IRA Financial Blog

Why Getting a Raise Can Hurt Your Retirement

how a raise can hurt your retirement

Here’s a shocker: getting a raise can actually hurt your retirement. Before you cry foul play, let us explain.

Typically, when an individual earns more, the percentage he/she puts towards retirement remains the same.

You may be thinking, ‘wouldn’t a salary increase also increase the amount people are putting towards their retirement?’ For example, if a worker saves an average 10%-15% for retirement and his original $50,000 salary was increased to $70,000, they’re still saving more.

So, what’s the problem?

According to new research by Morningstar, a global financial services firm, how an individual spends his/her raise is what will eventually hurt their retirement.

What is a Paycheck Creep?

Before we dive further into our topic, it’s important that you understand the term “paycheck creep.” Also referred to as “lifestyle creep,” it occurs when your standard of living has improved, and former luxuries become current necessities. Habits often begin modestly: for example, you dine out more and at fancier restaurants.

But over time, the habits become more extravagant, such as upgrading a perfectly reliable car for the latest model, or moving into a nicer home. Of course, the down payments for the latest model and the mortgage for the nicer home will result in a much larger bill. And according to authors of the Morningstar research, these habits become cyclical.

“It’s not a one-off thing,” said Steve Wendel, Morningstar’s head of behavioral science and one of four co-authors of the report. “It’s a continuing bill – you have to continue to pay for this new lifestyle.”

As you can see, a paycheck creep results in your retirement savings growing at a slower rate than your salary. Things that were once a luxury become the new norm. As a result, during retirement, individuals won’t be able to live the life they enjoyed while they were working.

How to Improve Your Retirement Savings After a Raise

Generally, most Americans do not increase their retirement savings when they get a raise, but they should. In order to achieve the same lifestyle during retirement, individuals must allocate a portion of their raise towards their retirement nest egg. You can implement a few strategies to help you effectively increase your retirement savings, whether you have a work-sponsored 401(k) or a Self-Directed IRA.

  1. You can “save your age.” For example, if you are 40 years old, you should put 40% into retirement saving.
  2. Or you can “save twice your age.” So, if you’re retiring in 20 years, you should save 40% for retirement.
  3. Finally, save 33% of your salary – no matter your age.

Morningstar reported that younger savers benefited most by all three strategies, but as individual’s grow older, the best strategy is to save twice your age. After all, as we get older, we have less time for our savings to appreciate in value.

The three strategies above are a good place to start, but it is advised to create a more detailed savings strategy with your financial advisor.


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