Today’s guest post is by Emily from Evolving Personal Finance. Emily and her husband live in Durham, NC; they are PhD candidates by day and PF bloggers by night.
Cat and her husband and I and my husband are facing a problem everyone would love to have: we are anticipating big income jumps in the next few years. Cat’s husband will go from being a debt-generating med student to an income-generating resident and then an income-generating physician; my husband and I will each go from earning small stipends while in our PhD programs to having adult-sized incomes after we graduate. Each of our household incomes will jump at least a couple times as our training progresses, so the question of what to do with income increases will come up more than once.
Large income jumps is rarely discussed, but plenty of people with newly-minted graduate degrees have questions about how to navigate them. They have sacrificed for years living on small incomes or debt to get where they are and they want to know if they can finally live it up!
After devoting considerable thought (i.e. daydreaming) to this scenario, I have some suggestions for fresh graduates goggling at their incomes for the first time.
1) Calculate your expenses with no lifestyle upgrade.
The cold hard truth is that your income won’t go as far as it might seem at first blush.
- You will likely be bumped into a higher income tax bracket and you may lose some education-related credits or deductions you were able to take previously.
- You probably weren’t paying payroll taxes at your university job if it related to your degree pursuit, but that break will end.
- You will have to start making payments on student loan debt you were able to defer during graduate school – at least the minimums.
- If your new job requires a move to a higher cost-of-living area, just staying in the same size and quality of home or buying the same groceries will force an increase in spending.
- You may also be losing out on some benefits that your student status conferred – think of health insurance, gym membership, subsidized entertainment, etc.
- Your new job may come with some necessary new expenses, like a wardrobe upgrade and a (reasonable!) car if you didn’t already own one.
- If you practice percentage-based budgeting the way that my husband and I do, your absolute saving and giving amounts will increase, whether or not you increase your lifestyle.
Before moving on, you must figure out what the gap between your new income and baseline expenses really is, after accounting for all the changes brought by no longer being a student, possibly moving, and having a new job. The true amount of excess money you’ll have is probably smaller than what you thought when you first got your offer, but it’s better to know the real figures than accidentally increase your lifestyle too far.
2) Consider your goals (or make some).
I won’t go into great detail about all the possible financial goals a new graduate might have – there is plenty of other material out there for that! For the purposes of figuring out to do with an income increase, there are two types of financial goals to consider: ongoing and finite. An example of an ongoing goal might be to max out your tax-advantaged retirement accounts every year of your working life. An example of a finite goal might be to save a down payment for a house.
You’ll likely have a mix of ongoing and finite goals or a prioritized list of finite goals (like paying off debt) before you get to more ongoing goals. Put dollar amounts and maximum timeframes on your finite goals so that you can calculate a monthly payment rate for your ongoing and finite goals. Compare the amount of money you want to put toward your goals each month or year with true income increase you calculated in step 1. Ideally, you’ll still have some income increase left, but if your goals have more than eaten up the increase they are probably too aggressive and you should adjust them.
3) Increase your lifestyle.
Now comes the payoff! If you can maintain your grad school lifestyle and meet your goals and still have some excess income left, you can feel free to increase your lifestyle. Buy yourself some toys, hire a cleaning service, go on vacation, whatever floats your boat. But please don’t just inflate your lifestyle mindlessly – really think about each increase and weigh out what it will mean to you to ensure you’re valuing your money well. If you have set some finite goals, it will help to compare the lifestyle increase you’re considering against the satisfaction of reaching that finite goal more quickly.
4) Go ahead, fudge the numbers.
I think that every graduate who has worked hard to land a great job deserves to increase her lifestyle a bit. (Unless she’s been living high on the hog on loans – in that case she’s in need of a reality check and possibly lifestyle deflation.) If you are totally satisfied with your grad student lifestyle and mega-motivated to meet your financial goals, then perhaps you can forgo the lifestyle increase. But the rest of us should materially enjoy our success to keep us motivated to strive for more. I think it’s reasonable to increase your lifestyle with 10-20% of the excess income you calculated in step 1, even if that means you can’t meet the most aggressive forms of your goals from step 2.
Many people inflate their lifestyle with every yearly raise and bonus, but they don’t necessarily derive more satisfaction from their lives by doing so. Already being accustomed to a lower lifestyle because of your time in school, you are in a unique position to capitalize on your big-girl/boy income and quickly meet your financial goals while enjoying the fruits of your hard work.
How have you handled significant income increases in the past or how do you plan to? How do you account for necessary lifestyle increases? Do you think you deserve to spend/enjoy a portion of a big income boost?
38 responses to “What to Do with a Big Income Increase”
My dad is a surgeon and he worries all the time about over inflation of lifestyle amongst his peers. He says it is common in the medical field for the reasons you shared. People go from making nothing (essentially) overnight to having a lot more disposable income. It is REALLY important to keep the big picture in perspective and not get too carried away even though it is tempting. There are a number of 60+ doctors running around now who don’t have enough for retirement because of too much lifestyle inflation.
It just goes to show that physicians are like everyone else with respect to their money – some are conscientious and some are not! They have a larger-than-average income potential – especially surgeons – but it’s what you save not what you make that will determine how you fare overall. I hope your dad turn some attention to the younger generations to pass on what he’s learned so they don’t make the mistakes he’s observed in his peers.
We lived through this “problem”, and it was a very good problem to have. But we’ve seen other folks have a lot of trouble navigating what to do when their salary increases a lot.
For us, the main thing was keeping the vast majority of our expenses the same (small house, modest cars, cheap cat), but giving ourselves a couple of indulgences in the everyday spending, for us it was a fancy-ish gym membership, and doubling the eating-out spending. Beyond that, when mini needs or wants came up, we generally let ourselves have them. They never amount to more than $500/month (and really, that’s on the very high end), and considering how much we’re saving (over 90% of Mr PoP’s post-FICA, pre-tax income), it’s just not worth stressing about.
Lol cheap cat! What’s an expensive cat??
Did you ever choose to increase your baseline expenses, after you gave your higher income some time to sink in? I suppose you have the carrot of FI to strive for maybe you don’t value those non-incidental increases.
Great job on the savings rate!
This is what we plan on doing when husband graduates. SO excited! Only 3ish years left.
Will you be moving at that time? If you can stay in the same place all these calculations are so much easier!
Great post, Emily. I think it’s crucial to give yourself a little bit of a bump in lifestyle when you get a huge pay raise, but like Shannon said in the comments, also so important not to go overboard and live an extravagant lifestyle. If you can continue to live well below your means for at least a few years after that huge pay jump, and sock away the savings, at least you’ve got yourself a nice cushion. 🙂
I bet there’s a correlation with satisfaction on that lower in-school income and the ability to save a lot and deliberately increase lifestyle with the higher income. If you’re chomping at the bit (or going into credit card debt) during school waiting for graduation, that’s a warning sign for spending your entire paycheck when you get the job.
Great point. I think there’s a difference between lifestyle inflation and conscious lifestyle upgrades.
I should finally write a whole post on that subject on EPF as I’ve said it enough times in comments around the blogosphere!
Fantastic post, Emily! I love that you pointed out a need for lifestyles inflation, but with considerations. I think the majority of people inflate their lifestyle without thinking of the value given to them by the lifestyle inflation. Then after they are set in their ways they don’t know how to go back. Now is the time to enjoy some of the hard work you have been putting in!
That is a great observation – once you inflate your lifestyle you don’t really know how to deflate it. With deliberate lifestyle increases, you’ve really thought through what you can live without and have a clear idea of how you lived before you got the big paycheck and how to get back.
Good topic to talk about Emily! I remember that first big paycheck I received…thought I had hit the lottery. #3 is the biggest issue I see and struggled with. We do sacrifice for such a long time and then think we deserve it all. I’d counsel to increase spending gradually and definitely weigh all the decisions. It’s really easy to inflate your lifestyle and get in over your head.
Even though I’m writing about this, I haven’t yet experienced it so I need to keep it all in mind for us. Our first pay bump is coming in July!
When I first graduated with my B.S. and started my full-time job, I thought I was rich! I sure wish I knew then what I know now about how much things cost. I had about 5 months of pay when I first started that I didn’t have to pay rent or a mortgage, but I blew all my money instead of saving or paying off debt… Sigh! Live and learn.
I never had that experience – my first salary was less than the living wage in the area I was living in so I had to figure out what was what really fast! It was hard but it provided lessons that I’m hoping to carry that mindset forward into our larger-salary life.
My gross salary went up 3.5x from my stipend… but my take home is only double. Oh the joys of going from not being taxed and not paying for things like health benefits (well okay I did but it was 200/year vs. $100/month), etc. It’s crazy how much comes off a cheque 🙂
I just applied for a job that will be a 50% raise from my current job, so maybe I’ll have to come back to this post so I don’t have spend it all 😉 Realistically if I got that sort of salary bump I would put it to debt and then have crazy savings. I might have about a 10% lifestyle inflation because I’m living fairly bare bones right now, but it’s all relative. I don’t automatically need thousands of dollars for food because I now have a better job 🙂
How did you navigate the 2x net jump? I know you moved, so did a lot of the raise get eaten up by the COL increase? I hope you get that job! Getting to a high salary at a young age will do you very well over the course of your lifetime.
Thanks Emily – I’m just hopeful for a call back 🙂 Essentially the majority of the increased take-home went to debt repayment (I put about 35% of take home toward debt) (the COL didn’t change much with that move). If I didn’t have debt the majority of it would have gone to retirement savings to try to catch-up. If I did somehow land that job I’d be a little surprised, but it was worth a shot. It is in a higher COL city, but taxes are way less so it should even out, roughly.
As far as financial problems go, this is a good one to have, except that if poorly handled it can set the stage for problems down the road. The options you outline are quite reasonable. Unfortunately the people who need to read it most are probably out shopping right now. 😉
Yeah, it’s a bit of an echo chamber in the PF blogosphere. But maybe some med students will see this post and take “live like a resident” to heart. 🙂
We experienced a nice income increase when I quit my job last year, and it was fun to see what we were earnings grow overnight. We haven’t changed much and just continue to save. I would say we’ve splurged on a few things, but it was all fairly calculated!
Sounds like you played it exactly right. You must be very gratified seeing your savings increase quickly.
My increase from college student to professional didn’t work out well for me. I spent most of my money. I got into serious debt. Now, when I get an increase, I save it.
I hope that by sharing your story you help others avoid that path!
My raises were always so small enough that I didn’t feel that huge boost. I do think somewhat of a lifestyle inflation is good, because you did earn it, but like you said, not mindlessly. Good tips!
I think it’s more difficult to be deliberate with frequent small increases than with a one-time big jump. After all, you do need to keep up with the inflation the entire economy experiences to avoid deflating your lifestyle, and that can happen a bit more mindlessly.
Even a $5K annual increase, spread over 12 months, is not much per month. It’s easy to spend it, harder to save it. Max out the 401K, and keep a reasonable life style. Avoid long term financial commitments. By a rental property..,.
Great suggestions! I think automated savings make the process so much easier. Even though we don’t have payroll deductions for our savings, we just set up the automatic transfers to go from our checking to Roth IRAs and we don’t have to re-evaluate the decision every month.
When the time that my income would increase, I plan on maintaining my current budget, and maybe wait for another increase or two before I increase my budget plan.
Sounds like a good idea to maintain your current habits.
My first advice with a big income increase would be to sock away as much of the difference for retirement as you can (assuming you don’t have high interest debt that really needs to be addressed first). It’s good to get that settled when it still feels like you’re having an income increase rather than a cut in your take-home pay. You won’t even notice it, but it puts you on good ground in the future. And if you find you’re putting away too much each month, it’s far easier to cut the amount you’re contributing to retirement than to find extra dollars to put into it later once you get used to spending more money. Plus if you’re going to making big big bucks in the future, you may run out of tax-advantaged places to hide the extra money– might as well get the post out of your tax-advantaged space while you can.
That’s a great goal suggestion, and exactly what we would do until we max out the tax-advantaged retirement contributions (aside from the small lifestyle increase).