Congratulations! All that hard work and determination have paid off in the form of a promotion and raise. It’s time to celebrate, right?

While it is important to reward yourself and appreciate the moment, much of the “hard work” is in front of you. A promotion tends to bring with it new responsibilities, as does having additional disposable income. As tempting as it may be to spend this money on lavish vacations or new toys, remember that the decisions you make today help pave the way for your future.

Having a financial plan will help give you the discipline to improve your situation in both the short and long term. It can also result in the form of entirely new goals that were not even on your radar. Here are some smart money moves to consider for your promotion or raise.

Take-Home Pay

The first step involves calculating your new take-home pay. It is essential to know exactly how much more your net paycheck will be after taxes and other deductions.

The good news is it’s fairly easy to figure out. Compare a new pay stub to one before your raise and calculate the difference. It would also be advisable to review your household budget to see if you need to make any alterations. This will provide you with a baseline to work from and help tackle the items below.

A significant pay increase could trigger tax issues you need to be aware of:

It may push a portion of your income into a higher tax bracket.
It could require an adjustment in tax withholdings or the need for quarterly estimates.
It may impact your ability to deduct certain items that you were able to in the past.

The upside is that with additional cash flow, there are strategies that you can implement to help limit the overall net tax impact.

Cash Reserve

When it comes to personal finance, a cash reserve is the foundation of any successful financial plan. While not flashy, a cash reserve and emergency fund are a must. A good rule of thumb is to have at least three to six months of living expenses, but your number can vary depending upon factors such as job security or a new baby.

If 2020 has taught us anything, it is to expect the unexpected. Having a large enough reserve can help avoid several pitfalls that you might otherwise fall prey to. A cash reserve can help you:

Avoid taking on additional high-interest debt, typically in the form of credit cards
Keep you invested during bouts of market volatility since you know you have a solid buffer
Make you more confident in systematically increasing saving toward your goals

Cash reserves should be saved in a liquid money market or high-yield savings account. While maintaining a cash reserve is vital, having too much in a bank account can negatively affect opportunity cost. With the average money market yielding a paltry .07%, you could allocate a portion to a low-risk bond portfolio in an attempt to earn a few percentage points. However, in the end, the purpose of your reserve is to protect against “what if” scenarios, and a solid reserve will help you sleep better at night!

Debt

Identifying the types of debt you are carrying is of utmost importance. Typically, the order of priority for paying down loans starts with the highest-interest-rate debt (though there is a strong argument that the “snowball method” of paying down debt also works well from a psychological perspective).

Getting a handle on your debt can help drastically improve your credit score. Some common forms include:

Credit card debt
Mortgages
Student loans
Auto loans
Medical bills
Personal loans

It should be pointed out that not all debts are created equal. The average credit card APR is ~15%, compared with the average 30-year, fixed-rate mortgage at ~3%, which puts the emphasis on paying down debts with higher interest rates first.

You might feel that you should focus on paying down debt prior to saving and investing. While paying down debt is never a bad thing, it can actually be an inefficient use of funds. Let’s take a look at an example:

Brian wants to buy a $30,000 car. He is debating whether he should purchase it with cash or finance it at 1.5% over five years and invest the $30,000.
- Finance: Brian would pay ~$1,172 of interest over the life of the loan.
- Invest: Brian invests the $30,000 in a moderate-risk portfolio and earns a 4% annualized return. At the end of year five, the $30,000 would have earned ~$6,629 (before taxes).

When illustrated as such, the choice seems obvious, right? The issue is that for this to work, Brian must have the discipline to keep this money invested and avoid selling during periods of market volatility, which are likely over five years. Also, while a 4% annualized return is a realistic assumption, it is not guaranteed.

Our Bethesda, MD fiduciary financial planning firm regularly crunches the numbers to help clients determine whether paying down debt or saving/investing is the better option. If you have concerns about which option is best for you, consider talking with a fee-only, fiduciary financial advisor who will look at your overall financial situation and goals.

Life Insurance

While the benefits of promotion are evident, an often-overlooked area is the role of life insurance. When you gain a higher level of income, a sudden permanent interruption can put your family at financial risk.

If you don’t have life insurance, now would be the time to look into obtaining coverage. If you do have it, it’s advisable to reassess your current coverage to see if it is adequate.

Generally speaking, the younger you are, the more favorable the premium. Determining how much insurance you need is based on many factors and needs to be carefully reviewed on a case-by-case basis.

Life insurance proceeds are generally tax-free and can be used to pay off debt, replenish cash reserves, and cover short-term needs while still investing a portion for the long term.

Investing

Now comes the fun part—investing your hard-earned dollars. Additional disposable income allows you to not only boost your investment savings but also take advantage of other investment vehicles. The most common types of investment vehicles are:

Retirement: Employer-sponsored plans [e.g., 401(k)], IRAs, and Roth IRAs
Education: 529 plans or Coverdell IRA
Health/medical: Health savings accounts (HSAs) or flexible savings accounts (FSAs)
Other: Taxable accounts, employee stock purchase plans, options, and non-qualified deferred compensation plan (to name a few)

Each vehicle has its pros and cons and should not be viewed as a “one size fits all” approach. It is worth noting that some of these vehicles may not be available to you, and some have income and contribution limits.

Working with a fee-only, fiduciary financial advisor can help identify which investment vehicles are best suited for you. Investing is one of the best ways to increase your net worth while creating passive income over the long run. The one caveat is, the sooner you start, the better!

Download the Checklist

We have a checklist to help you consider your issues and options after a promotion or raise. You may find that working through it uncovers concerns or opportunities that you would not have considered otherwise.

You might also find that you want to work with a financial advisor who integrates all the financial areas of your life into a comprehensive plan for achieving your goals.

Whatever route you take, we wish you every success!

Discuss your situation with a fee-only financial advisor.

The commentary on this website reflects the personal opinions, viewpoints and analyses of the Divergent Planning, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Divergent Planning, LLC or performance returns of any Divergent Planning, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Divergent Planning, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

Divergent Planning, LLC provides links for your convenience to websites produced by other providers or industry related material. Accessing websites through links directs you away from our website. Divergent Planning, LLC is not responsible for errors or omissions in the material on third party websites, and does not necessarily approve of or endorse the information provided. Users who gain access to third party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from use of those websites.

Divergent Planning, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Divergent Planning, LLC and its representatives are properly licensed or exempt from licensure. This website is solely for informational purposes. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Divergent Planning, LLC unless a client service agreement is in place.

General Notice to Users: While we appreciate your comments and feedback, please be aware that any form of testimony from current or past clients about their experience with our firm on our website or social media platforms is strictly forbidden under current securities laws.