What to do with large salary increase?

**MonkeyMama** · 02-12-2012, 04:16 PM

That's great!

Your taxes are going to be massive with your new income. I would absolutely max out your 401k ($17,000 per year) and continue to max out your HSA. (Unfortunately, you may be unable to put that much into 401k as a highly compensated employee - you won't know for sure until year is over, probably - just a heads up).

Without knowing your state tax or insurance situation, I'd say you will be taking home around $3500 per check before those kick in. (After max to 401k). So that's another solid $4k/month of take-home? Consider yourself warned that the IRS wants a chunk. IF you are in a high taxed state, your state will want a chunk too.

Considering that you don't seem to have any other assets to speak of, I'd put a solid 6-12 months expenses in cash, to start (build up emergency savings). This might only take a few months, but they say not to make any big money decisions when you come into an inheritance, and I would think the same should apply in a situation like this. You don't want to get ahead of yourself and start making assumptions about future income, etc. You'll want to stick with the job a while, make sure you like it and that it will be around a while, before you make commitments that you can't keep without the new income.

Real estate investing is fine, but I would ease into it. I see way too much "real estate will make me rich" kinds of mentality from people who have no idea what they are doing. I'd just say, don't be rash about it, and don't get in over your head. It's probably wise to start smaller than a whole apartment complex, unless your relative has more experience there.

It is generally recommended to put 15% of income to retirement. At your age, this is probably a good idea. Since you can only put 11% or so into 401k, I would also put 5% of pay into taxable mutual funds earmarked for retirement (rounding up a bit). That's just at the minimum, of course.

OF course, those are just the basics. Ease into it, take it slow, and depends on your risk level and goals/dreams for the rest.

Good Luck!

**kork13** · 02-12-2012, 04:21 PM

Well, first off congrats on the new job!

One of the most challenging things to do as you make more money is not growing into your paycheck. Are you happy with how you're living with your $50k/yr salary? Try to keep your spending fairly close to what you're doing now. Of course you can raise your standard of living somewhat, but don't let yourself go overboard. You have a great opportunity to save a significant portion of your paycheck.

The best advice I can give is that you should write out a solid plan for your savings and investments, then you can spend what's left. It may sound crazy, but consider saving 50% of your new income... Live on $75k, save $75k. Saving $75k/yr will put you in incredibly good shape for any future you choose, you're in a position right now to do it easily. I apologize in advance for being verbose.... but here are some thoughts to consider:

Debt: There's really no reason for you to needlessly have any.
- Pay off your car loan ASAP.
- Consider accelerating your mortgage payoff... perhaps make a double payment each month to put against your principle. It'll cut your mortgage cost and duration significantly.

Taxes: With an income jump like you're getting, you're going to be stupefied at the spike in your taxes. Personally, I'd recommend sitting down with a good CPA to do some tax planning so you know what to expect tax-wise. Until you know what your tax picture will look like, you might consider putting away some money to cover the tax bill...you'll probably be surprised next year.

Cash Savings:
- Figure out what you need for an Emergency Fund. Let's say as a rough wag $35k (or whatever you decide you want/need). You can save that up pretty easily within the first few months of your new job.
- You should also put aside some cash monthly for your general spending, whether for travel, toys (electronics, etc.), car replacement, or whatever.

Taxable (regular) Investments: This will likely make up the core of your monthly savings.
- Educate yourself. If individual trades in stocks, bonds, and ETFs aren't for you, stick with mutual funds. There are alot of good options out there...the typical suggestions around here are Vanguard or Fidelity.
- Determine your desired investment mix (asset allocation). Pick your investments based on that, and stick to it.

Real estate: If you do it smartly, real estate can be a good option for a PART of your investments....don't ever put too many eggs in the real estate basket.
- Save up the cash for a very healthy downpayment (at least 30%-40%) before you consider buying any sort of investment property. This high starting equity will protect you.
- Look into establishing an LLC or other type of business for yourself. This protects you and your business (the investment property), and should be a part of any plans to own a rental property of any sort.

Retirement: This should be no problem for you. You have 35+ years before retirement, and in that time you can amass a significant horde for yourself. Even as a conservative estimate, just by maxing your IRAs and 401k every year, you can easily accumulate more that $2 Million in those accounts by age 65.
- Make sure that you've maxed out your Roth IRA for 2011... After your pay raise, you probably will make to much to contribute directly to it.
- In future years, max out a non-deductible IRA every year, then annually convert ("re-characterize") it into to a Roth.
- - Alternately.... After speaking with a CPA, using a deductible IRA might make more sense for you, in which case forget the Roth.
- Max out your 401k. No reason not to, and it'll spare you at least somewhat tax-wise.

Okay... "uncle"... shutting up now. Bottom line: Make a plan for yourself, stick to it, and you'll do great. Get good advice from qualified, impartial advisers (CPA, CFP, etc.).

**MonkeyMama** · 02-12-2012, 04:42 PM

Originally posted by kork13 View Post

Well, first off congrats on the new job!

Taxes: With an income jump like you're getting, you're going to be stupefied at the spike in your taxes. Personally, I'd recommend sitting down with a good CPA to do some tax planning so you know what to expect tax-wise. Until you know what your tax picture will look like, you might consider putting away some money to cover the tax bill...you'll probably be surprised next year.

Kork has good advice all around, but I wanted to comment on some of it. I disagree with getting tax help. If you want to cut your tax bill you will max out 401k, max out HSA, and you can always contribute to charity if you really rather the money not go to the IRS.

There is just not a lot else you can do at that income level. (I am a CPA, for reference). So yeah, don't waste your money on a CPA. Your withholding on your paycheck should cover it, I really wouldn't expect you to owe. Though you may owe more taxes than usual considering rental income? Because it will be taxed at a MUCH higher tax rate. Just be prepared to owe a little money in regards to that. I wouldn't waste your money on tax advice. You'll be taxed a whole hell of a lot and there won't be much you can do about it.

Originally posted by kork13 View Post

- Look into establishing an LLC or other type of business for yourself. This protects you and your business (the investment property), and should be a part of any plans to own a rental property of any sort.

I don't agree with this advice either until you have some pretty serious assets in your name. Like maybe once you pass the $1 million mark? Better advice is to get a good umbrella insurance policy (MUCH cheaper and generally more useful anyway). As you may in general become a higher lawsuit target with your increased income. When you make your millions you will be hiring more CPAs and lawyers, but don't waste your money at this point in the game.

Originally posted by kork13 View Post

- In future years, max out a non-deductible IRA every year, then annually convert ("re-characterize") it into to a Roth.

Excellent advice on the IRAs.

**kork13** · 02-12-2012, 05:04 PM

I'll defer to MM, especially on the taxes...she's the expert around here for that.

To be clear though, my mention of a CPA is only intended as a one-time advisory sort of meeting, to get an idea of what to expect and what to look at in the future. May or may not be worthwhile, depending on your knowledge of taxes.

For the LLC, that's only second-hand advice, which I included particularly because it sounds like you're looking at getting into real estate with your relative... A close friend of mine owns a couple rental properties, and the LLC was his recommendation to me a couple years ago. I haven't purchased any rentals yet (previous plans changed when I moved overseas), so all I can say is to get educated and make the smart decisions that are right for you.

**snafu** · 02-12-2012, 05:51 PM

Before making concrete plans, get past the probationary period to make certain your new job is a good fit. Likewise, before jumping into apartment complex rental, carefully examine your skill sets and those of a proposed partner. You need to have both the time and ability to do most of the routine maintenance or tradesmen costs will take to large a chunk from any profit line. Your emergency fund needs to be substantial as tenant defaults, secret grow ops, and a million small details can run your operation of the tracks.

**photo** · 02-12-2012, 06:19 PM

Congrats, but remember that the poor live like they're rich, and the rich live like they're poor. (And don't forget that the IRS will punch you where it hurts, so you won't end up with nearly the money you may think you'll have.)

**greenskeeper** · 02-13-2012, 12:44 PM

keep living at your old salary and you'll never have money problems. AKA live below your means.

**PMMM** · 02-13-2012, 02:10 PM

I was in the same situation for about 6 years running but it was due to the division of the company I worked for was doing very well and I was able to share in some rather very large bonuses. The tax man will cometh and he will take a mighty chunk. I remember writing a check for like 16K one year. It was nice to have the money in the bank and know that you made a cubic buttload so you were able to pay it but it hurts.

My advice as others have already said is to be ready for the tax man and sock away as much as you can in the 401K, HSA, and get a nice emergency fund saved up. Lets face it you never know when your fortunes may go south.

Congratulations on the promotion!!

**disneysteve** · 02-13-2012, 03:06 PM

Originally posted by greenskeeper View Post

keep living at your old salary and you'll never have money problems. AKA live below your means.

I think the best possible advice is this, or at least a version of this. Anytime your salary goes up, whether by a little or by a lot, the very first thing you should do is boost your savings rate. I'd say at least 50% of any raise should go to savings. There is nothing wrong with elevating your lifestyle as your income rises. That's certainly no crime. What good is working if you don't get to enjoy some of the fruits of your labor. However, if you boost your savings too, as greenskeeper said, you'll never have money problems.

When I first started working, we were saving 6% of my take-home pay. Now, 18 years later, I earn a lot more and we spend a lot more but we also save at least 23% of my gross pay and 50% of my wife's gross. There's no way we could have saved that much back then because we would have starved and had to live in a box under a highway overpass. Now, it is easy to save that much because what remains is still plenty to have a comfortable lifestyle, much nicer than what we enjoyed back then with a much lower savings rate.

So my advice echoes what others have said. Boost the savings first (but don't forget about taxes). Then don't be afraid to sweeten the lifestyle a bit, too.

**bjl584** · 02-14-2012, 04:50 AM

It would be unrealistic to tell you not to improve your lifestyle. At least a little bit. There is nothing wrong with improving your situation as long as you keep to a budget. Continue saving 15% to 20% for retirement and maintain an adequate savings and emergency fund, and the rest of your money is basically yours to do with as you please.

**Like2Plan** · 02-14-2012, 06:16 AM

Originally posted by MonkeyMama View Post

That's great!

Your taxes are going to be massive with your new income. I would absolutely max out your 401k ($17,000 per year) and continue to max out your HSA. (Unfortunately, you may be unable to put that much into 401k as a highly compensated employee - you won't know for sure until year is over, probably - just a heads up).

I thought they set the HCE participation based on your previous year's earnings?

For example,
Employees who earned $110,000 or more in 2011 will be classified as "highly compensated employees" (HCEs) in 2012.

I believe the HCE earning level is 115,000 for 2012. So, if you earn more than 115,00 in 2012 you will be a HCE for 2013.

I believe the reason this rule was put in place was so that 401Ks are not "top heavy" meaning they didn't want this to be just the folks who make the most money only participating in the plan. The company figures out the overall level of participation (HCEs to non-HCEs) in the 401K plan and will set the percentage the HCE can contribute not to exceed the IRS limit (17,000 in 2012). The maximum percentage the company sets can change from year to year--a higher percentage allowed with more overall participation.

The OP should be all right for maxing out contributions this year even with the bump up in salary. If the OP exceeds the 115K this year, the HCE limits would come into play for next year. The OP should check with HR, but most likely if the election exceeded the HCE limitation it would be automatically capped at the limit.

**Slug** · 02-14-2012, 06:57 AM

Like2Plan is correct. OP should be safe for at least a year and should take advantage of that fact. Actually by doing so, he will help the HCE's in his organization because he will drive up the average contribution in the non-HCE category.

**Like2Plan** · 02-14-2012, 08:07 AM

I'm in agreement with the advice previously given. OP has done an excellant job with finances so far.

Three things OP might want to do right away:
1. Max out 401K.
2. Increase EF--ideally at least 6months of expenses (and 12 months of expenses would not be too much.)
3. Go to the IRS tax withholding calculator IRS Tax withholding calculator

The following link is from last year, but it gives you an idea. IRS takes a tougher stance on underwithholding as you get into higher tax brackets. It's a good idea to take a snapshot and see how you are doing throughout the year using the tax withholding calculator.
IRS PUB 505 Chapter 4 Underpayment Penalty for 2010
"General Rule
In general, you may owe a penalty for 2010 if the total of your withholding and timely estimated tax payments did not equal at least the smaller of:

90% of your 2010 tax, or
100% of your 2009 tax. (Your 2009 tax return must cover a 12-month period.)
Your 2010 tax, for this purpose, is defined under Total tax for 2010 on page 49.

Higher income taxpayers. If your AGI for 2009 was more than $150,000 ($75,000 if your 2010 filing status is married filing a separate return), substitute 110% for 100% in (2) under General Rule on this page."

As far as the long range plan, I also agree OP might want to take a slower approach. OP will want to make sure overall fundamentals are sound--that will not go away even if OP waits to save up more capital with the proper reserves. Sometimes market timing works out quite well (can real estate go any lower?), but sometimes it doesn't and OP could over leverage. Then, there is the management of the property--does OP plan to take an active role in managing the property or hire someone to manage it?

I think it's a very good idea to invest the increase in salary. OP seems to be managing quite well on current income. If OP invests the increase--he/she won't get used to spending it. OP might want to consult with a fee-only financial planner in order to get a good diversified overall investment plan.

**BackupMan28** · 02-14-2012, 02:17 PM

Hi all!

I can't tell you how much I appreciate the responses! There are some very detailed responses here that have helped immensely. I will do my best to try and incorporate nearly all of the ideas... Here is what I have come up with so far. Please let me know if anything else needs to be added, or if I managed to forget something.

150k Salary.

The below are estimations from paycheck city's website payroll calculator, for Florida (no state tax woohoo).

Gross, Bi-Weekly: $5,769
Fed w/h: -1,087
SS: -210
Medicare: -72
HSA: -120 ($3,120 per year)
401k: -576 (I set it for $15k per year but will adjust this in new budget in future)

Net: $3,641 (Compared to current: $1,313)

Total Net Increase of $2,328 bi-weekly.

This grants me a nearly fully funded 401k, a fully funded HSA.

Current budget changes:

The below are per paycheck.
Create and fund Roth IRA: -$211
Additional Funds to Emergency until reach 20k (1 year all bills): -$1,000
Additional Entertainment funds (I currently budget $180 every two weeks): -$120 (So I will have 300 every two weeks for whatever I want)
Additional Bill Pay Checking Funds: -$120 (Current budget is a little tight, a lil' more will allow for a random high electric bill or etc.)
Debt Pay Fund off THEN ACCT BECOMES "Create Investing Fund for Real Estate\Opening Businesses\Etc. Fund": -$800

Plans:
For the above, I will be using the $800 per paycheck to pay off my 2011 Civic, which has a 16k balance. This will then free up an additional $350 monthly. The car would be paid off in a little less than 10 months. This will also be happening at the same time my Emergency savings is being bulked up to 20K... By my estimates they should each reach my goals at around the same time, give or take a month... Which will then free up $2,150 to do whatever I please with. At this point, I will most likely give myself an additional $100 per paycheck to my "Entertainment Fund" (So it will total $400 every two weeks) and keep the remaining $2,050 for Investments....

As it stands, I currently do the Dave Ramsey style of "Envelope Budgeting", and it works great. All my funds and transfer currently are fully funded so I shouldn't really need to add any funds to those.. and if I do, it would only be 10-20 bucks a paycheck.

I def. do not want to grow into my new salary.... Not yet at least. I want to use my late 20's and early 30's growing my wealth through investments. Besides, $400 per two weeks is more then enough to live the lifestyle I really want, especially for now.

I estimate that after 1 year of saving and paying off debt... I could have a little over 50k cash to invest how I see fit, and still have a fully funded 401k\HSA\Roth IRA to fall back in case my investments completely flop for some strange reason.

Please let me know what you guys think of the above!

I thank you all for your time and responses, I can't tell you how much I appreciate them!!!

Questions:
1) Where do I stick the Emergency Fund cash in? I don't want to put it where it currently sits.. I dont even think it earns 1% lol.
2) This salary would be just starting and may increase with bonuses.. What do you suggest I do with any future increases? Should I split any future salary\bonuses 30\30\40 to Entertainment\Investment\GeneralSavings?
3) My current house I do not plan to stay at forever. I bought it with the idea of renting it out. It would probably cash flow positive as it sits for roughly 300-400 a month or so. What should I do in terms of buying my next house? I estimate my next house to be anywhere from $250-300k... How should I go about changing my budget to save for my next home?

What to do with large salary increase?