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Beware of ‘lifestyle creep’ chipping away at your well-earned pay rise

With salaries expected to rise above inflation this year, take care first to pay down your most expensive debt and then consider your options

Don't squander the benefit of any pay rise you are likely to receive this year. Photograph: iStock

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Joanne Hunt
Fri Jan 12 2024 - 11:00

Expecting a pay rise in 2024? Good for you. But if an increase in income just sees you increasing spending on non-essential expenses, then you are back to square one. Welcome to lifestyle creep.

Lifestyle creep means spending more as you earn more. It can happen after you get a pay rise, a new job or come into some money. Spending on nicer things can feel like progress in life. What’s the point in having more money if you can’t enjoy it, right?

Switching to a more expensive supermarket, eating out more, getting a nicer car, going on “better” holidays – all of this is discretionary spend which, if not monitored, can leave you financially worse off in the long run.

If you don’t earmark at least some of that pay rise for longer-term financial goals, the extra can get absorbed into your monthly spending leaving you without much to show for it.

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Don’t ‘should’ it away

If you’ve reached a long hoped-for salary bracket, be careful not to “should” your good fortune away. You might feel that someone on your pay “should” be driving a different car, they should be going on a particular kind of holiday and they should definitely be past choosing between a starter or a dessert.

If you’re fortunate enough to be able to cover the basics and have some left over, you have some decisions to make. Some purchases can be money well spent. Paying for more childcare, hiring a cleaner, using a laundry service, a dog-walker or spending on education can be an investment in facilitating you to work at what you love, or earn more. It can help you enjoy your free time more too.

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Just keep an eye on the bottom line. If more holidays are leaving you short, or the brand new car or house extension is funded by big debt rather than personal wealth, you’ve probably got a case of lifestyle creep.

If your pay rise will stretch to it, consider the 50/50 rule, says credit ratings firm Experian. That means at least half of any additional money you earn should go to saving, paying down debt or investing and the other half is up for grabs. That way, your income is helping you reach your financial goals even as it is improving your lifestyle.

Do the maths

Some 73 per cent of businesses will give a pay rise in 2024, according to recruitment company Robert Walters. If you’re lucky enough to get one, your boss will likely talk in percentages. But exactly how much extra in after tax income will this deliver? Chances are it is less than you think.

Ask your company’s payroll department or use an online salary calculator to find out what, for example, a 4 per cent pay rise means in euro and cent.

Three-quarters of white-collar firms gave pay rises in January 2023, according to a survey by Robert Walters. The average pay increase was about 4 per cent. For an Irish professional earning €44,202 annually, that means the average increase equates to an extra €76 per month after tax.

Higher grocery, energy and insurance bills gobbled up most if not all of that, leaving many of those who got a pay rise quids out even without scaling up their discretionary spending.

Wage growth of 5.5 per cent is expected in 2024, according to the European Commission’s economic forecast for Ireland. Inflation is forecast to drop to 2.7 per cent in 2024 and to 2.1 per cent in 2025, so workers should start at least to feel more benefit from any increase.

Budget

Once you’ve calculated what a pay rise means for your monthly pay cheque, it’s time to get forensic. Make a list of the things you would like that money to do. If inflation has seen you relying too much on an overdraft or credit card to cover day-to-day expenses, you will need some or all of that pay increase just to stand still.

Squirrelling money into savings or trying to overpay your mortgage doesn’t make sense if you are paying interest on personal loans, credit card debt or going overdrawn every month.

Once any personal loan or credit card debt is under control and you have an emergency fund to cover unexpected expenses, you have some choices. If you consistently have a bit extra in your current account at the end of the month, give that extra money a purpose. Except don’t wait until the end of the month.

Pay yourself first, says Cliodhna Hughes, a certified financial planner with MGM Financial Services. “Oftentimes, people think they will save what’s left at the end of the month, but there is nothing left at the end of the month,” says Hughes. “Set up a direct debit so the extra is gone as soon as the money comes in, whether that’s into a pension or a savings product,” she says.

If you are worried about access, set up a regular payment into a Revolut Vault or Bunq account, for example. That way your money is accessible while still being out of reach.

If you’ve managed not to touch it for six months, you are probably in a position to consider a longer-term solution, says Hughes. You’re moving away from simply ringfencing the money to growing it.

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“Start sending the extra into long-term savings, a pension or regular savings plan – something that’s invested,” says Hughes.

There isn’t much growth to be had from money on deposit right now. If you can save €150 a month, for example, Bank of Ireland, EBS and AIB are each offering 3 per cent. After a year, you’ll have saved €1,800 of your own money and earned €29.25 in gross interest which after deposit interest tax leaves you with about €19 extra. Not exactly compelling, but it’s better than the whole lot evaporating in lifestyle creep.

Directing that pay rise into pension is a great way to grow it. When you save money into a pension, the Government rewards you in that the money you were supposed to pay as tax on those earnings goes to your pension instead.

For example, putting €100 a month into a pension will only cost you €80 if you pay tax at 20 per cent; if you pay income tax at 40 per cent, it will only cost you €60.

The maximum you can put into your pension in any one year while securing tax relief is related to your age. Those aged between 30 and 39 can contribute 20 per cent of their earnings. That rises to 25 per cent for those aged 40-49, and those aged 50-54 and 55 – 59 can contribute 30 per cent and 35 per cent respectively.

“We see people at the other end when they are coming to retirement and I’ve never met anyone who said, ‘God I’m sorry I put that money into pension’,” says Hughes. “What they say is, ‘God I wish I started earlier, or I wish I had put more in’.”

If you have a long-term savings goal such as a college fund in mind, think about a savings product. Investing €140 a month over 18 years at an estimated 5 per cent growth, less an annual fund charge of 1.25 per cent would give you €42,960. Now, of that, €30,240 is the money you put in yourself. And then there will be a 41 per cent tax on the gain. That leaves you with about €7,500 of a return over the 18 years, plus the money you saved.

It still makes more sense than seeing that €140 going on takeaways, coffees and streaming services but it does put things in perspective.

Young and free

Lifestyle creep can hit younger professionals the hardest, says Daniel Hardiman, a financial planning consultant with Hardiman Life & Pensions.

“They are looking at everyone living their best lives on Instagram, while also facing inflated rents and house prices,” he says. “Life can feel hard, so when a salary increase comes along, the mindset is, ‘I deserve to treat myself’.”

Some young earners who don’t yet have mortgage or childcare costs can, depending on their housing costs, have relatively high disposable income. Nights out, city breaks, a new phone and subscriptions can all seem affordable.

“It’s important to think about the things you might want in future. Delayed gratification needs to kick in,” says Hardiman. “If you want to avoid former luxuries becoming necessities, get into the habit of asking yourself, do I need this particular item, or do I just want it?”

Remember, the person driving the new car is probably paying off a pricey car loan.

That €4 coffee, the €160 beauty treatments, the gym membership, the growing roster of streaming subscriptions – all of these things are leeching your pay rise. While a life like this might feel abundant, think about your future self.

Putting money into a pension won’t seem like the most pressing need but those who start young, even with a small amount every month, will make the biggest gains. “It will yield the highest return over the long term and give you the best chance of obtaining financial independence,” says Hardiman.

As time goes on, people also start to value time over material goods, says Hardiman.

“Having the time and resources to live life on your terms at some point in the future becomes more important than upgrading the car. The fastest way to achieve financial independence is to invest the maximum you can afford into your pension every year.”

Once salary increases start to come, ring a pension adviser.

You can contact us at OnTheMoney@irishtimes.com with personal finance questions you would like to see us address. If you missed our most recent newsletter, you can read it here.