Exactly how to adjust your budget after getting a raise to avoid ‘lifestyle creep’

So, since you finally got that well-deserved pay raise, you can ignore all the guidelines you previously followed about how to budget efficiently, right? Depending on the size of your raise you theoretically can buy that Peloton and trade in your 10-year-old car for a newer, sleeker, pricier model without thinking twice about it. But while splurging on impulse buys and increasing your recurring expenses after getting a fatter paycheck might be tempting, if long-term financial health is your goal, there are savvier ways to manage a monthly increase in cash flow.

“The biggest mistake people make when they get a raise is spending it all,” says Bola Sokunbi, certified financial education instructor and CEO of Clever Girl Finance. Sometimes, this takes the form of a one-time splurge—like, say, booking a $5,000 vacation as a reward for your $5,000 annual raise. Or, it can turn into what Sokunbi calls “lifestyle creep.” “As people earn more money, they increase their costs of living because they’re upgrading to [more expensive] things, like a car or a house,” she says. “They put themselves into the position where, despite the extra money they’re earning, their debt and savings percentage stays the same.”

“As people earn more money, they increase their costs of living. Despite the extra money they’re earning, their debt and savings percentage stays the same.” —Bola Sokunbi, CEO of Clever Girl Finance

Of course, says Sokunbi, there’s nothing wrong with treating yourself to celebrate a job well done, as long as the expenditure is reasonable given your budget. (For example, you might commemorate a $5,000 raise with a $250 vacation-rental getaway with friends.) It’s also possible to responsibly increase your monthly living expenses while avoiding lifestyle creep by considering the context of your big-picture financial plans. “Pause for a moment and assess how you can make that change while still saving, paying off extra debt, or investing more,” says Sokunbi. “When you get a raise, you want to be purposeful about where that money goes.'” Below, she lays out a simple strategy for allocating a pay increase that’ll bring you both short-term happiness and lasting satisfaction.

3 tips to avoid lifestyle creep from compromising your finances after you get a raise.

1. Prioritize paying off high-interest debt and building emergency savings

If you have credit card debt or a negative balance in your savings account, Sokunbi says this should be your financial priority. “I recommend an 80-20 split, where 80 percent of the money from your raise goes toward the debt and 20 percent goes to your emergency savings until you max it out,” she says. “You should have at least $1,000 in savings, so you have money to cover things like a flat tire, an emergency plane ticket, or a doctor’s visit.”

You can save more than $1,000, of course—many experts suggest stashing away enough money for six to nine months of living expenses.  Once your debt is paid in full and your savings account is stacked, you can start putting that money toward other things.

2. Make a list of your top 5 financial goals, and distribute your pay raise accordingly

For those who don’t have debt and already have a decent emergency fund, there’s no hard-and-fast rule about adjusting your budget after getting a raise. “Everyone’s situation is different, so it really comes down to your priorities,” says Sokunbi of avoiding lifestyle creep. “When you look at your finances, what are your top five priorities? You can look at those priorities and split the money accordingly.”

Let’s say your current life goals are buying a home, increasing your investments, paying off student loans, saving for a health-coach certification program, and buying a more reliable car. Once you put them in order of importance, Sokunbi says that your top priority should get the biggest percentage of your raise—50 percent, perhaps—while the others get 15 to 20 percent of the total. The exact numbers you choose are up to you.

“You were surviving before you got the raise. You should be acting like you didn’t get it and instead just apply that money to your [big goals].” —Sokunbi

What’s most important is to give your money direction so you don’t end up frittering it away on happy hours and impulse shopping—AKA your “fun and BS” account. “It’s all about not allowing yourself to get used to the idea of extra money [in your account],” says Sokunbi. “You were surviving before you got the raise. You should be acting like you didn’t get it and instead just apply that money to your [big goals].”

3. Don’t forget about taxes

In reality, a $10,000 raise isn’t really a $10,000 raise at all because a percentage of it belongs to the government. It’s especially important for independent contractors to remember to increase their tax allocations as they make more money, especially if their pay raise bumps them into a higher tax bracket, because that income will be taxed at a higher rate. (I’ve personally made this mistake more than once.) “Anyone who’s a business owner or freelancer needs to have a separate tax account where they put about 25 to 30 percent of their income,” Sokunbi says. “At the end of the year, if you have some really awesome deductions and you get money back, that’s just a bonus.” Yes, it can be a major drag to bid adieu to a chunk of your raise before you even see it—but at least the next time a pay hike comes along, you won’t have to spend it on IRS debt.

Raise or no raise, queue up these podcasts if you want to improve your financial health in 2020. Or take it a step further and complete our Renew Year 28-day financial wellness challenge.