If you’ve recently received a raise, congrats! We’re sure it’s well deserved. Now, before you do anything else, let us explain how that pay bump can be a bad thing. Don’t blame the messenger — we’re only doing this to help.
According to a recent study from Morningstar, getting a raise can actually hurt you in retirement. As the New York Times reports, the researchers studied 1,619 American households that were participating in a workplace retirement plan. They found that there was almost no difference in savings rate between workers who received a raise and workers who did not. This is bad news, because people are notoriously bad at avoiding lifestyle creep — the tendency to spend more as you get paid more.
The Morningstar report explained that if your pay was bumped up from $100,000 to $120,000, and you keep your savings rate at 10 percent, yes, you’ll be saving more. However, you need to save even more than 10 percent, because chances are you’re now spending more than you ever did. If you keep that 10 percent savings rate, when it comes to retirement, you’ll likely face a shortfall.
Fortunately, the Morningstar report also found two potential solutions to this issue. First, try to avoid lifestyle creep. This means doing your best to keep expenses where they were prior to your raise. However, given the difficulty of that, your best bet might be simply increasing your savings rate. Morningstar’s team suggested that each time you get a raise, you allow yourself to spend a percentage of it that’s twice the number of years until retirement — and then save the rest. So if you have 10 years until retirement, you spend 20 percent of the raise, and stash the remainder. Increasing your savings along with your pay raises might be hard, but you’ll be happy you did when retirement comes.