rewarding, as it can mean early financial independence, the ability to work part-time or take a sabbatical, or opportunities for travel and other unique experiences.

Small steps over time can make a big difference. So, consider bumping up your savings rate by 1% each time you get a raise.

For example, if your salary was $200,000 and you had been saving $30,000 per year, that’s a 15% savings rate. Now imagine you get an 8% raise – to a salary of $216,000. If you bump up your annual savings to $34,560, that would be a 16% savings rate ($34,560 divided by $216,000). You’re already accustomed to living off the lower pay of $200,000. So, even if you plan to save about $4,500 additional dollars per year, you still have more than $11,000 extra to use as you wish.

Paying yourself first provides a painless way to save more. On the other hand, if you immediately start spending more and then try to bump up your savings, it will feel like a cut. Put another way: it will feel like being on a budget, which usually isn’t much fun! Make it easy on yourself instead by capturing the savings first and then planning how to use the remaining surplus.

Automation is one of the best ways to pay yourself first. Here are a few ways to save more without spending too much of your valuable time on your budget:

• Increase your 401(k) / 403(b) contribution rate by 1%. This applies if you are not already on pace to contribute the annual maximum of $23,000 (or $30,500 if you are 50 or older).
• If your payroll system lets you split your paycheck into multiple bank accounts, increase the amount that goes into your high-yield savings account.
• If you have scheduled automatic transfers from your checking account to your high-yield savings account, bump up the dollar amount of the recurring transfers.
• Increase the amount of your monthly or twice-a-month investment contributions. If you have investment accounts with Austin Wealth Management, contact support@austinwealthmgmt, and we’ll update the contribution amount for you. Plus, we like celebrating wins with you when you get raises!

Where should the extra savings go? The exact answer will depend on your specific financial plan and what you want to accomplish. However, here are a few good places for most people to save or invest:

• 401(k), 403(b) or other employer retirement account. Try to contribute the annual maximum, especially if you are looking for ways to reduce your taxes.
• Health Savings Account, if applicable. Remember, HSAs are tax-savings powerhouses!
• High-yield savings account. This is especially important if your emergency fund is a bit light, or if you’re saving for a big purchase.
• Brokerage account
• 529 accounts

Plan for taxes

Admittedly, accounting for taxes is not as fun as boosting your savings. However, it’s essential. A raise is a good time to review your tax withholding to see if you are setting aside enough for the IRS.

The IRS withholding calculator can be a good place to start, especially if you have owed significant taxes or gotten big refunds in the past. If your refund (or tax bill) has been fairly small and not much has changed in your financial life except for your raise, you may need only minor changes to your withholding.

The tax system is complex, though, so if you need help calculating the appropriate withholding rate, please contact your planner and/or financial advisor.

Increase charitable contributions (if desired)

This may not apply in all cases. However, if philanthropy is one of your key values, a pay increase offers a great opportunity to give more to causes you are passionate about.

If you tithe or otherwise calculate your charitable giving based on a percentage of income, a change in pay means it’s time to do some math. If you prefer to give a dollar amount instead of a percentage, you can decide whether to boost your contribution to a favorite charity, support an additional cause – or do both!

Adjust your budget

There’s no doubt about it: prices are rising. A pay increase can help you adjust your budget accordingly so it will be more realistic. That’s important, because we all are more likely to stick with a goal when it feels achievable.

Your mileage may vary, but for many families, we consistently hear that the biggest cost increases lately have been in food, entertainment and travel – especially airfare and lodging. Health care is another tough one, especially if you have young kids. With one or more little ones stealing your heart – and also picking up germs – expenses can add up faster than you expect. Your health costs also may have risen if you are trying to be proactive – think supplements, healthier food, personal training or finally scheduling a check-up. (Guilty as charged – but I did at least make a doctor’s appointment this month!)

Whatever your expense patterns, it’s a good idea to use some of a raise to add to the budget line items that have been toughest to meet. If your travel has seemed expensive, for example, don’t beat yourself up about it. Just add to the budget so your plan is more doable. If you followed the earlier steps, you already have boosted your savings. That means extra spending can be guilt-free.

Treat yourself

In fact, don’t feel bad about treating yourself. Once you have addressed your needs, it’s a great idea to allocate some of your raise toward rewarding yourself for your hard work.

Think of what motivates you – the ways you truly enjoy spending. Maybe that means planning for an extra spa day each month. Maybe it’s a little more in the tool and home improvement budget. Perhaps it’s an art class, a little more convenience in your life (pre-packaged healthy meal service, anyone?) or an extra date night. If you have children or a significant other, the “treat yourself” plan may include splurging a bit more on experiences with those you love. After all, they probably support you a lot in your work. Plus, you may be motivated, at least in part, to achieve in your career so you can provide a rich life for your family. It’s fun to share wins, so let a raise be an occasion for joy for the whole family.

Sample spending plan

Let’s pull it all together. Here’s an example of how a hypothetical W-2 employee could divvy up a pay increase.

• Before the raise
  • Salary: $200,000
  • Savings rate: 15% ($30,000)
  • Average tax rate (total tax bill divided by total income): 20%. This is just an example. Please work with your financial advisor and/or CPA for more precise calculations for your situation.

• After the raise
  • Salary: $216,000
  • Allocate the extra pay as follows:
    • $16,000 pay raise
    • -$4,500 extra savings / investing. This raises the savings rate to about 16%.
    • – $5,000 additional taxes. Again, this is just an example. Please check with your financial advisor and/or CPA.
    • – $3,500 of increases to budget line items. That could be $50-$100 per month extra for specific categories, such as food, travel, health care, etc.
    • – $3,000 to treat yourself. That means you can spend an extra $250 per month on things you enjoy. Or, set aside $250 per month until you’re ready to splurge on a big one-time expense.

We hope this is a helpful framework for putting a raise to work for you. Happy performance review season!