The groundhog has emerged to forecast the prospects for the rest of winter, and for many employees, that means it's time to begin preparing for that yearly rite of passage: the annual work performance review. Some are hoping for big raises and bonuses; for others working for employers announcing layoffs, such as IT consultantUnisys
If you're lucky enough to find yourself with more money in your paycheck, it's a good opportunity for you to revisit your savings plan. While it can be difficult to find ways to cut expenses and let yourself save more, increasing your savings right after you get a raise or bonus can be the closest thing to painless that you'll ever find.
You won't notice
For many people, the key to a successful savings plan is never knowing they had the money to spend in the first place. The less opportunity you have to see money in your paycheck or bank account, the less chance you'll spend it on unnecessary purchases. Thanks to this attitude, the idea of "paying yourself first" is popular among savers; if you treat your savings like just another bill, one you absolutely have to pay before you can do anything else with your money, you'll have the discipline to keep making those monthly contributions throughout the year, even when particular situations make it challenging to make ends meet.
Similarly, passing through a raise directly toward your savings is one way to make yourself forget about having any extra money. If you get paid on a salary basis, then you're used to seeing a set amount get deposited to your account on your payday. By diverting whatever extra money you get into your savings or investment accounts, you'll be able to increase the amount you set aside without having to suffer a decrease in how much money you have to spend.
How to save your raise
There are a number of ways to take advantage of a raise to bolster your savings. One way is by increasing your contribution toward your retirement savings. If your employer offers a 401(k) or other retirement plan, it's fairly easy to calculate how to adjust your savings to take your raise into account. For example, if you get a 3% raise, then you can increase the amount you have withheld from your paycheck for retirement by 3%. If you follow this simple guideline, it's likely that your take-home pay will be mostly unchanged from what you were paid before your raise. Because contributions to most retirement plans are tax-deductible, diverting your raise toward your retirement essentially eliminates most of its potential impact on your income-tax liability. If your employer offers matching contributions when you participate in your retirement plan, increasing your own plan contributions will give you an even better return on your money.
If you don't have access to a retirement plan at work, wait until you get your first paycheck, then compare the new amount with what you were paid before. Once you have that figure, increasing your savings is as easy as arranging to have automatic withdrawals from your bank account take place immediately after you get paid. With many mutual fund companies allowing automatic transfers as low as $25 or $50, you can make even small raises work in your favor.
Why bother?
When you're discussing your new compensation at your performance review, your raise may sound like a really big deal. Yet when you see the impact your raise has on your regular paycheck, you might be disappointed. For instance, if you get paid every two weeks, a raise of $1,250 translates to less than $50 extra in your gross pay during each pay period; after accounting for withholding tax, it's not uncommon to see that $50 shrink to $25 or $30 in your net pay. Seeing how small your raise appears may make you wonder whether it's worth the trouble to change your savings plan.
However, small amounts do add up over time. If you took $30 every two weeks and invested it in a balanced fund with an average return of 6%, it would grow to more than $10,000 after just 10 years. That's not too shabby for an amount that hardly seemed worth your while. If you are more aggressive and earn a 10% return, 20 years of steady savings will result in nearly $50,000 in extra cash to put toward your financial goals. Moreover, over the course of your career, you'll probably get many raises. If you set aside each one, you'll find your savings will snowball over time. For instance, if you get a $30-per-paycheck raise each year, then by saving $30 every two weeks during the first year, $60 during the second, and so on, your savings will grow even more quickly.
If you walked out of your performance review with a raise this year, congratulations -- you've earned it. To make the most of that newfound money, pass that raise on to your savings. In the long run, you'll be glad you did.
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Fool contributor Dan Caplinger has been saving money since he was 5. He doesn't own shares of the companies mentioned in this article. New York Times is an Income Investor pick. The Fool's disclosure policy pays you dividends.
