When it comes to your income, you probably expect to make more later in your career compared to when you start out. And in many cases, as income grows so does lifestyle. This is called lifestyle inflation. It’s perfectly normal because who wants to live on that college budget forever? You deserve to be rewarded for your hard work! However, as with many things, moderation is key.
Without moderation, the risk is that your lifestyle will continue to grow with your income and it will absorb all or most of your income. Fast forward to retirement and your lifestyle isn’t supported by the savings you’ve accumulated. Uh oh! So at retirement you’re forced to live on a fixed income which is less than your normal standard of living. You could also work longer but this isn’t always an option.
This scenario can easily be avoided though. The goal is to balance lifestyle inflation and savings so that your lifestyle doesn’t need to adjust in an extreme way, today or in retirement. To accomplish this, it takes intentional savings. If you wait for money to be left over at the end of the month, you’re much less likely to save. I know this isn’t a new concept but it’s much easier said than done! This is why I’ve included actionable strategies to help you manage lifestyle inflation so you can plan for the future without neglecting today.
A great strategy for managing raises is to have a plan in place for each raise you receive beforehand. For example, a predetermined percent of your raise can go toward rewarding yourself and a predetermined percent can go toward savings. One way to automate this is to increase your 401k contributions immediately after your raise goes into effect. For example, you could increase your contribution from 7% to 8%. Alternatively, if your 401k contributions are already maxed, you could set up automatic savings from your checking account to a Roth IRA, brokerage account, or another savings vehicle.
Increased Income from a Small Business
The strategy for raises can also be applied to increased income from a small business you own. When you own a business, your take home pay can increase significantly and you’ll want to have plan in place so that your savings increases as your lifestyle increases. Plan on maxing retirement contributions as soon as feasible (even if you never plan to retire!). There are many directions you could go after retirement contributions are being maxed and this may be a time to work with a financial planner if you aren’t already.
Having a plan in place before you receive a bonus is just as helpful as with raises. Otherwise, it’s far too easy to spend it all! A strategy to manage bonuses is to set a predetermined amount that can go toward a short-term goal or need (which may include tax payments) and a predetermined amount that can go toward a long-term goal (like saving for retirement). As soon as you receive the bonus, send the amount earmarked for long-term savings to the applicable account rather than waiting for what’s left over.
Another strategy for managing bonuses is to pay for some of your annual expenses from your bonus. For example, auto insurance or personal life insurance premiums. You can save money by paying annually rather than monthly and paying these with your bonus means you free up regular income for other goals. It can also be helpful to earmark some of your bonus in this way so your bonus isn’t all spent on impulse purchases. Again, there’s nothing wrong with rewarding yourself but its best when planned so you stay in control of your money – rather than it controlling you.
A take-away from all of this is that if you automate savings goals, you’re less likely to spend what’s left over after paying bills. Also, create a plan for raises and bonuses before they occur. Being intentional about saving and moderating lifestyle inflation enables you to enjoy your money today AND to enjoy retirement. An extreme lifestyle adjustment can be avoided with proper planning! Contact me if you have any questions about creating a savings plan.