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Earning more money than usual through a raise, a new job, a bonus or some other incentive is one of those “problems” that many people would love to have. But a sudden increase in income can cause problems that can set you back financially.
From overspending to making the wrong investments, a sudden increase in income can take some adjusting. Financial experts share tips on how to do it in a way that will bring you financial success.
Want to save $100,000? Avoid these six costly mistakes.
Create or update your budget
It’s easy to overlook the basics of financial planning because you think you have everything under control. However, basic budgets are always essential for good financial health. Bill Ryze, a certified financial advisor at Fiona.com, recommends that you adjust your budget to account for your additional income.
“Set aside money for savings, investments and necessary expenses,” Ryze said. “I recommend using budgeting tools or apps to monitor spending and make sure you’re living within your means.”
Create or increase an emergency fund
You may be making more money now, but there’s no guarantee for the future. Ryze says now is the perfect time to build up your emergency fund or start one if you don’t already have one.
“You need to have at least three to six months of expenses available as an emergency fund. I suggest using some of your increased income to strengthen your emergency fund.”
Increase your savings rate
Another option, according to Abid Salahi, co-founder of Finly Wealth, is to increase the savings rate.
“This move takes advantage of the increase in income while maintaining financial discipline,” Salahi said. “I recommend putting at least 50% of the increase toward savings or investments. For example, if you get a $20,000 annual raise, you should try to save or invest at least $10,000 of that extra income.”
Pay off high-interest debt
If you have high-interest debt, such as credit cards or personal loans, that you’re having trouble paying off, an increase in income is a good time to pay off that debt.
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“I recommend methods like the avalanche or snowball system (paying off the lowest interest rates first) to pay off debt efficiently,” Ryze said.
Maximize your retirement savings contributions
An increase in income also offers the ideal opportunity to secure your future, said Ryze.
“You can increase your 401(k) contributions or other employer-sponsored retirement plans. One of the best ways is to contribute to an IRA or Roth IRA for additional retirement savings.”
Consider other tax-advantaged accounts
If you are eligible, Ryze recommends contributing to other tax-advantaged accounts as well, such as an HSA (Health Savings Account) for medical expenses or an FSA (Flexible Spending Account) for healthcare or dependent care expenses.
Invest in a diversified portfolio
If you are investing or planning to do so, remember the golden rule of investing that Ryze said: “Don’t put all your eggs in one basket.”
Salahi agreed, adding, “With a sudden increase in income, you have the opportunity to spread your investments across different asset classes. This not only helps with risk management, but also enables you to take advantage of growth in different market sectors. I have had clients who used their increase in income to invest in real estate investment trusts (REITs) or peer-to-peer lending platforms, which gave them new sources of income and accelerated their path to financial independence.”
Save for future goals
If you haven’t already, an increase in income can also give you an opportunity to save for the future, whether in the form of a 529 plan for your children’s education or for a home, car or vacation, Ryze said.
Review and adjust insurance coverage
Your health should also be your top priority, even if you’re young and healthy. This is a good time to invest in things like long-term care insurance, annuities and other insurance that will protect you in old age or if you have a medical crisis or generally secure your family’s future if you’re the breadwinner, Ryze says.
Continue your education and develop additional skills
An increase in income is great – but perhaps you can get an even bigger one by developing additional skills, both Ryze and Salahi said.
“One of the best returns on investment you can get is investing in yourself. Whether you take a course to improve your professional skills, hire a coach to improve your leadership skills, or start a side hustle, these investments in yourself can pay off for years to come,” Salahi explained.
He said he has seen clients turn a $5,000 investment in professional certification into a $30,000 annual income increase in just a few years.
Charitable purposes
If you’ve taken care of all your financial needs yourself, Ryze says, “Remember the saying, ‘Charity begins at home.’ You should consider setting aside a portion of your income for charitable giving. This can also give you tax benefits.”
Create a financial plan
In closing, Salahi stressed the importance of creating or updating a comprehensive financial plan. “A sudden increase in income is the perfect time to reassess your financial goals and create a plan to achieve them.”
“With a significant increase in income, you have the opportunity to reach your financial goals faster,” Salahi said.
Whether it’s retiring early, buying a home or starting a business, a well-crafted financial plan will help you align your newfound funds with your long-term goals, he said. “I’ve had clients use a sizable bonus as a catalyst to create a 10-year financial plan that put them on track to retire a decade earlier than they originally thought possible.”
Above all, if you avoid a creeping increase in your lifestyle and prioritize saving, investing and paying down debt, you may be able to reap the rewards of your increased income in the years to come.
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