This is a guest post by Hank Coleman.
Pay raise? What pay raise? I know what you are thinking. But, believe it or not, many Americans received a pay raise this year. Many receive a pay raise as a cost of living adjustment every year from their pension or an annual increase in their salaries from their employer. The United States military, for example, received a 1.4% pay raise this past January, and they have received a raise every year since the end of World War II. Every American actually received a pay raise this year also, and many did not even realize it. This year only, Congress reduced Social Security tax withholding from 6.2% to 4.2%. So, in essence, every taxpaying American received a 2% pay raise. So, now that we have it, what are we going to do with it? There are three great uses for a pay raise that can increase your wealth.
Pay Off Debt
If you have a credit card that is charging you 18% interest on your debt and you pay the card off, that is exactly like earning an 18% return on your money. There are not too many investments even in todayís hot stock market that can earn you an 18% rate of return. Paying off debt also has the added benefit of increasing your net worth. Most people only look at the asset side of the balance sheet equation, but you can raise your net worth by reducing your debt as well. Using a pay raise to increase your debt snowball or completely pay off a credit card is an excellent choice for the new money in your paycheck every month.
Save An Emergency Fund
One of the biggest things that Americans are lacking is a fully funded emergency fund. Recent studies have shown that almost half of all Americans do not have three to six months of living expenses saved in an emergency fund. You can never go wrong by using a new pay raise to beef up your emergency fund. I was personally surprised when I actually took the time to calculate just how much money constituted six months of expenses. I found out that I had been underfunding my emergency fund for years. Do you have enough saved in your rainy day fund? Have you done the simple math calculations to ensure that you really do have three to six months saved or have you just picked a random number such as $10,000 to set aside?
Invest Your Raise
Everyone knows that they should maximize their retirement plan contributions, but many people find themselves coming up short at the end of the year for one reason or another. Using a portion of your pay raise to finish your contributions would be a great use for that money. For example, the maximum contribution limit for a Roth IRA for someone under the age of 50 is $5,000 per year. If you have not contributed up to your maximum, you have until April 15th, 2011 to finish contributing for 2010ís $5,000 cap.
The beauty of a pay raise is that it is money that you previously didnít have allocated in your budget. It is basically found money. It was not already earmarked for any purpose. You can use that money to strengthen your financial picture and make your familyís financial lives better. You can use a pay raise for all kinds of purposes that you have been putting off such as paying off debt, funding an emergency fund, or investing for retirement. So, think twice before you splurge with your new pay raise. There may be a better use for that money.