Everyone loves a raise—and who can blame us? Every little bit of extra income makes life that much easier. That's probably why a recent ABC News survey shows that advice on how to get a raise is more important to most Americans than advice on reducing spending or increasing savings. A pay raise is the answer to both of those problems, right?
Most working Americans can expect a 3% bump in pay this year, the same average increase workers received last year and the year before that. On a $45,000 annual income, a 3% raise works out to $1,350, or $112.50 per month.
While it may not sound like all that much, it is extra money. What really matters is how you put it to use. Folks in the ABC survey had 20 spending options to choose from, and we placed their top choices into a few categories: Not a Terrible Idea, Huge Mistake and Great Idea. Do you agree with our reasoning, or are there better ways to use a raise this year?
Vacation: Not a Terrible Idea
The most popular way to spend a raise, according to the ABC survey, is on travel and vacations. While we're all for vacations when the bills are paid and you don't have any debt hanging over your head, maybe a getaway shouldn't be your top priority as you decide how to spend your raise.
Take Rick and Carla, for example. They're each making close to $45,000, so they're expecting the average raise—$110 or so per month for each of them. But there's some bad news. That $110 increase is based on their gross pay. Their actual take‑home pay increase will be less—a lot less depending on the state they live in and their tax filing status. Since Rick and Carla live in a state with no income tax, their raises work out to about $80 a month each, making their $2,640 income boost look more like $1,920.
The average vacation costs right at $1,000 per person, so Rick and Carla could cover a quick escape for two without putting a dent in their budget. To truly enjoy their vacation, however, Rick and Carla need to make sure all their financial bases are covered and they aren't using bill money, debt‑snowball money or emergency savings to pay for their holiday.
Stay Afloat: Huge Mistake
Darlene can't wait to get her raise. She's been struggling to make ends meet for several months. She's making a good income, so she can't figure out how she's gotten behind. But she's sure this raise is the answer she's been looking for.
Darlene's plan to use her raise to catch up on her bills and cover other household expenses is the second most popular way to spend a raise. While this seems responsible, Darlene should be looking forward and using her raise to get ahead financially, not to stay afloat.
Her problem isn't income—it's budgeting. Darlene needs to get a handle on her spending by creating a budget where she decides how to spend each dollar she makes before it hits her bank account. With her everyday expenses covered by the income she already has, she can use her raise to pay off her debt.
Pay Off Debt: Great Idea
At least some of the people in the survey will use their extra income to pay off debt. If Darlene gets her spending under control and applies her $80 per month take‑home pay increase to her minimum payment on her $15,000 credit card debt, she'll be debt‑free in a little more than two years and save more than $4,000 in interest!
Retirement: Great Idea
When it comes to retirement, your raise can do even greater things. For the last few years, Margaret has been contributing just 3% of her pay, $112, to her 401(k). Her take‑home pay is $3,099 per month.
When she gets her raise, she could choose to bump up her take‑home pay by $84 per month, or she could put her entire raise to work in her 401(k). If she increases her contribution by the amount of her raise, her take-home pay would drop by just $7, but her 401(k) contribution would jump to $231. That's $116 more for retirement for just $7!
That's because 401(k) contributions are pre‑tax. By contributing more to her retirement account, Margaret lowers her taxable income and puts the full power of her raise to work building her nest egg.
And what a difference it will make! Over 30 years, that monthly $116 could boost her retirement savings by more than $250,000—even more if her employer matches all or part of her increased contribution!
Margaret plans to talk to her financial advisor to see if her 401(k) is the best place to use her raise to build up her retirement fund. She could also open a Roth IRA to build up her savings outside her workplace plan. While she won't get the same initial tax benefits with a Roth IRA as she could with her 401(k), her Roth investments will grow tax‑free and she'll be able to use her savings tax‑free when she retires.
What about you? What are you looking forward to doing with your raise this year?