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Make your next raise really pay off
by: MP Dunleavey
Do not spend your next raise before you get it. Use it to pay off debt.

In theory, a raise is great. But if you're not careful, that fatter paycheck can make you feel like you just got a green light to go shopping. I should know; I recently landed a new project and didn't even wait for my first paycheck to arrive before spending it. Sigh. If a seasoned money writer like myself (ahem) could make such a dumb money blunder, naturally I was worried when I heard that the two youngest members of the Women in Red also came into pay increases.

Two 20-somethings suddenly endowed with extra cash may not sound like a national emergency. But if Lyndsey and Stephanie (and you, too!) want to get the most financial benefit from their raises, they need to strategize. The long-term potential Negotiating for raises -- and using them wisely -- is especially key for women, say Linda Babcock, Ph.D., and Sara Laschever, co-authors of "Women Don't Ask: Negotiation and the Gender Divide."

Based on their extensive research, Babcock and Laschever found that 20% of women avoid asking for a raise even when they know it's appropriate. But those who do ask stand to gain as much as $1 million during their working lives compared to women who don't. It stands to reason, then, that it's worth taking a few more steps to make sure your raise really boosts your bottom line and not your credit card balance.

This is especially true for Stephanie, 27, and Lyndsey, 26, who are trying to dig themselves out of debt. Stephanie has about $28,000 in school and car loans, plus some credit card debt. Lyndsey has about $11,000 in pure plastic.

How to prepare for a raise Most people have a couple of weeks' notice before a raise takes effect, which is plenty of time to mourn the death of your spending fantasies and think about your financial aims. (There, there.)

Lyndsey just got a 5% raise, boosting her salary by $2,000 to about $45,000, while Stephanie's husband got a whopping 22% increase, adding another $7,000 or so to their yearly household income.

Step 1: Prioritize: When it comes to a raise or any other windfall, big or small, mental preparation is as important as good money management. Rather than think of the money as "extra," decide in advance which goals to target -- e.g. paying off debt, bolstering your retirement fund, adding to your savings cushion. Not -- repeat, not -- redecorating the dining room.

Step 2: Avoid lifestyle upgrades: A small splurge or two is a fine way to celebrate a raise (more on that in a moment). The mistake you don't want to make is using the raise to bump up your cost of living -- with a higher car payment, eating out more, etc. -- which would eat up the windfall and do little for your bottom line. Managing the dollars and cents Once you get the raise, there are a few different options for maximizing the financial angle.

Option 1: Rebalance your budget: You can deploy a raise in such a way that it's evenly distributed throughout your budget from day one -- rebalancing your asset base, so to say. In that case, I might take the additional $1,000 gross I'm earning per month and divide it according to the 60% Solution budget method (of course).

Monthly pay raise: $1,000

Retirement savings: $100

Long-term savings: $100

Irregular expenses: $100

Fun money: $100

Taxes and committed expenses: $600

You have to be disciplined about allocating your money, so I strongly advise relying on Mother Technology to help you via automatic transfers and financial-tracking software, like Money or Quicken. I would not have a dime in savings or retirement were it not for this miracle.

The nice thing about this method is that you get a little bit of everything: some fun money to splurge with, more in savings and some money for keeping up with inflation and, perhaps, enhancing your lifestyle a bit.

Option 2: The two-stage approach: Another option is to take the entire amount of your raise and put it toward a single goal, like paying off debt. Once that goal is met, you weave the money into your overall budget, as in Option 1.

This would be a good strategy for Stephanie and her husband. At the couple's current payment rate of about $700 a month, they can expect to be debt-free in a little less than four years.

But if they put her husband's entire raise toward paying down debt, about $450 after taxes, they would be debt-free in just over two years. (Alternatively, they could dramatically increase their retirement savings, which have been minimal until now, and keep whittling down their debt more slowly.)

Once the debt was paid off, they could use the 60% Solution budget method to rebalance their budget, dividing the raise into each category.

Here's how much additional money they'd be spending and saving:

Monthly pay raise: $583

Retirement savings: $58

Long-term savings: $58

Irregular expenses: $58

Fun money: $58

Taxes and committed expenses: $351

By then, Stephanie and her husband might have earned additional pay increases, which they could fold into this plan -- or use for one of the other options.

Option 3: Pretend you never got a raise: Like Option 1, you simply take the entire raise and put it toward one of your financial goals, but when that one's complete, you simply shift the money toward another goal.

This might work well for Lyndsey, who can now put an additional $130 a month after taxes toward debt, becoming debt-free in 19 months instead of two years.

Once she's finished paying off her debt, Lyndsey could put the raise toward her retirement, to which she's only contributing 1% of her income. In this case, she would be able to sock away the gross amount of her raise each month, about $180, because her contributions would be tax-deferred.

This option requires a pretty Zen mindset, because you have to be content with your lifestyle as is.

A word about fun money Obviously a raise is a cause for celebration, so it's fine to treat yourself -- within reason. But if you splurge, do it with the first month's increased income and then settle in to one of the options outlined above.

Whichever way you do it, I strongly advise spending a little something on pure pleasure. Too much budgeting makes Jill a dull and cranky girl who might rebel and order irresponsibly from the L.L. Bean catalog. That's only a theory, of course.

Source: MyFico.com