After putting in the late hours and hard work, the day finally arrived: You earned that big promotion, new job title and pay raise. Congratulations!
You have joined the ranks of many others who have received raises. In the 12-month period ending in December 2020, employee average wages and salary ranges increased 2.8%(PDF, 500KB) — a rise of 2 percentage points from December 2019, according to the U.S. Bureau of Labor Statistics.
This accounts for cost-of-living and merit-based increases, but if you received a promotion with a new job title and responsibilities, chances are you might have earned even more than this.
When such an event occurs, the salary increase could potentially be life-changing. Before you start shopping for a new car or plan that much-needed vacation, take some time to review your new financial situation and how it will impact your life. This insight can allow you to maximize the value of the pay increase and establish a foundation for long-term financial security well into your retirement years.
Consider these nine smart financial steps to take after you earn a big promotion:
Step 1: Revisit your personal budget
After a salary increase, you should avoid the urge to start spending indiscriminately. Now is not the time to throw away your budget. In fact, revisiting your personal budget following a promotion can potentially provide ways for you to improve your spending habits and even increase your credit score.
For example, if the salary increase gives you a bigger financial cushion, think about setting up autopay for recurring bills. This helps you avoid late payments and keeps your credit on the right track.
Yes, with some extra income, you can increase your discretionary spending and indulge in some of the finer things you have had your eye on. However, beware of budget creep — where you continue to add expenses without first taking into account some of the other financial steps on this list.
Step 2: Eliminate any debt
With a new budget in place, you can use it to identify line items where you can apply the extra income to chip away at any debts, like credit card bills, student loans or car payments.
Focus first on any outstanding back taxes, since the government can garnish your new wages.
Then prioritize paying off any high-interest debt next. This will not only free up money once you pay it off, it will help you avoid costly interest payments on the debt down the road.
Low-interest obligations, like student loans, should not be forgotten, but you can worry about making larger principal payments on these once you have eliminated high-interest debts. When working down student loan debt, remember that even a small increase in monthly payments can help you pay off the loan faster and avoid off additional interest payments over the long term.
Step 3: Set aside additional emergency funds
While you might already have money stashed away for a rainy day, consider adding a little more to this amount. Maintaining a solid emergency fund can be one of the important savings tools to ensure your family’s financial security. From unexpected emergencies to the sudden loss of a job, having an emergency fund to help can be the difference between relief and disaster in one of these situations.
The general rule of thumb states that you should have enough money in your emergency fund to cover three to six months worth of expenses. Once you have received a raise and have adjusted your budget accordingly, you will notice that you might have more expenses now. If this is the case, it might require you to add to your emergency fund to ensure the amount will cover your newly updated expenses.
Step 4: Update long-term financial goals
Now that you will be taking home more money each year, consider setting new long-term financial goals. This can apply to retirement, financial independence or other aspirations.
For example, if you previously set a goal to retire by age 65, you might find that after crunching the numbers on your savings and investments, your promotion and pay increase will allow you to retire by 60.
Other examples include speeding up debts payments or using the extra income to fund a side business or hobby.
Check out some of the available online retirement calculators to find out what you need to set aside to raise the likelihood of early retirement or financial independence.
Step 5. Examine new tax obligations
If you received a promotion that comes with a significant salary increase, it might have additional tax-related implications.
An earnings hike does not necessarily mean you will end up paying more in taxes or lose money in the long term. However, it can be a good idea to check your deductions and new take-home amount.
You might discover a larger difference in your gross salary and your after-taxes income than you initially expected. For instance, if you received a $10,000 raise, this does not mean you will have an additional $10,000 to spend each year, as you will have to pay taxes on that.
Keep in mind that taxes work at a marginal rate, so you will only end up paying more taxes on income above certain thresholds. You may want to speak with your Human Resources and Payroll departments for more information. Also consider working with an accountant for at least the first year of taxes at your new pay scale.
Step 6: Increase your retirement savings
A higher pay grade provides the perfect opportunity to grow your retirement fund. Take this moment to review your monthly contributions to an Individual Retirement Account (IRA) or 401(k) accounts you have in place. If you do not yet have one set up, consider establishing an IRA with a trusted banking partner.
You may want to increase your contributions to the highest level you can afford, after taking into consideration your other monthly expenses. If possible, consider maxing out your contributions.
The Internal Revenue Service (IRS) sets the maximum IRA contribution levels, and this can vary from year to year. For 2021, 2020 and 2019, you can contribute up to $6,000 if you are under 50, and up to $7,000 if you are age 50 or older.
Step 7: Look into mortgage refinancing
There are a few good times when you should consider refinancing your mortgage, and following a big pay raise may be one of them.
By refinancing your mortgage and increasing your monthly principal payments, you can potentially shorten your loan term. This will let you save on interest and pay off your home sooner.
If you do opt to refinance your mortgage, be aware that this process typically requires conducting title search, obtaining an appraisal and paying application fees. This route might not be the best for those who have a high debt-to-income ratio, but if your budget has the room for higher monthly mortgage payments, this could be a good idea.
Step 8: Reward yourself
Once you have considered the financial steps listed above, the next step to take could be to reward yourself. After all, you worked hard enough for your employer to offer you a promotion — make sure you celebrate your efforts.
Consider taking a vacation or buying that special now-affordable item that has been sitting in an online shopping cart for a while now.
Rewarding yourself can also potentially come with additional benefits too. Your new salary might provide the extra money needed for a down payment on a second home or a rental unit. Purchases like these may serve as an opportunity to utilize the money in a way to potentially earn a long-term return on the investment. Ultimately, this option may help you grow your retirement fund too.
Step 9: Speak with a wealth management advisor
Even if your big promotion does not place you in the echelons of what you consider “wealthy,” it should not dissuade you from consulting with a wealth management advisor.
Wealth management advisors and financial planners work with people earning a wide range of salaries and income levels to help them achieve their aspirations and financial goals. They can provide a holistic planning-based approach to help you with investment strategies that may maximize your wealth at all stages of your life.
Want to learn more about the best financial steps to take after earning a big promotion? Comerica Bank can help. Reach out to us today.