What Should You Do with Your Year-End Salary Increase? Raise Your Retirement Contribution. Here's Why

When you get a salary increase, what's the first thing you do (besides a little happy dance)? Celebrate your newfound wealth by going out to eat? Splurging at happy hour? Buy the new car you've had your eye on?

Not so fast. Why not zip online and increase your retirement savings contribution? Even a 1% increase can make a huge difference.

Nearly half of families have no retirement account savings at all, according to the Economic Policy Institute. Median retirement savings values are low for all age groups, ranging from $1,000 for families in their mid-30s to $21,000 for families approaching retirement. Median account balances in 2016 were lower than at the start of the new millennium.

Besides that scary reason to contribute more, let's work our way through other reasons why you want to save your raise. 

Reason 1: Experts suggest saving at least 15% of your income to go toward retirement.

Fidelity suggests saving at least 15% of your income toward retirement annually, which includes any matching contributions or profit sharing your employer makes to your workplace retirement account, like a 401(k) or 403(b). Saving at least 15% of your income can help you make sure you keep your current lifestyle the same as in retirement.

If you aren't currently saving 15%, you'll want to seriously consider doing so or risk having to downsize your retirement.

Reason 2: You can increase it incrementally so it doesn't feel like a major impact.

You don't have to break the bank. Consider raising your retirement savings percentage to just a 1% increase. Doesn't seem like anything at all, does it? In fact, it's a win-win situation — you increase your savings and you don't feel the bite at all. Here's what you can consider doing to increase to 15% each year, assuming you're already saving at least 5%:

• Year 1: Raise to 6% at year end, then to 7% six months later.
• Year 2: Raise to 8% at year end, then to 9% six months later.
• Year 3: Raise to 10% at year end, then to 11% six months later. 
• Year 4: Raise to 12% at year end, then to 13% six months later.
• Year 5: Raise to 14% at year end, then to 15% six months later. 

It seems like a no-brainer, but sometimes mapping out your plans like this can help you see the progression of how you'll get there. If you want to continue, go for it, until you max out your savings.

Reason 3: 401(k) contributions increase every year.

The IRS raises the contribution limits each year. Sounds like a good enough excuse to raise your retirement contribution, right? For example, contributions went from $19,000 to $19,500 for employees under 50 in 2021. The IRS will likely raise contribution amounts in 2022, though the exact amounts haven't yet been announced. Between the Internal Revenue Code’s cost-of-living adjustment and Consumer Price Index indicators, the contribution limits for 401(k)s will likely increase from $19,500 to $20,500 in 2022, according to Mercer projections. 

Reason 4: You may strengthen your goal-setting tendencies.

When you start thinking about how you'll use your year-end salary increase to save for retirement, you start thinking about your overall goals. 

It gets you thinking about how much you'll need to retire comfortably and how much you'll need to save per month to achieve it. Unfortunately, there's no perfect figure for every single person. You must consider your current spending and saving levels and lifestyle preferences in retirement when you consider the right amount to target.

Reason 5: You can think through other savings goals. 

You may be all set to invest in your employer's 401(k) or 403(b) (and you should, to get the match). However, you might also want to consider investing in a Roth IRA or a traditional IRA if you want. This allows you to think beyond your employer's retirement fund, especially if your employer doesn't offer the investment options that you like.

If you like the Roth 401(k) option instead of the traditional tax-deferred plan, you could also consider investing in one of those. Learn more about whether your company offers a Roth 401(k) as well.

What other savings goals do you have? Saving for your kids' college education? Saving for a much-needed vacation? Use this salary increase as an opportunity to figure out what you really want, both in the long- and short-term.

Reason 6: You can use it as a springboard to consider how you might pay back debt.

If you have other debts, your year-end salary increase might also lead you to contemplate how you might pay it back. According to Equifax, common debts include credit card debt, mortgages, auto loans, student loans and medical debt. Along with that debt comes tax implications and potential negative impact on your credit score

You'll also get to consider the common question: Pay off debts before saving for retirement or vice versa? Some experts suggest pausing your other money goals and hone in on paying off your debt first, particularly if you have high-interest credit card debt. Others take the approach that you'll pay bills your entire life, so you might as well save for retirement first. 

If your company offers a 401(k) match, most experts agree that you should invest up to the limit to get your free money, then tackle debt repayment.

Invest Your Salary Increase into Your Retirement

When you get that salary increase, pause for a second. Consider a renewed commitment to your future. Start with the end in mind and work backward. What do you want your retirement picture to look like? Don't put a dent in your future. If you get really adventurous, you could also try maxing out your retirement contributions to your 401(k). 

You can do anything you put your mind (and money) to. It all starts with careful planning and consideration and a determination to pay yourself first.