I recently found myself in front of a room full of people who just received a very large pay increase.
At first glance, the group seemed quite pleased with their higher incomes. Many in the audience saw their income increase 20% or more in the last 12 months. Yet, there was a major problem afoot. Nearly every single person in the room was now further away from their retirement goals. And, after closer examination, I realized how often a substantial pay raise results in a major problem for its recipient, especially if the pay raise trickles its way into a person’s life.
Welcome to the world of a variable or commission income.
Living on a commission income can quickly become a series of pressure build-up and pressure release months stacked on top of each other. A “down” month creates shortages, shrinks cushions and builds stress, only to be saved by a good month which releases the financial pressure. All the while, the person’s dependency on their income appears steady. Unfortunately, it’s not.
Imagine freaking-out because ends aren’t meeting, and then finding the sweet relief of a larger-than-normal paycheck. You may have never been in this situation but, let me tell you, every penny of this larger-than-normal paycheck feels instantly necessary.
When you’re on a commission or variable income, your raises don’t necessarily look or feel like raises. Instead, they look and feel like just another variation in pay. It’s very different than receiving a raise when you’re part of a fixed-compensation employment relationship. In other words, a raise is easier to both recognize and utilize when you’re not on a variable or commission income. When your pay is steady and a raise arises, you can instantly prevent yourself from creating dependency on the additional income.
That’s the trick. Anytime anyone receives a raise, they must ensure the increased income doesn’t lead to increased spending. If they don’t do this, lifestyle creep is the result. You will never be able to retire if you increase your lifestyle every time you increase your income, because you’ll constantly become more dependent on more income.
The more dependent you are on your current income, the further you are away from financial independence. You can’t possibly accumulate enough retirement assets when you’re utilizing your entire income now.
Whether you earn a variable income or not, you are dependent on some portion of your current income. You aren’t dependent on the portion of your money you’re currently saving, investing or using to aggressively pay-down consumer debt. For instance, if your current after-tax annual income is $50,000, and you save or invest $5,000 of it, then your lifestyle is dependent on $45,000. To maintain your current lifestyle, you need $45,000-a-year at the ready.
Now imagine a scenario in which you receive a $10,000 net raise on your $50,000 net income. While saving or investing the entire $10,000 pay increase is what I’d prefer you to do, reality suggests you won’t do that. Reality suggests you will create new dependencies and obligations with your increased income, which means you would then be more dependent on more income. However, if you are able to save some or all of your raise, you’ve just prevented lifestyle creep.
It is hard enough to prevent lifestyle creep when you know a raise is in the cards, but it’s nearly impossible when you don’t realize you’re in the midst of receiving a raise as your variable income ebbs and flows. This is precisely why people who live on variable incomes are often less financially healthy than people on a fixed income.
The next time you get a pay raise, make sure it’s creating independence, not more dependence on more income.
Peter Dunn is an author, speaker and radio host, and he has a free podcast: Million Dollar Plan. Have a question about money for Pete the Planner? Email him at[email protected]