Ask anyone who is getting a raise this year how they plan to put that money to use, and they'll probably have at least a few ideas. Spending at least some of it can feel like a well-deserved reward for your hard work, especially after dealing with high inflation over the past year. You may even plan to use your raise to help shore up your emergency fund and help budget for higher food prices. But if you don't need it to help pay your bills, you might consider putting a portion of it away for retirement.
It might be hard to lock away a few thousand dollars a year right now, but that money could turn into tens of thousands of dollars or more down the road with the right investments.
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How retirement accounts grow your wealth
Retirement accounts offer tax-advantaged ways to invest your money for the future. You choose what you want to invest in and contribute money over time, ideally on a regular schedule. Your investments give you an ownership stake in various companies and when they do well, their stock share prices rise.
When you're ready to cash out, you can sell your shares and the difference between your sale price and your original purchase price is known as your earnings. Often, the longer you've held an investment for, the more earnings you wind up with. More earnings mean you can set aside less of your personal savings for retirement.
Retirement accounts force you to lock up your savings for many years. You'll usually have to pay a penalty to withdraw funds from them before you turn 59 1/2, unlike taxable brokerage accounts, which allow you to make withdrawals without penalty at any time. But in exchange, you get a tax break. With tax-deferred accounts, you'll delay paying taxes on your retirement funds until you're ready to withdraw them, while with Roth accounts, you contribute money you've already paid taxes on, but you will be able to take withdrawals tax-free later. But in order to take advantage of any of these benefits, you first need money.
How saving your raise could help your retirement savings
Investing provides an opportunity to turn small amounts of cash today into larger amounts tomorrow. Anything you can do to grow your monthly retirement contributions will help you in the future, including saving your raise.
Median earnings for full-time workers were about $56,420 in 2022, and the average raise is projected to be about 4% in 2023, according to Salary.com. A 4% raise would bring the median salary in 2023 to about $58,679. That's a difference of $2,259, or about $188 per month.
Saving $188 a month in a low-interest savings account would net you about $67,680 after 30 years. But if you invested that money instead in stocks that produced an 8% average annual rate of return, after 30 years, it would have grown into over $266,500. And that's assuming you invested only your 4% raise and nothing more.
If you'd already been investing and just increased the rate of your contributions, you could wind up with considerably more. For example, if you earned the median of $56,420 in 2022 and invested 10% of your income, or about $470 per month, and then you added an additional $188 per month when you got your 2023 raise, you could be looking at over $900,000 after earning an 8% average annual return for 30 years. That may not be enough to cover all your retirement expenses, but it'll certainly go a long way.
It doesn't have to be all or nothing
The more you can save for retirement now, the sooner you'll be able to quit the workforce. But it's all about balance. It's normal to want to spend some of your hard-earned cash right now, and it's OK if you aren't comfortable saving all of your raise for the future.
You could compromise by saving a third or half of your raise if that works better for your finances. Use the rest to improve your lifestyle right now. And if you receive another raise in the future, you can always boost your monthly retirement contribution again.
