How Making More Money Can Drive You Into Debt, and How to Avoid It

You’ve probably heard the stories of those folks who have made vast sums of money and find that with every pay raise and with every pay check their costs increase, their savings diminish and their debt mounts. It seems counter-intuitive, doesn’t it? Why should making more money actually cause a financial burden?

One of the main reasons why making more money can cause financial distress is because we often over-estimate exactly how much our buying power has increased with our pay raise. We tend to think of the extra cash as a “lump-sum” despite the extra taxes and social security we might have to shell out due to receiving it. Your pay raise may even push you into a higher tax bracket without you knowing it, which could mean that your buying power hasn’t changed much at all.

We don’t often take the above factors into account because there is probably something that we’ve been dreaming about buying for the last couple of months (like a home theater system or a new car) that we just couldn’t afford before. The pent-up demand for a new toy or luxury was so great that a little pay raise was the only spark needed to set off a buying frenzy.

Not only do we overestimate how much more money we’re actually getting from our pay raise, but we also underestimate (or even ignore) the hidden costs that our new purchase might bring. We had enough money to make monthly payments on that shiny new car, but what about auto-insurance, licensing fees, gas money, and maintenance costs? Be sure to take those into account before you rush off to the dealership.

Finally, your costs don’t just go up when you make large purchases, but you’ll probably find that you’re spending a lot more money on day to day costs (like spending more money for groceries or going to restaurants more often). Before you know it, you’ll be looking at your bank account at the end of the month and wonder where it all went–just like you did before the raise.

Although it might seem difficult problem to avoid there is a very simple way to reign in our expenses every time our salary gets a bump. One way is to immediately take half of your pay increase and put it immediately into savings. This will become a set amount of money to put away each month. If your pay increase amounts to 100$ per month, then put away 50$. If you get another $100 raise, then put away another $50 and so on. Not only is this a good way to establish the habit of saving, but it also acts as “insurance” to pay for the expenses of certain purchases you haven’t forseen.

Finally, be sure to calculate just how much money you need to put away for taxes, and if you do make a larger purchase, be sure to take your time and make a note of all the possible expenses that could accrue due to making that purchase. If you make sure you do this, and put half of your pay increases away, you’ll be able to avoid the increased costs that come with increased income.

What about you? What tips do you have to keep from “over-extending” yourself when a little extra pay comes in?