Getting a raise can make you feel on top of the world. You get to do the same job for more money. Who wouldn’t want that?
Still, it’s important to put your raise to work if you don’t want it to disappear. Lifestyle inflation can take over when you’re complacent, which is why you should create a plan for your newfound wealth.
Before you do anything, wait a few weeks to let your raise sink in. Ask yourself what you want out of life and how your excess funds can help you achieve it. From there, come up with a strategy to put your raise to work.
Here are some of the best options.
1. Boost your 401(k) contributions
If a wealthy retirement is at the top of your list of future goals, using your raise to boost your retirement contributions is a smart move. This is easy if you invest for retirement through an employer.
With a work-sponsored account like a 401(k), all you have to do is increase your retirement contributions in an amount commensurate with your raise. If you scored a 5% raise, for example, head to your workplace human resources department and ask about increasing your contribution this much. Your employer may ask you to fill out a new W-4 form to set your new contribution level.
This strategy is easy since it’s automatic and conducted via payroll. You may never see the money from your raise, but it will grow for the future thanks to compound interest.
2. Open an IRA
Another option to consider is opening an individual retirement account. You can open this type of account whether you have a workplace retirement account or not.
There are two main types of IRAs to choose from — the traditional IRA and the Roth IRA. In 2018, you can contribute up to $5,500 across both accounts (or $6,500 if you’re age 50 or older).
Money contributed to a traditional IRA can be tax-deductible if you meet certain income requirements. Once you contribute, your money grows tax-free until retirement.
With a Roth IRA, on the other hand, you contribute with after-tax dollars. However, your money grows tax-free and you can take tax-free distributions once you reach age 59 1/2. You can also take out your contributions to this type of account at any time without penalty, which is why some people use this account to save for college or other goals.
3. Pay down debt
Paying down debt is a smart move since it can help reduce interest costs and increase cash flow. Since the average credit card interest rate reached 17% in May, according to Bankrate, it’s easy to imagine how paying off high-interest debt like credit card bills could improve your finances.
While your raise won’t arrive in a lump sum, you can still use it to pay down debt faster. Add the amount of your raise to the monthly payments you make each month, starting at your highest-interest debts. You’ll pay down debt faster and reduce the interest you pay.
4. Build an emergency fund
If you don’t have an emergency fund, you’re setting yourself up for a world of hurt. After all, cars need repairs and roofs need replacement — and insurance doesn’t always cover your bills.
Most experts suggest you have three to six months of expenses saved in an emergency fund. This way, you’ll be okay if you lose your job, take a pay cut or face unexpected medical or home repair bills.
You can use a raise to start building your emergency fund. Open a new savings account designated for your emergency fund only, then set up regular contributions on payday or once per month. If it seems like you’re saving for no reason, think how grateful you’ll be next time a surprise expense pops up and you have the cash to cover it.
5. Set up targeted savings accounts
Investing and debt repayment are important, but what if you want to have some fun? Whether you set aside money for retirement or pay down debt, you can still allocate part of your raise toward something you want.
Whether it’s a family vacation, a new deck for your backyard or a new car, set up a targeted savings account and automatic contributions. Even if you can only contribute $20 of your raise each week toward the cause, the money you save will add up — especially if you put it in a high-interest savings account that earns a decent return.
A raise means you'll have to redraft your budget. Check out our simple budget template to get started.