I’m a Financial Advisor: Here Are 7 Money Moves To Make If Your Income Rises Significantly
Having a serious boost to your income is cause for celebration — a rising income means greater stability and more opportunities to do the things you love.
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But it also comes with additional responsibility to ensure you’re making the most of your money and laying a solid foundation for future financial success.
GOBankingRates spoke with Tyler Weerden, financial planner and founder at Layered Financial, to discuss the top money moves you should make if your income rises significantly.
First, Understand Your Actual Net Pay After Taxes
“The first thing to do before making any changes to your savings, spending or investing is to get an accurate picture of what exactly the net effect of that additional income will look like,” Weerden said.
“Someone who gets a $50,000 raise expecting to see $1,923 more in their paycheck ($50,000/26 biweekly paychecks) is going to be terribly surprised when they see the actual net increase after taxes and other income-based deductions.”
He said that employees should expect their federal tax, state tax, percentage-based retirement contributions, Social Security tax and Medicare tax to all increase as their income increases.
“Taxes also have to be considered before making any moves,” he explained. “If the new income will push you into a higher tax bracket, are there other tax dominoes that will fall? Should you be making 401(k) contributions pretax (traditional) or post-tax (Roth)?”
He added that other financial effects of higher income include the taxation of Social Security benefits, Medicare Part B surcharges (IRMAA), the 3.8% net investment income tax, health insurance marketplace premium tax credits, income-based student loan repayment plans and other tax credits and deductions.
“Once you have a true understanding of your net cash flow increase and tax consequences, these are the steps to take.”
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Ensure You’re Getting the Employer Match in Your 401(k)
“This free money is the best guaranteed rate of return someone will ever get,” Weerden said.
“Let’s say a 30-year-old will work until age 60 and has a new salary of $150,000. We’ll assume they get a 1% raise each year and earn a 7% annualized return on their 401(k) investments over 30 years. If they contributed 5% of their salary and their employer matched 5%, the ending balance would be $1,624,870.
“Their personal contributions over 30 years were $260,886,” he explained.
“Without the employer match, using the same timeframe and return, they would end up with $812,435. This means a 5% employer match earned them an additional $812,435.”
Build Up Emergency Reserves
“According to a 2024 Bankrate survey, 44% of Americans say they cannot afford a $1,000 emergency expense,” Weerden highlighted.
Building a strong financial foundation with emergency reserves will benefit your mental and physical well-being, he noted.
“It’s hard to excel and grow as a person when you’re stressed about buying groceries or a car repair. Money might not buy happiness, but being financially secure can greatly reduce your stress and allow you to focus on the other parts of your life that bring you joy.
“How much emergency fund? Most financial gurus suggest 3-6 months, but your mileage may vary depending on job stability, cash flow, and unique family circumstances.”
Enjoy Some of the Money You’ve Earned
“Life’s decisions should not be reduced to a spreadsheet,” Weerden said. “Dying rich should not be prioritized over living a rich life.
“We can always make an argument for saving and investing, but not to the point of being a miser,” he explained. “With a significant increase in your income, don’t feel guilty about rewarding yourself for the work you put in to get that increase. Maybe you take a family vacation, maybe you buy those shoes you’ve been eyeing. Either way, big or small, do something for yourself.”
‘Lifestyle Creep’ Is a True Threat to Wealth Building
According to Weerden, as people make more money, they tend to spend more money, reducing the positive effects of their increased income.
“However, there’s a balance. If your income increases significantly and you experience lifestyle creep, you need to also have saving and investing creep.”
However, keep in mind that you don’t have too live completely frugally.
“You don’t need to live like a college student on rice and beans forever.”
Max Out a Roth IRA
“Originally called the ‘American Dream IRA’ when it was created by law in 1997, Roth IRAs are powerful tools,” Weerden said. “Investments in a Roth IRA grow tax-free and come out tax-free after age 59 ½.
“Why not max out a Roth 401(k) before a Roth IRA?” he continued. “Flexibility, fees and investment options. Contributions made to a Roth IRA can be withdrawn at any time without tax or penalty.”
While withdrawing contributions before retirement is not recommended, he added that in a true emergency where you have no other option, you can take money out of the Roth IRA without worrying about tax or penalty.
“This isn’t an absolute, but a Roth IRA held at a low-cost custodian like Vanguard, Fidelity, or Schwab will tend to have lower fees and more investment options than your employer’s Roth 401(k).” The 2024 contribution limit for Roth IRAs is $7,000 or $8,000 for those age 50 and older.”
Invest More If You Still Have Extra Cash Flow
After maxing out a Roth IRA, Weerden said investors should consider three investment options: (1) investing in a triple tax-advantaged health savings account (HSA), (2) contributing more to their 401(k) or (3) investing in a plain vanilla taxable brokerage account.
“All three of these options have different tax and investment pros and cons, but none of them would be considered a bad option. Unique family circumstances, goals and values, health status, tax status, investor knowledge, individual preferences, liquidity needs, and risk profile should all be examined first.”
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This article originally appeared on GOBankingRates.com: I’m a Financial Advisor: Here Are 7 Money Moves To Make If Your Income Rises Significantly
