Why Pay Raises Hurt You — 4 Keys to Avoid the Pain
Pay raises. They’re a good thing right? You’ve worked hard enough and smart enough in your chosen career to get some tangible recognition for a job well-done. Now you can see that recognition in your check at the end of every pay period. You’ve gained a little more job security. You’ve proved your worth to the company.
So all around good things right? Well, while pay raises are great and they certainly represent a career milestone that’s definitely worth celebrating, countless Americans suffer from pay craise every year.
Pay craise is that feeling you probably get right after you find out the good news. Just like the cartoons you watched as a kid, dollar signs pop up in your eyes as you start imagining what the pay raise could offer — a car, a bigger house, a trip, or even just a little more wiggle room at the end of the month!
Sound familiar? It’s the same story for many Americans. Some people call it lifestyle inflation, we like to call it Pay Craise.
While there are many different names for it, the definition is the same: adjusting your lifestyle as your income increases. Most people don’t live their entire lives on the same salary. You get experience, get a new job, or a promotion, all of which come with a better salary.
The desire to spend that extra money is a huge temptation and many people fall prey to it. Whether it’s a desire to reward yourself for working hard, or a “keeping up with the Joneses” mentality, it’s easy to overlook — or ignore — how this can hurt you down the road. So we have come up with four ways an unchecked pay raise can hurt you.
1. A pay raise can keep you in debt
Many people see a raise as an opportunity to improve their lifestyle. They’ve worked hard for their money, and they should reward themselves. The problem with this mentality is that it keeps you in debt. The new car, new phone, new clothes, or whatever vice you have, feels good in the moment. However, it shackles your future.
Remember, debt is money you earn tomorrow that you spend today. Every dollar in debt you have today is a dollar that you can’t save for tomorrow. You’re just spending money you haven’t earned yet.
According to the Federal Reserve, the average US household carries about $137K in debt, but only makes about $59K/yr. This is because a lot of American households fall in to the Pay Raise trap, and live above their means.
Rather than using the extra income to pay for more debt, you can set yourself up for a better financial future by using that extra income to reduce your debt load.
2. Extra debt increases your financial risk
A study from Rutgers University indicated, one-fifth of the American workforce had been laid off since the financial crisis. You may have been a part of that unfortunate 22%, many of whom have since struggled with financial stability. The moment those workers were laid off, they lost the ability to pay their existing financial obligations. That’s homes lost, cars repossessed, and retirements destroyed.
The point being, we should plan on being jobless at least once in our careers, through no fault of our own. Carrying extra debt makes it harder to weather unforeseen joblessness or drops in income. Anyone would be served well by exercising some contentment, even if its for a short while after a pay raise.
Conversely, there are times when you might find yourself needing to borrow money for some unforeseen expense. Medical procedures, natural disasters, and other situations often place individuals in a place where they have to borrow money. Maxing out the amount of debt you can carry today (also called being over-leveraged), means that it will be harder to borrow money in the future, when you really need it.
3. Extra debt shifts interest earnings
Money borrowed means interest paid to someone else. This could be money saved and invested with interest paid to you. If you have an increase in income, find a portion of it to set aside for yourself first, before you begin looking at other discretionary spending. Just remember: You are more important so pay yourself first.
For example, a $1.50/hr. pay raise is an increase of $3,120 per year, assuming you work full time hours. If you use that extra income for a Pay Craise purchase, like a new car, that money effectively disappears through interest payments and depreciation. It will be worth $0 in 30 years.
However, if you pay yourself first, and invest the extra $3,120 you made that year, assuming an 8% average annual return, that pay raise will be worth $32,790 in 30 years. Again, that’s just foregoing the raise for one year and spending the rest forever more. That’s a huge difference in money set aside for retirement just waiting twelve months.
4. A pay raise can cause a tax crunch
I’ve seen way too many people learn this one the hard way. More income means a higher tax bracket. If your withholding’s aren’t adjusted properly, then you could be stuck with a hefty tax bill at the end of the year.
The IRS doesn’t often offer much wiggle room with tax bills. If you can’t make up the difference by April 15, you’ll be hit with fines and interest, taking even more of your hard earned money from you.
For 30 years I’ve been fortunate to have had money set aside for this so my annual meeting with the taxman ended okay. Had we adjusted our lifestyle with every pay raise, we would have been forced into a payment plan that would have drained our monthly income even further, and left us paying even more than we owed through fines, fees, and interest.
CONCLUSION
As a Christian, there is one thing I know is promised. That is, I will face trials and tribulations — and that I don’t know what’s coming next. God is there to help provide us all strength in our trials, but we were given free will. We can make future financial trials a little easier by taking some time to plan ahead, and not falling for the Pay Craise trap.
A great place to start exercising smart free will is budgeting. I wrote a blog not long ago titled: 10 Ways to Keep a Better Budget that can give you some good pointers and make it fun. If you are just getting started or want to keep a better budget you will definitely want to check it out HERE. There are many places to find the right tools for budgeting. Just make sure the tool you choose:
• Features easy-to-input budget items by date and frequency
• Enables you to account for interest earned on a bank account
• Permits you to account for a percentage of your giving
• Allows you to enter your income and expenses easily
• Can give you reports
Then decide which is best for your family and stick to it. If you don’t know where to start, you can find a FREE budget tool here that meets those criteria.
Getting a raise is awesome, but resisting the temptation to adjust your lifestyle with that raise is often difficult. We’re here to help provide you with the tools you need to make smart decisions about how to manage your money and secure financial freedom for yourself. It’s always worth it in the end.
How are you exercising your free will? What else can we all do to prevent falling into a Pay Craise?
No one knows your money better than “U”!
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