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Here are 7 financial moves to make if your income increases significantly
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Having a big increase in your income is cause for celebration – a growing income means greater stability and more opportunities to do the things you love.
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But it also brings an added responsibility to ensure you make the most of your money and establish a solid foundation for future financial success.
GOBankingRates spoke with Tyler Weerden, financial planner and founder of Layered financeto discuss the Top Money Moves You Should Make If Your Income Increases Significantly.
First, understand your real net salary after taxes
“The first thing to do before making any changes to your savings, spending or investments is to get an accurate picture of exactly what the net effect of this additional income will be,” Weerden said.
“Someone who gets a $50,000 raise expecting to see $1,923 more in their salary ($50,000/26 biweekly paychecks) will be terribly surprised when they see the actual net increase after taxes and other income-based deductions.”
He said employees should expect their federal taxes, state taxes, percentage-based retirement contributions, Social Security taxes and Medicare taxes to increase as their income increases.
“Taxes must also be considered before taking any action,” he explained. “If new income is going to push you into a higher tax bracket, will there be other tax dominoes that fall? Should you make 401(k) contributions before taxes (traditional) or after taxes (Roth)?”
He added that other financial effects of higher income include taxation of Social Security benefits, Medicare Part B (IRMAA) surcharges, the 3.8% net investment income tax, health insurance marketplace premium tax credits , student loan repayment plans based on income and other taxes. credits and deductions.
“Once you have a true understanding of increasing net cash flow and the tax consequences, these are the steps to take.”
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Make sure you get the employer match on your 401(k)
“This free money is the best guaranteed rate of return anyone will ever get,” Weerden said.
“Let’s say a 30-year-old works until he’s 60 and receives a new salary of US$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 final balance would be $1,624,870.
“His personal contributions over 30 years were $260,886,” he explained.
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“Without the employer match, using the same time frame and return, they would end up with $812,435. That means a 5% employer match netted them an additional $812,435.”
Build emergency reserves
“According to a 2024 Bankrate survey, 44% of Americans say they cannot afford a $1,000 emergency expense,” Weerden highlighted.
Building a solid financial foundation with emergency reserves will benefit your physical and mental well-being, he noted.
“It’s hard to stand out and grow as a person when you’re stressed about buying groceries or fixing your car. Money may not buy happiness, but being financially secure can greatly reduce 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 to 6 months, but your mileage may vary depending on job stability, cash flow, and specific family circumstances.”
Enjoy some of the money you earned
“Life decisions should not be reduced to a spreadsheet,” Weerden said. “Dying rich should not be prioritized over living a rich life.
“We can always defend savings and investment, but not to the point of being greedy”, he explained. “With a significant increase in your income, don’t feel guilty about rewarding yourself for the work you did to get that increase. Maybe you take a family vacation, maybe you buy those shoes you’ve been eyeing. In any way, big or small, do something for yourself.”
‘Lifestyle Creep’ Is a True Threat to Building Wealth
According to Weerden, as people earn more money, they tend to spend more money, reducing the positive effects of increasing their income.
“However, there is a balance. If your income increases significantly and you experience an increase in lifestyle, you also need to experience an increase in savings and investment.
However, keep in mind that you don’t have to live completely frugally.
“You don’t have to live like a college student eating rice and beans forever.”
Maximize a Roth IRA
“Originally called the ‘American Dream IRA’ when they were created by law in 1997, Roth IRAs are powerful tools,” said Weerden. “Investments in a Roth IRA grow tax-free and exit tax-free after age 59½.
“Why not max out a Roth 401(k) before a Roth IRA?” He continued. “Flexibility, rates and investment options. Contributions made to a Roth IRA can be withdrawn at any time without taxes or penalties.”
While it’s not recommended to withdraw contributions before retirement, he added that in a true emergency where you have no other option, you can withdraw money from your Roth IRA without worrying about taxes or penalties.
“This is not absolute, but a Roth IRA held in 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 people 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) invest in a simple 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 situation, investor knowledge, individual preferences, liquidity needs, and risk profile should all be examined first.”
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This article originally appeared on GOBankingRates. with: I’m a Financial Advisor: Here Are 7 Financial Moves to Make If Your Income Increases Significantly