When most of us see a change in our incomes it is a slight increase or decrease. While we fear a sudden layoff or a huge reduction in our sales month over month, the more likely change that we see in income is a slight alteration here and there. A bump in the road you may call it. Or you may see a slight increase in income for whatever reason. Even if your yearly salary remains the same a bonus that aligns with inflation is common for many of us.
We consider these small changes in income and can then make similar changes to our financial planning that are commensurate with these small changes in income. If the change is small enough or short-lived enough, we may not even need to make any changes to our financial planning. For many of us, a household budget performed on a month-to-month basis would be the only way to truly tell that a small change in income (up or down) has occurred. Otherwise, we may just pass right on by without even noticing the change.
However, what we are going to talk about in today’s blog post from the Law Office of Bryan Fagan is how to financially plan your life and your estate when you experience a significant increase in your income. This can happen to you for any number of reasons, but the key is to be prepared for when you do see your yearly income increase by leaps and bounds. Using the same financial plan that you always have simply because you are used to it or because you don’t know any better is not good enough. Rather, you should evolve with your changing circumstances so that you can better serve those around you.
Changes in income can bring about other changes, as well
One of the most common issues that the attorneys with the Law Office of Bryan Fagan hear about from estate planning clients is that once their income increases their lifestyles increase as well. Anyone reading this blog post who has seen an increase in their pay over the past few years can appreciate what these folks mean. For instance, how many of you lead the same kind of lifestyle now that you did when you were only a year out from college or the start of your career? This may be a worthwhile goal to have as far as your finances are concerned but it is not going to be the most likely outcome.
Rather, you have probably experienced some degree of “lifestyle creep” as your income has increased over the years. There is nothing wrong with this, either. All we mean by lifestyle creep is that your tastes have matured and evolved along with your income. Rather than going out for fast food once a week as a treat you and your family eat out at nice restaurants twice a week. Your ten-year-old domestic-made vehicle has since been upgraded to a one-year-old foreign vehicle. As we make more money, we tend to see a similar increase in our lifestyle choices.
When you are trying to reimagine your financial goals, you should keep in mind that just because you are making more money that does not mean that you can always afford to spend more, as well. In some ways, yes, you can afford to spend more money on nonessentials like food, consumer goods, or even an upgrade in your home. However, it is easier to increase your lifestyle than it is to increase your income. If you are not careful you will find yourself in a position where you are going to be faced with the challenge of needing to slow down your spending to match your income.
Getting on a budget is a major area that we could all stand to benefit from. In truth, few of us perform the sort of detailed budgeting that would prevent this sort of lifestyle creep from happening. Think about your spending choices on a percentage basis. To me, this is a healthy way to think about your income, spending habits, and the fear of lifestyle creep. You can do the following with money: 1) spend it 2) save it 3) invest it. We are going to cover all three today but let’s start with the spend-it part of the equation.
If you spend 10% of your monthly income on lifestyle categories, then you should feel no need to increase that percentage just because you experience a significant increase in your income. Staying with that 10% number allows you to still increase the amount of fun you have without falling into the trap of lifestyle creep. Ten years from now probably will not remember a particular meal out or a vacation that was upgraded. However, you would remember the look your granddaughter gave you after you made her lifelong dream of owning a pony come true.
When we talk about creating a budget for your household spending, this does not have to be an extravagant or fancy attempt that you make. You can use the notes application on your phone or even a yellow legal pad. Figuring out your monthly income from all sources and then subtracting the monthly expenditures puts you in a position that most Americans would be envious of. Simply knowing how much money you have coming in versus how much is going out provides you with a great vantage point when it comes to monthly budgeting.
One of the best pieces of financial planning that you can perform right now is to figure out where your money goes each month. A budget does not tell you how to spend money. Rather, it helps you to identify where your money goes so that you can address any issues in your household related to spending. Do you need to subscribe to 14 different streaming services? Are you contributing too little (or too much) to your retirement savings? All these questions can be answered by compiling a month-to-month budget.
A budget permits you to spend. By having peace of mind in spending all this money, you can move with confidence through estate planning, as well. At this point, you will know whether you were justified in spending more money on your home, recreational activities, or anything else because of getting a raise in income. What’s better is that the first month or two of budgeting may end up being the most difficult months you experience for the entirety of the budgeting process. By month three, you should have a rhythm down as far as how to complete the budget.
A month-to-month budget does not require much more than the will to look deeper into your month-to-month life. There may be some circumstances which are more complex than others. However, you may have gotten a new job or taken on other responsibilities which makes your new life more complex at least from a financial perspective. For this, budgeting is a great way to focus on what matters from a dollars and cents vantage point.
Look at your investments after a big increase in your income
If you contribute to a Roth IRA, then your increase in income may have knocked you out of the income bracket where a Roth can be directly funded. There are income limits both for individuals and spouses when it comes to Roth IRAs. If you earn more than that income limit, then you would not be able to contribute to a Roth. Doing so would cause you some income tax headaches down the road. So, does that mean that you can no longer contribute to an IRA on a “pay the taxes now and not later” basis?
Thankfully, no. You can still choose to pay taxes now in an IRA by contributing to what is known informally as a “backdoor Roth” conversion. You would need to open a traditional IRA, contribute whatever you choose to invest (maximum amounts vary based on your age), and once that IRA is funded you would convert that IRA into a Roth. The attorneys at the Law Office of Bryan Fagan are not investment professionals so you should consult with one if you have a question about anything you read today. This is not to be taken as investment advice, either. Rather, we want to help you understand what options are available if you are interested in any tax-advantaged investment accounts.
The overall point is that if you are investing in the same manner that you were before your big increase in income then you are potentially making a major mistake. On the one hand, you could be sacrificing dollars by not taking advantage of different investment opportunities based on your higher income. On the other hand, you may be putting yourself in a position where you will be running afoul of the IRS by not updating your investment planning.
When do you think you will retire?
Many of us have 401Ks through our employer. One of the mutual fund options that comes as a part of every 401K is the retirement year targeted account. For example, this may be a “2050” plan for my fellow millennials. Or yours may be a 2030 plan or a 2065 plan depending on your age. It doesn’t matter. My point is that we can select investments based on the year that we think we can realistically retire.
However, now that you are experiencing a significant increase in your income, you should consider updating your plan. You may be in a position where you can realistically retire sooner than you ever would have imagined previously. The website for your retirement investments likely has a calculator that allows you to change the year in which you anticipate retiring. What this calculator allows you to do is to learn how much you would need to invest every year, for how long, and at what percentage gain to retire comfortably.
This is the great part about retirement planning. Retirement can seem like more of a “feel” thing than a “numbers” thing for whatever reason. You may be ready to retire from a number’s perspective but from a feel perspective, you may not be ready. Facts are your friends, folks. Set aside how you feel for a moment, and you can rely on the numbers and how they fall out for you. Rather than going off how you feel, why not take a look at your retirement numbers and see where they stack up? You may be surprised to learn that you are closer to your goals than you may have imagined.
Even if you are not close to your retirement goals you still have an opportunity to change that. The types of funds that you are invested in are one way that you can consider making some changes. Depending upon how long you have maintained certain investments it may be time to sell a stock or mutual fund in favor of another which is performing better. Working with a financial planner who has the heart of a teacher and advice you can trust is crucial when it comes to assets like these.
For many of us, however, investing in our retirement funds is not so much a problem with how much we need to invest but rather investing in the first place. There are so many ways to invest that it can be overwhelming to an extent. However, once you learn more about these methods you need to step up to the plate and finish the job. Invest your money while you can and let the compound interest do the work.
It is up to you how much money you invest in your retirement savings. It may be that you have a set percentage that you were comfortable investing back at your prior income. However, now that you are earning substantially more money it may be that you should consider increasing the amount of money that you invest into your retirement savings. Depending upon your specific goals for retirement up to 15% of your take-home pay would be a good start for investing purposes.
If you are unable to invest 15% of your take-home pay even after a substantial increase in your income, then you should look to your expenses in your budget to determine where you could cut down your lifestyle to increase the available income that you have to invest. You have retirement and will probably not care very much if you were to eliminate streaming services to start the process of investing.
How to find the motivation to start thinking critically about adjusting your financial goals
So, you find yourself in a position where you have seen a major increase in your income. This alone probably makes you feel like you have done all that you need to do at least for the time being when it comes to your finances. All the extreme income is going to be put to good use and you and your family will benefit as a result. However, what you can also do is think more about why you should put thought into your increase in income to invest differently.
Without motivation, you will have little reason to change what you are doing currently. For many people, it is your family that presents the major motivation in your life when it comes to planning. For example, if your spouse has no income or retirement savings to share then it may be that you are making wise decisions with your financial planning matters even more. You can use this pressure to refine your focus. Rather than losing yourself in a great deal of concern and worry over issues like this you can’t force yourself to focus even harder to better manage the assets that have been earned by you over the years.
As you think more about planning and your future there are several ways to begin planning for the future of your estate even after you pass away. The estate planning attorneys with the Law Office of Bryan Fagan are equipped to help you manage your estate and wealth planning. This means walking you through the different options that you may have in terms of retirement savings, investing, and budgeting. All of this can be done to save as much money as you can to build wealth and the value of your estate.
We thank you for joining us on the blog for the Law Office of Bryan Fagan. We post unique and original content every day on our blog on a variety of legal topics. We invite you to join us as we walk you through different scenarios and circumstances which may be relevant in your life.
Questions about the material contained in today’s blog post? Contact the Law Office of Bryan Fagan
If you have any questions about the material contained in today’s blog post place you know as a day to contact the Law Office of Bryan Fagan. Our licensed estate planning attorneys offer free-of-charge consultations six days a week in person, over the phone, and via video. These consultations are a great way for you to learn more about the world of Texas estate planning as well as how your family’s circumstances may be affected by the filing of a probate case.
Evan Hochschild was raised in Houston, TX and graduated from Cypress Creek High School. He went on to graduate from Southwestern University in Georgetown, TX with an undergraduate degree in Political Science. While in college, Evan was a four-year letterman on the Cross Country team.
Following in the footsteps of his grandfather and uncle before him, Evan attended law school after he completed in his undergraduate studies. He graduated from St. Mary’s University School of Law and has practiced in a variety of areas in the law- including family law.
Mr. Hochschild is guided by principles which place the interests of clients first. Additionally, Evan seeks to provide information and support for his clients with the heart of a teacher.
Evan and his wife have four small children together. He enjoys afternoons out and about with his family, teaching Sunday school at his church and exercising. A veteran attorney of fourteen years, Mr. Hochschild excels in communicating complex ideas in family law simply and directly.
