Why your pay raise isn’t as big as you think

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Why your pay raise isn’t as big as you think

You just got out of your first big performance review with a pay raise and you’re pretty excited about it. First off, congrats! You earned it. Second off, don’t make any rash decisions about what to do with that money.
We get it, honestly, we do–that $2,000 raise looks really big on paper. You might be thinking, "I can afford to move into a bigger place, I can afford that more expensive car, I can afford a personal nutcracker who shells my pistachios for me."
Unfortunately, after you’ve taken out the government’s cut, you’re left with a monthly take-home that’s a lot smaller than you initially thought.
To give you an idea of what a pay raise looks like in real, take-home dollars, we created this chart to show some sample numbers from someone currently making $40,000 per year. The average raise the last few years has hovered around 3%, so we included numbers ranging from 1% to 5%.
Pay Raise Table
We can accurately guess how much your raise will be taxed thanks to our country’s progressive tax rate. If you’re filing as single in 2015, any income above $37,451 will be taxed at 25%. Note that we don’t take into account state or city tax, additional federal taxes for Medicare or Social Security, or voluntary withholdings. You can run a more detailed calculation of your own tax liability here.
Compare that actual monthly take-home to the cost of a new car. The average new car payment in 2014 was $471 per month. A used car payment is slightly better, coming in at $352. If you’re making $40k per year, you’d need a raise of over 11% to pay for a used car without impacting your current budget.

What about rent? If you want to find a nicer place to live (or just an apartment closer to work), you may be looking at an increase of hundreds of dollars per month. With your average 3% raise, you’ll be lucky to pay your landlord’s new asking price (in Brooklyn, the average rent increased almost $100 last year).
So while a new car or new apartment might not be the best use of your new pay raise, you can still get a ton of value out of even a small pay bump. Here are a few ideas on how to get the best bang for your buck:
Pay off debt. If you’re just making minimum monthly payments on credit card debt, an auto loan, or student loan debt, you can use this pay raise as an opportunity to start seriously tackling your debt. Using something called the snowball method, you can use your disposable income to quickly pay down your debt until there’s nothing left. The best part about getting rid of your debt? No more monthly payments, effectively giving you a huge raise without going through HR. Check out our guide to the snowball method.
Build your emergency fund. If you don’t have an emergency fund already, this one is a no-brainer. Not to be a Debbie Downer, but expensive emergencies happen all the time. You might lose your job or your car might break down or something might go wrong in your house or apartment. With an emergency fund stashed away, you’ll have a financial buffer between you and all of these unfortunate events. Read our advice on how to build an emergency fund.
Invest in your retirement. If you’re not already maxing out your company’s 401(k) plan or contributing to your own retirement account, use this pay raise as chance to catch up on retirement saving. The earlier you start, the more you’ll be able to harness the power of compound interest. While it may seem like kind of a bummer to put a huge chunk of your paycheck into your retirement fund every month, your 65-year-old self will thank you. Check out our investing resources.
Review your insurance coverage. Do you have enough life insurance? Renter’s insurance? Long-term disability? Health insurance? A raise may be the perfect opportunity to review your current insurance coverage to see if there are any gaps in your coverage. Why is it so important that you’re covered? Same reason an emergency fund is important: insurance provides a crucial financial buffer between you and all of the terrible events that life can throw at you. Check out our Insurance Checkup to see if you’re adequately covered.

Image: William Warby