You Got Your Dream Job – Now Make the Most of Your Dream Income

Did you recently start your new dream job? Are you making more income now than ever before? Before the income gets folded into your budget to cover the costs of daily living, take time to stop and think. What are your current expenses? Are you saving enough for retirement? Should you max out your 401k? How can you leverage this increase in income to secure a better future for yourself? It’s important to consider these questions and plan ahead for a financially sound future. Answering these questions can help you know what to do with your money when you get a raise.

Understanding Lifestyle Creep

One trap people can fall into as their income increases is lifestyle creep. Lifestyle creep occurs when an individual's standard of living improves as their discretionary income rises and former luxuries become new necessities. Consumers start to see nonessential items as a right rather than a choice. You can now afford to reward yourself by traveling more, eating at higher-end restaurants, buying a new luxury car, or having the latest and best new cell phone. As you grow accustomed to this lifestyle, you expect it to continue.

Unfortunately, lifestyle creep can be a considerable problem in times of rising inflation. The cost of essential and nonessential goods rise with inflation, requiring more from your budget. If you have already increased your expenses to meet your new income, it can be challenging to reduce expenses. This can also be a problem if you expect to receive the same bonus you received in the previous year. You build in a bonus to your budget, and then the company has a bad year or shuts down from a global pandemic. You will no longer receive your bonus, but you already factored it in. This can lead to higher credit card balances and even taking out loans to maintain your new lifestyle. In the long term, this could lead to you working longer to retire comfortably.

How to Fight Lifestyle Creep

Understanding your current expenses is one way to avoid lifestyle creep and this pattern. You can start by listing all your monthly recurring expenses to determine the amount needed to cover bills and obligations. After you know your essential expenses, the remaining income will be your disposable income, which is left to use at your discretion. To help control lifestyle creep, consider starting or increasing your monthly savings plan. This can be a complex process on a monthly or yearly basis, with unexpected expenses popping up throughout the year. That's why automated savings are important; they will be part of your budget, and you will not have to decide to add to your savings, which can be difficult for most of us.

To avoid lifestyle creep and get a handle on your finances, a financial advisor can help you work through your current finances and create a plan for your future. They can help ensure you make sound financial decisions with your newly increased income. Here are a few considerations of what to do with your increased income.

Establish An Emergency Fund

With extra income, you likely now have extra funds to make decisions about. Before saving in other accounts, you want to establish a cash reserve for basic living expenses, also known as an emergency fund. If your income is stable and secure and you are single, a 9-month emergency fund is an excellent place to start. If you are married and both are working with stable and secure income, a 6-month emergency fund is a reasonable foundation. There is also a behavioral component to how much to have in your emergency fund, as you want to be comfortable with your amount. If you want to save and hold onto more cash, holding onto 12 months of basic expenses is fine. In the past, holding onto cash receiving an interest rate of 0.01% while inflation was 5-6%, you were losing 5-6% of your money sitting in the bank. With current savings rates being more attractive, holding cash in the bank is more beneficial than in the past. Ensure that you receive an attractive interest rate if you hold onto extra cash. Any excess cash over the emergency fund amount you are comfortable with should be invested.

Build Your Retirement Funds

Now that you have an established emergency fund and are comfortable with the cash you have in the bank, should you save additional money for retirement funds through your employer? When investing in your employer retirement plan, an excellent place to start with your contributions is the company match. Most companies will offer a matching contribution, meaning they will match the employee's contributions up to a maximum, usually 3-5%. If you are not contributing the maximum matching contributions, increase your contributions to at least the matching contribution. That way, you are enjoying the match and not missing out on "free" money.

A financial advisor can be a great resource to help determine how much you should contribute through your employer retirement plan. They will review your income, help you decide when you want to retire, how much current savings you have, and the lifestyle you would like to live in retirement, along with other financial factors, to determine what percentage you should save to reach your goals. With your increase in income, it can be a great time to increase your retirement contributions. Going through this process and increasing your contributions before seeing your increased income can help you save. It will be much harder to change this later, especially if your increase in income has already been incorporated into your budget.

Set Your Future Financial Goals

Once you have established a cash reserve and started contributing to your employer's retirement plan, it's important to think about your future financial goals. Have you thought about helping your children pay for their education? Or do you dream of taking a once-in-a-lifetime vacation, moving to a bigger home, or relocating after retirement? A financial advisor can help you establish these goals and create a timeline to achieve them. They will also assist you in determining which goals to prioritize and the most effective way to fund them.

The financial planning process can also help you determine if a goal you previously thought was unreachable can now be funded with your increased income. Knowing your expenses are taken care of, and that you are also properly funding your retirement plans can give you peace of mind that funding other goals now will not be detrimental later in life. Those goals could be setting aside money for your children's education through a 529 plan or opening an investment account to save for a future house. This can be a great time to establish a plan and set automatic contributions to them so you do not have to think about what you would like to save.

As you move through life, your goals will inevitably change, so it is important to understand your financial position and make changes when needed. Going through your financial situation and goals can be a great exercise to do at least annually.

A Financial Advisor Works for You

Knowing how to make the most of a raise or bonus can be daunting. Do financial advisors add value when your income changes? Absolutely. An advisor who does comprehensive financial planning, reviewing all aspects of your financial plan can help illuminate opportunities and strengthen your finances today and for the future. They will review cash flow, insurance, tax, investment, retirement, and estate planning to ensure you are on the right track. As your financial advisor performs investment and retirement planning, your advisor will determine if you are taking on unnecessary or insufficient risk to reach your goals. They can also help determine how much to save for retirement funds and how much to save in nonretirement funds. That way, you have a good mix of assets when you retire and can continue to live the life you have grown accustomed to. Your financial advisors will also work with you for saving and planning for any shorter-term goals, such as buying a new home or helping your children through college. By working through the cash flow, you will establish your new income and current expenses. That will help determine if you are spending too much on nonessentials that could jeopardize your retirement.

Ensure You Include Insurance in Your Financial Planning

Insurance planning is also an essential part of your finances that can be overlooked. If you are the main provider in your household, it is crucial to consider what will happen in the event that you become unable to work or pass away. Will your family be taken care of? With the increased income, it is the ideal time to review your insurance and determine if you have enough protection.  

Structure Your Savings with Taxes in Mind

Tax planning can be critical with the increase in income. You may be in an entirely new tax bracket with your increase and need to review your withholding so that you do not have a tax bill at the end of the year. During the year, there may be ways to reduce your tax due, which is why it is important to talk through your increase in income not only with your financial advisor but also with a CPA.

Estate planning is often overlooked, especially by younger clients. Thinking about a disability or death can be very uncomfortable, and we tend to put it off. At this stage of financial planning, your financial advisor will provide tailored estate planning tips, and talk through important details like who you would like to take care of you and your finances if you were to become incapacitated. It will also establish where your money will go in the event of your death. Although it may be hard to think about, it is a crucial part of your financial plan. 

Having a professional to discuss your finances with is an invaluable resource. As you become established in your career and your income grows, it can be easy for anyone to have lifestyle creep and end up in the same financial position they were in before the raise. Meeting with a financial advisor when you get the raise can be beneficial. You will work with your advisor to determine how your new income changes your plans. They can help you save additional money and possibly start saving towards new goals too. You will gain peace of mind knowing that a professional is looking over your finances and that you are making the right decisions with your new increased income.

This article is meant to give a brief overview and does not constitute financial or tax planning advice. Consult with a financial planning or tax professional for more information.

Matt Jaspert, CFP® | Allegheny Financial Group | March 2024

Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.